Year: 2015

The market for vehicle leasing and funding has evolved in recent years to span multiple countries and various continents, offering customers more services than ever before, and new benefits through technological innovation. The financial crisis was a turning point for the industry – generally, only the largest have survived. The most financially robust and well-structured companies have been able to absorb falling vehicle resale prices and withstand fierce competition.

One such firm is ALD Automotive, Europe’s leading service provider for company car contract hire and fleet management. World Finance spoke with Gilles Momper, the group’s Chief Financial Officer and Stéphane Renie, ALD’s Sales and Marketing Director, to discuss recent trends in the industry and how ALD has been able to continue growing and expanding.

The past crisis and general market conditions have made it increasingly difficult for small and local players to remain competitive

How has the vehicle funding and management industry changed recently?
Renie: The first striking change within the industry in recent years is a very clear movement of concentration, with a greater market share for international players. The past crisis and general market conditions have made it increasingly difficult for small and local players to remain competitive.

Secondly, there has been a vast geographical expansion of the product; up until 10 years ago, it was focused mostly in mature markets, but the service has since spread to emerging fleet markets, such as Brazil, Mexico, Turkey and India.

Momper: I would say that the other main hinge in recent years is that during the financial crisis, operational vehicle-leasing players suffered an unexpected decrease of used-car prices in Europe, which generated significant losses when customers returned their vehicles at the end of the leasing contract. Since then, used car prices in Europe have never recovered to the level they were before the recession, and as such, residual value remains the main risk that we carry for our customers.

Why is ALD recognised as one of the industry’s leading service providers?
Renie: We now have a market leadership position as we manage more than 1.1 million cars across the globe and we have experienced a compound annual growth rate of eight percent for the past 10 years. The other dimension is one of geography, whereby we have the broadest presence in our industry.

We are now covering 40 markets – the mature western European markets, but also Central and Eastern Europe, the BRICs and other emerging economies. Moreover, even through difficult times, we continued to be a sustainable partner to our customers, which is partly due to a strong shareholder structure.

This also stems from our long-term approach as a business and our commitment to quality services – which make us stand out in the industry.

What benefits does belonging to a banking group entail?
Momper: Belonging to a banking group is obviously a key advantage in receiving competitive funding to support both our organic and external growth in the long term. It is also an advantage from the commercial point of view to have access to the market and promote vehicle-leasing products through the network and corporate customer base of the bank. Also, being part of Societe Generale imposes a prudent approach to ALD in terms of asset and liability management: assets and liabilities are matched in duration, currency, and type of rates. This provides extra assurance to our customers that ALD has a consistent, long-term and sustainable approach when dealing with funding.

What does ALD offer as an optimal solution for car fleet management?
Renie: We tend to think that our core product, which we call full service leasing or full operational leasing, is today more than ever the optimal solution when it comes to car fleet management. It provides a one-stop shop for our customers that encompass vehicle purchase, a financial path and operational services for a fixed monthly rental, which lasts on average 43 months.

From a financial perspective, this is a stable cost and so does not suffer from any unexpected variations, thereby making it easy for companies to budget for, while also mitigating many risks for the customer. From an operational point of view, it simplifies issues for our customers when it comes to supplier management and the quality of the services that are eventually delivered to drivers.

That being said, our approach is not monolithic; we have diverse solutions in our portfolio, such as fleet management, which now comprises 25 percent of our product offerings. We think of ourselves as being part of the service industry more than anything else, so the capability of ALD to provide these two products and a number of variations for them both, puts us in an excellent position to really fit and adapt to customer needs – today and going forward.

How can companies establish a lasting risk reduction programme?
Momper: I would say that operational vehicle leasing in itself is a risk reduction option – as Stéphane was saying – customers pay a fixed monthly rental, which protects them against any residual value risk or maintenance risk, on top of not having the cost and burden of dealing with complex operational matters for non-core activities. We also offer a consistent and compliant platform, which provides comfort for international groups that have subsidiaries in countries that are located far away from their headquarters.

How does ALD facilitate value management for customers?
Momper: The economy of scale acts as the main driver of value creation for our customers – our size and growth matters to us, but it also matters to our customers as they benefit from our procurement power. We are buying more than 230,000 cars and 1.2 million tyres per year worldwide, which contributes greatly to decreasing operational costs.

Renie: Beyond the quantitative side of value creation for customers that Gilles described, there is also a qualitative aspect to the work we do. Another part of our job is to provide consultancy for our customers regarding the best ways to optimise their fleet management policies that can lead to savings – this is very much part of our core services.

How is ALD driving innovation within the industry?
Renie: When you think of innovation, you immediately think about technology, and clearly technology in our industry can be a major transformation factor. When it comes to client-facing solutions, we want to be ahead of the game in terms of interaction with drivers and fleet managers by providing client and driver portals, which can be accessed from anywhere in the world. This platform encompasses everything they need to know about their relationship with ALD on a given vehicle, or more broadly on their entire fleet.

Similarly, we have rolled out an app in over 30 markets for drivers to optimise their search for the closest location where they can have their vehicle serviced, thereby simplifying the job of maintaining their car. There is also another angle, which is creating new products to address new needs, such as the new mobility product field, in which we try to think of alternative solutions to test the standard company car assigned to a given individual for a whole year.

We have a lab in the Netherlands, which has a specific mandate within the group to test and learn new mobility solutions – that is the way we drive innovation internally and hope to be at the forefront of the market.

What role do strategic partners play within ALD’s business model?
Renie: We have strategic partnerships in areas of the globe that we do not cover with direct affiliates. That’s particularly true for North America where we have an alliance with Wheels, which is a top three player in the North American leasing and fleet management industry. We also have associate companies in South Africa, Australia, New Zealand and Ireland. The purpose of these strategic partnerships is to provide for customers within our portfolio that require a global solution. We have noticed that this trend is increasing; many more customers want to optimise the service from a global standpoint, instead of just regionally, which was previously the case.

What regions does ALD operate in and which markets offer the greatest potential for growth on a global scale?
Momper: We currently operate in 40 countries and we have just opened a subsidiary in Chile and a branch in Kazakhstan last year. Our approach has always been to open subsidiaries or branches wherever our international customers are established – of course this also depends on the fleet potential.

In terms of further growth, there are still many countries, even in Europe, where operational vehicle leasing has great room for expansion, especially on the SME market. This is even the case in France and South Europe. Regarding the rest of the world, for the time being, we are experiencing the highest percentage of growth in Brazil, Mexico, China, India and Russia – although, our absolute fleet numbers remain the highest in Western Europe.

Since the early 1970s there has been an increasing trend for airlines around the world to rely on operating leasing as an alternate means to managing their financing and fleet requirements for commercial aircraft.

Under an operating lease structure, the airline commits to a long-term lease agreement for the aircraft from a lessor (typically between six to 12 years), with all related operating expenses borne by the airline. At the end of the lease term, the aircraft lease can either be extended for a further period, or the aircraft is returned to the lessor in compliance with the provisions in the lease agreement, which typically relate to the aircraft’s maintenance condition. In the latter case, the lessor will transition the aircraft to another operator, or when the aircraft has reached the end of its useful life, sell it for parts in the spares market.

Given the prevalence of operating leasing, the benefits over aircraft ownership have been clearly recognised by airlines

Given the prevalence of operating leasing, the benefits over aircraft ownership have been clearly recognised by airlines. Operating lessors control a large portion of the Airbus and Boeing original equipment manufacturer (OEM) order books. Sometimes airlines have difficulty purchasing directly from the OEMs as the order backlog means they are sold out for many years. Airlines will also often approach lessors with regards to leasing solutions. In addition, operating leasing provides attractive fleet flexibility to airlines since aircraft are leased for fixed terms resulting in no residual value asset risk for airlines. Operating leasing is also attractive to bank lenders as it reduces the lending risk profile for them with the operating lessor ‘sandwiched’ between themselves and the operator. Operating leases also improve cash flows for airlines, in that pre-delivery payments to OEMs for lessor orders are borne by the lessor. Security deposits during the lease term are smaller than the equity contributions required for a financing. Given that most lessors are able to draw financings cheaper and from a more diversified pool of debt sources than many airlines, it is no surprise that the percentage of commercial aircraft under operating leases amounts to almost 50 percent of the worlds total commercial aircraft fleet today (see Figs. 1 and 2).

Investor interest
Private equity investors have long been attracted to the investment rationales of operating lessors. For example, Cerberus Capital Management, a US based private equity firm, invested in Dutch-based commercial aircraft lessor AerCap, which it took public in 2006. AerCap has subsequently grown to be the largest aircraft lessor in the world through the acquisition of International Lease Finance Corporation (ILFC) from AIG. Cerberus successfully completed its exit from the investment in 2012. Aircastle, another publicly traded commercial aircraft lessor, was founded by private equity firm Fortress Investment Group in 2004 and taken public in 2006. In 2006 Terra Firma, a UK based private equity firm, acquired AWAS for $2.5bn in cash plus the assumption of liabilities from Morgan Stanley. In 2007 Terra Firma then further agreed to purchase Pegasus Aviation from the US private equity firm Oaktree Capital Management, and combined AWAS and Pegasus to create the new AWAS, then the world’s third-largest aircraft leasing business. More recently, Avolon Aerospace Leasing, a lessor founded in 2010, backed by private equity firms Cinven, CVC Capital Partners and Oak Hill Capital Partners, successfully took the business public in December 2014.

So why is private equity so enamoured with investing in this space? One of the principal attractions for the aircraft leasing space is that the sector serves a growing airline industry with an attractive aircraft capacity supply and demand dynamic. Air traffic has historically doubled every 15 years and is, according to research by The Airline Monitor, projected to have an average annual growth rate of 4.8 percent for the next 20 years, thereby doubling traffic again over the next 15 years. Air traffic has exceeded GDP growth by approximately 1.9 times over the past 40 years and the sector has been very resilient to external shocks.

World air traffic recovered to a long-term trend only a year after a drop in 2009 and it took only three years for traffic to recover from the events in 2001. The reasons that have contributed to this traffic growth have been the expansion of urban populations, the rise of a global middle class, the rise of low cost carriers and greater globalisation and cross-border economic activity. This increase in travel demand has continuously increased the demand for aircraft capacity.

What is also attractive to private equity is that from a supply side perspective, the industry is dominated by only two major established players, Airbus and Boeing, with smaller players like Brazil’s Embraer, Canada’s Bombardier and France’s ATR competing in the market for turboprop aircraft and smaller jets. Suppliers such as Russia’s Sukhoi, China’s COMAC and Japan’s Mitsubishi have entered the market with small jet offerings but are expected to take several decades before becoming serious competitors to the established players on a global scale.

Growth within growth
Investors are investing in a growth industry within a growth industry. Driven by air travel demand, the latest Boeing and Airbus forecasts show that the commercial aircraft fleet is expected to more than double over the next two decades from its current level of roughly 20,000 commercial aircraft. Retirements of aircraft at the end of their economic lives (approximately 25 to 30 years) and their replacement by more fuel-efficient types further drives the demand for new aircraft production.

In a rising fuel price environment, replacement demand for fuel inefficient aircraft is strong. Whereas fuel cost as a share of total operating expenses was in the mid teens in the years 2003/2004, it has now risen to a stable 30 percent share, further driving replacement demand for older aircraft. Even in an environment with lower fuel prices, this trend is expected to continue. The introduction of more fuel-efficient new technology aircraft will de-risk the negative effects on airlines’ operations in the event of a fuel price spike.

Another attraction from an investor’s perspective in this space is that the two largest suppliers to the industry are relatively constrained in terms of their production capacity. Changes to production, whether it is an increase or decrease, is difficult given the long lead times involved and their supply chain capacity constraints. Extensive production backlogs on the most popular models allow Boeing and Airbus to manage their production levels as regional or individual customer demand shocks can be evened out by reallocation of order slots to other customers.

Private equity investors haven taken into account what are significant hurdles to entry into the aircraft leasing space, given that the businesses are very capital intensive with acceptable returns only provided on a levered basis. Private equity investors are familiar with different leverage options making them natural investors in the aircraft leasing space. They often apply a diversified debt funding mix to the lessor with funding ranging from the standard bank financings to export credit supported loans or even the US capital markets.

Investors are also drawn to this industry by the fact that investments in operating lessors are in long-lived assets. The value of these assets is relatively predictable. It is also supported by the solid fundamentals given the attractive supply/demand dynamic around aircraft capacity. Relatively predictable new aircraft production levels and a steady outlook in terms of growth and aircraft replacement demand drives such a dynamic. There is volatility in aircraft values, driven by supply/demand and competitive factors. However that volatility is mitigated when looking at aircraft values on a lease encumbered basis, where the lease cash flows and aircraft residual values mitigate a pure asset value view.

Similar to investments in real estate, large chunks of equity from investors can be deployed efficiently and quickly, with the most prevalent narrow body aircraft costing upwards to $50m and widebody aircraft prices starting from the low $100m per aircraft. However security lies in the fact that the assets can be moved from one operator to the next, should that be required at the end of a lease be it scheduled or unscheduled. The worldwide mobility of aircraft to different airlines around the world provides tremendous risk mitigation to the investor.

Aircraft leasing businesses are capital-intensive operations and the forward orders with Airbus and Boeing carry significant cash drag through the associated pre-delivery payments. In addition, there is placement risk for the aircraft, interest rate risk and financing risk that need to be managed. For that reason, many lessors tend to focus on sale-lease back transactions or trades from other lessors where all of these risks can be mitigated since the aircraft are already on lease to an operator and financing requirements are near term with very limited interest rate risk exposure.

Track record
Even though the investor focus draws comfort from the underlying asset values, private equity investors tend to invest in businesses and management teams rather than pools of assets themselves. This approach is largely based on the realisation that the aircraft leasing business is a relationship business, where airline and supplier relationships allow for the best realisation of value in transactions.

Private equity firms have now branched out into other aviation leasing areas, such as helicopters, as shown by the $375m of equity capital that funds associated with MSD Capital, Soros and Cartesian Capital Group have committed to helicopter lessor Waypoint Leasing. The attraction for private equity investors to the aircraft leasing business will likely remain strong given the solid fundamentals around asset values, the favourable and predictable supply and demand characteristics of aircraft assets and the long-term steady returns that lessors have provided throughout various industry cycles.

Most importantly, a positive track record by private equity investments in the aircraft leasing space has been established with several successful investment liquidations, whether private or into the public space. Private equity certainly has an important role to play to capitalise the aircraft lessors that are playing the economic cycles and investments in diverse aircraft assets in various ways. We should certainly be looking for more activity by private equity in the space.

Owning your own home tends to be most people’s main aspiration. The security – both financial and psychological – that comes from owning a property means that it is the first thing that people look to buy when their careers start taking off. However, with a soaring global population and an increasing shift towards city living, many of the world’s working population are finding getting on the property ladder a financially unrealistic proposition.

Sky-high demand for property and not enough space to build in many of the world’s major cities is meaning many people are being priced out of the market. At the same time, property markets have become a far more stable investment that others in recent years, with real estate in cities like London proving more resilient to market changes than traditionally low risk investments like government bonds. This has in turn pushed prices up, as investors pour money into property with little intention of actually living in the properties, therefore taking homes out of the market for potential homebuyers.

Calm before the storm
While investors have enjoyed strong returns on their property portfolios in recent years, there are growing fears among observers that a global property bubble is getting out of hand. Were it to burst, a huge amount of money will be lost, which could in turn send shockwaves through many developed economies that are only just getting to grips with the downturn over the last seven years.

A recent report by US-based analysts MSCI showed that 2014 had been a bumper year for real estate investors, with an average rise in value of 9.9 percent. This represented the fifth consecutive year of increases and the best figure since 2007. However, while investors have increasingly seen property as a safe-haven for their money, MSCI’s Head of Real Estate Research, Peter Hobbs, warned that the strong performance might not be sustainable. This is because rental yields are hitting record lows – a sign last seen in the run-up to 2008’s crisis.

“With much of the strong recent performance being driven by falling property yields, increasing concerns are being raised over its sustainability. On the one hand, income returns – that tend to account for the largest component of real estate performance – have fallen sharply, from an annualised 7.4 percent in the UK at the end of 2009 to 5.6 percent today, and from seven percent to 5.3 percent in the US between mid-2010 and today. On the other, these yields are down to levels not seen since 2007/8, the prior cyclical peak and a powerful signal of market pricing”, writes Hobbs.

The real estate markets, like most other markets, tends to be cyclical in how it performs, with the downturns having severe consequences for the wider economy. The problem with housing market bubbles is that they tend to affect a wider proportion of the population – and therefore of GDP – than a stock market bubble (see Fig. 1). According to studies by the IMF, stock market bubbles tend to be relatively frequent and last under three years, with losses of around four percent to GDP. By contrast, property bubbles have far greater impact, even though they are less frequent. The IMF estimates that the effects linger for around seven years and cause roughly eight percent in lost GDP.

Instigating factor
The global financial crisis that began in 2007 has some roots in the bursting of a number of housing bubbles that had grown to unsustainable limits around the world during the beginning of the decade. A huge swathe of countries experienced soaring property prices, including the US, Austria, UK, Italy, Turkey, Brazil, Denmark, Portugal, China, Mexico, India, Hong Kong, Ireland and South Korea.

During the middle of the last decade, The Economist described the global rise in property prices as “the biggest bubble in history”. When the crash hit – most notably in the US subprime mortgage crisis of 2007 – homeowners were finding their mortgage’s exceeded the value of their properties, severely damaging the solvency of the banks that had lent them the money.

The consequences of the housing crash around the world – and the subsequent financial crisis it contributed to – have been well documented. In the US, almost a quarter of all residential properties were found to be in negative equity at the end of 2010, while commercial properties in the UK had sunk to around 35 percent of the value they were at the height of the bubble. However, with many countries experiencing a steady rise in prices over recent years, many observers are starting to worry that a similarly devastating burst bubble might be around the corner.

Many of the markets experiencing strong real estate growth are doing so for differing reasons, and the solutions to the problem of excessively high prices will differ as a result. Here, World Finance has looked at four major cities where there is a real danger of property prices spiralling out of control, and what solutions have been mooted.