Air Finance Journal, May 19, 2017
“We’re not the Aergo we were three years ago; we’re an entirely different company these days,” chief executive officer Fred Browne tells Airfinance Journal.
Browne set up Aergo Capital in 1999 with Denis O’Brien, an Irish telecoms tycoon with an estimated net worth of $4.9 billion. The company was focused on aircraft trading from its inception, with a portfolio of 110 aircraft worth $500 million at its peak, trading its way through around 250 aircraft before CarVal Investors acquired 90% of the company in 2014.
Now, under the new owner, Aergo is making the transition from being primarily an aircraft trader to an “airline-centric operating lessor”.
With a portfolio of 48 aircraft (including six aircraft on finance lease and 12 aircraft committed and under contract) the company is targeting higher risk flag carriers such as Pakistan International Airlines (PIA) and South African Airlines (SAA), in a bid to “eke out good returns” and avoid the “crazy 0.6%-0.7% lease rate factors, which are driven by cheap money”.
“It’s a race to the bottom. I wouldn’t be surprised if we saw more lease rate factors figures even below 0.6%,” says Browne.
“We don’t believe that reflects the risk of this business, even if it is a brand new aircraft into Etihad Airways or Qatar Airways.”
Initially, Aergo’s thinking was that the mid-life aircraft segment – Boeing 737-800s and Airbus A320s – was where to play, but the company “rapidly found out that it was a fairly crowded space”.
“Everybody was trying to do the same thing, so we’ve been pretty flexible about the way we’ve gone about it. We’ve bought some 1997-vintage 767-300ERs with six years remaining on the lease,” says Browne.
“On the other end of the scale, we’ve bought brand new aircraft.”
Aergo has four A330s (including three under contract), as well as Boeing 737 and Airbus A320 family aircraft already in its fleet. In addition, it has purchased 15 turboprops, including four Bombardier Q400s, eight ATR72-500s, two ATR72-600s and one ATR42-500.
With a weighted average fleet age of around five years and average lease term of eight years, Aergo is “attractive to investors”, Browne says.
“We’re at a size where we’re looking to not only to expand the business but also trade out some of the aircraft. We are well over the $1 billion mark at this stage and it’s given us the scale to play around in the capital markets.”
The benefit of CarVal
CarVal’s interest in aviation did not start with Aergo. Founded in 1987 by Cargill, CarVal became an independent subsidiary in 2006. Cargill is a Minnesota-based privately held corporation founded in 1865 that employs over 150,000 people.
“Originally, CarVal was similar to the GE Capital relationship with General Electric in that it focused on financial investments for Cargill. In 2006, CarVal Investors became an independent subsidiary of Cargill,” says CarVal Investors principal Justin Bradburn, who has aviation experience dating back to 1999 with GECAS, RBS, Morgan Stanley, Brigade Capital and CarVal.
Besides aviation, CarVal’s “big buckets” are emerging markets, distressed and liquidating companies, high yield debt, securitised products, loan portfolios and hard assets. Bradburn declines to disclose how much of CarVal’s business is comprised of aviation business.
Before the Aergo acquisition, CarVal’s aviation business primarily consisted of distressed acquisitions. For example, if an airline went bankrupt and CarVal owned aircraft backed bonds issued by the airline, the company might go in and repossess the aircraft, then put that aircraft back out on lease to another airline. The company also was a “very large investor” in the Delta/Northwest bankruptcy of 2005.
“Post 9/11, CarVal ended up in aircraft leasing through its investments in bankrupt aviation bonds and I think that was the intent back then, but we weren’t necessarily going out and building a portfolio of leased aircraft,” he says.
Explaining CarVal’s rationale for buying into a lessor, Bradburn says that he felt “CarVal needed to have the capability to do everything from a brand new aircraft, all the way through to a full part-out, and we needed the right mix of business to do that.
“Owning the companies gives us the option to sell single aircraft, portfolios of aircraft, securitise aircraft, do a trade sale of the whole business or IPO the company,” he says.
In addition to Aergo, CarVal also bought a majority stake in Welsh part-out operation AerFin, a company that is in the process of parting out 11 of Cathay Pacific’s A340-300s.
Bradburn formerly worked with Fred Browne when he was at Brigade Capital, so already had a good relationship with him.
“When I came over to CarVal, I reached out to Fred. It was fortuitous because the current owner at that time had given Fred the mandate to look for another potential buyer, so there was a meeting of minds at that point. We agreed to buy a majority stake in Aergo,” he says.
“Bob and I had met several times and I had tried to convince Bob over the years to do some deals with him and never quite got there, but again, when I reached out to Bob at the same time as reaching out to Fred, Bob was in a position where he wanted to bring in more capital to the business. There was a good opportunity there, and we acquired a majority stake in AerFin as well.”
At the time of acquisition, Aergo had six employees and AerFin had 25. This increased to 20 and 82, respectively. AerFin’s 55,000 square foot warehouse in Cardiff increased to 100,000 square feet. Aergo strengthened its sales and marketing team, adding people in New York, Dublin, Jakarta, Nairobi, London, Dubai and Hong Kong.
“We’ve got some really nice humming machines that are enabling us to go out and buy stuff,” says Bradburn.
As a company whose goal is to maximise returns for its investors, one potential option for CarVal is eventually to sell Aergo.
“At CarVal, our job is to make sure our investors get the best possible return. If somebody offers an attractive price for one or more of the businesses, it’s beholden on us to consider that,” Bradburn says, declining to comment on whether CarVal is actively trying to sell Aergo.
Aergo and AerFin must remain “truly arms-length businesses” because they are owned by separate groups of funds.
“That means I could never force Bob to take a part-out aircraft off Fred, and if there was a similar scenario in the other direction I couldn’t force the opposite,” says Bradburn.
However, there are ways that the two businesses can work together and complement each other.
“We’ve set up processes to make sure if Bob’s team sees a leased aircraft deal but it doesn’t fit his remit, then that gets punted across to Fred’s team, and vice versa,” says Bradburn.
“That’s the biggest synergy – making sure that coverage we have all over the market with over 100-odd people over the two businesses just allows us to see a tremendous amount of deal flow.”
Aergo can also tap into AerFin’s expertise in aircraft appraisal and ask them to provide valuations of aircraft Aergo acquires that are nearing the end of their lives and bound for part-out.
“To the extent we get to the end of the lease and we hadn’t sold the aircraft and we were going to a part-out, we would then reach out to Bob and say, ‘Bob, what’s the number you would put on this this?’”
Bradburn believes this level of cooperation is enough, saying that while some companies try to “smash stuff together”, at the end of the day, running a part out business is “night and day” to running a leasing business, requiring a different skill set, management team and structure.
Bradburn’s theory is that the aircraft leasing market – similar to almost every market – is defined by “boxes”.
“You have the Chinese institutions, the Chinese leasing companies and they like a particular type of lessee, a particular type of aircraft, a particular type of duration, and that will define a fairly clear box in terms of what they want to do,” he explains.
“Their cost of capital is clearly a lot lower than ours, so we can’t play in that box, so we know that’s a box we have to avoid.”
He adds that a problem with the mid-life aircraft market is that that “box” is defined by the securitisation market and “what the rating agencies thought was the best deal to put together”.
“The guys that are constructing the securitisation vehicles are out there specifically trying to pick aircraft credits and jurisdictions to try to get exactly the right mix to get that securitisation done. They are willing to pay up and make the bet that the securitisation will be there to take them out. The danger is that that market can shut in a heartbeat. If you’re long a portfolio that you’ve paid up specifically for that, that’s risky,” he says.
“That defines another box where – if you don’t want to take that bet on the securitisation market – it’s hard to play there. We’ve found that these boxes become clearer over time and we try to avoid them, and that’s when we realised that we can still get deals done.”
Overall, Bradburn is optimistic about the future of Aergo and AerFin and says deal flow across the companies is “tremendous”.
“This is a tough market, whatever way you cut it, but what we’re finding is if you kiss enough frogs eventually you’re going to find a prince or two, so we’ve been kissing a tremendous amount of frogs to find princes.”