Why buy aircraft when planes can be leased?

LOS ANGELES--International Lease Finance Corp. is discreetly perched in a high-rise penthouse in the Century City area of this sprawling metropolis, an appropriate statement on its position as a force in the global aerospace industry.

The airplane-leasing company, known as ILFC, is the largest single customer of both Boeing and Airbus Industrie for many of the models made by the two companies.

It employs fewer than 100 people yet sells more aircraft than the manufacturers themselves. It is not an airline, yet it controls a fleet of more than 500 planes.

And while the largest leasing company in the world, it is far from alone in the industry.

In the past few months, aircraft-leasing companies including ILFC, General Electric Capital Aviation Services, Boullioun Aviation and a dozen smaller companies have ordered billions of dollars worth of commercial jets from Boeing and Airbus--more than $10 billion alone at the recent Farnborough International air show

The deals shined a spotlight on an increasingly important player in the high-stakes game of commercial-jet sales.

Individual airlines as a group remain the largest purchasers of aircraft, but the leasing industry is on its way to controlling almost a third of the industry.

"Ten years ago, leasing accounted for 14 percent of the industry," said John Willingham of Boullioun Aviation, a Bellevue leasing company that in its 12 years has risen into the upper echelon of the industry. "Now it is more than 20 percent and could be 30 percent in a few years."

Most experts put the market share now at 24 percent. That means that of the 12,000 or so aircraft flying commercially in the world today, more than 2,880 are on leases. Over the next five years, that figure is expected to reach 30 percent, and could go higher than that.

For Boeing and Airbus, leasing companies are key. Orders from leasing companies have totaled more than 900 aircraft at Boeing over the past 20 years. Leasing companies hold more than 22 percent of Boeing's total backlog of more than 1,500 planes still to be built.

Leasing is even more important to Airbus, especially in terms of backlog. Leasing companies have ordered more than 650 planes from the European maker. Because many of the orders are recent, Airbus is not as far along in deliveries as Boeing. Leasing companies now control more than 40 percent of Airbus' backlog.

The stratospheric growth of airplane leasing also comes at a time when Boeing itself is revving up Boeing Capital, using the financing arm it inherited from McDonnell Douglas to become increasingly serious and creative about airplane sales.

One recent example: Boeing won a dizzyingly complex deal with American Trans Air in which ATA will buy and lease 45 new Boeing jets worth some $2.9 billion.

"The ATA deal was the first time that both the lessors and the manufacturer got together" to co-finance a deal, said Tom Motherway, president of Boeing Capital. "The result was terrific."

Boeing, ILFC and GE Capital (known as Gecas, pronounced "GEE-cass") joined to structure the deal.

The deal, however, shows how the business in changing. Boeing in the past has resisted financing sales to its customers, preferring clean cash deals.

In the past, the company "got its margin at the factory door," said Motherway. "The shift is in realizing there are two or three financing cycles plus modification cycles," where Boeing could make money for shareholders. Modification refers to the time at which many passenger jets are converted into freighters when they become obsolete for airlines.

How leasing works

Leasing has been around for years and used for many things--automobiles, heavy-duty trucks, even workers.

Aircraft leases were used as early as the 1970s, almost exclusively for older used aircraft. In 1980, leases represented a minuscule 3 percent of the aircraft-financing market, with large and medium-sized carriers preferring to buy aircraft outright.

Companies such as ILFC, however, saw a market that leasing companies could serve. ILFC could buy aircraft on a speculative basis, then lease them not only to small, emerging airlines but to major airlines as well.

While leasing can be complicated in its details, the basics of the business are straightforward. Leasing companies buy new planes from manufacturers such as Boeing and Airbus and lease those airplanes for a fee to airlines. After several years--usually seven to 10--the companies sell the used planes to airlines or other customers and use the cash to buy new ones.

By the late 1980s, 14 percent of the world's commercial jets were leased, attracting even more players such as Boullioun, which was formed in 1988.

The market has taken off since then. Between 1986 and 1996, leasing's market share grew to 19 percent of planes in service.

During the same period, the proportion of airlines operating all-leased fleets grew from 15 percent to 42 percent. The number of airlines that owned their entire fleets dropped from 41 percent to 16 percent.

Leases usually range in length from three to 10 years. In an operating lease, the lessee pays to use the aircraft during the lease term, but does not fully repay the lessor's investment and does not own the aircraft when the lease ends. An airline is responsible for maintenance and other measures to keep the aircraft in top condition.

Boullioun officials say there are so many different lease conditions that almost all leases are tailored to the individual airline--its routes, fleet makeup, financial strength and other factors.

Major airlines such as British Airways or United Airlines can lease planes with staggered terms, expanding or shrinking their fleets as the market changes.

Like a company leasing cars for its executives, airlines can lease planes and pay a fixed monthly operating cost. A Boeing 757, for example, leases for about $242,000 a month.

Leases also allow airlines to use their limited capital for other investment needs.

And finally, the leasing companies, especially the big ones making huge orders with the manufacturers, are able to command the most favorable prices possible.

Leader of the pack

The reception area at ILFC looks a bit like the home of a model-aircraft collector gone wild. Throughout the plush waiting area are rows and rows of model planes, the logos of the world's airlines painted on them. African airlines. Asian airlines. Mexico, South America, the United States, Europe. All are represented. A few models carry just the ILFC logo, representing "speculative buys"--planes ILFC bought for perhaps $100 million without known customers.

"We are actually quite conservative," said John Plueger, ILFC chief operating officer. "We typically buy ahead only about half of the planes that we typically will place." ILFC has ordered planes for delivery out to about 2006.

ILFC began in the early 1970s when Steven Udvar-Hazy, then a student at UCLA, began looking at the airline industry and its capital needs. In the 1960s, airlines were moving rapidly from relatively low-cost fleets of propeller-driven planes to more expensive jet aircraft.

Udvar-Hazy saw that airlines were embarking on huge expenditures to modernize their fleets; he likes to use the analogy of people moving from radios to televisions, a big jump in cost. He realized that many airlines could not finance this massive jump into the jet age, at least not through traditional means.

Enter the leasing companies.

ILFC started slowly at first but is now the largest leasing company in the world with a fleet of 500 planes worth $18 billion. Revenues have grown rapidly in recent years--to $2.3 billion last year. Profit totaled $453 million last year. Those figures are up sharply even from 1998's $1.8 billion in revenue and $369 million in profit.

That puts profit margins in the 20 percent range, far above the 6 percent Boeing makes manufacturing airplanes.

The growth of leasing has given companies such as ILFC more clout than ever.

ILFC, for example, has been courted by Airbus as the European jet maker seeks customers that will pledge to order its A3XX superjumbo.

At the Farnborough International air show last month, the fact that ILFC was one of the first to confirm orders for the plane was seen as a coup for Airbus.

Plueger, ILFC's chief operating officer, said the company also is in talks with Boeing about a 747X, a stretched version of the original widebody jet that would compete with Airbus in the jumbo market. No commitment has been made as yet.

More business for Boeing

When the subject of leasing's future comes up, a frequent example that's cited is the deal in May in which American Trans Air acquired 47 new aircraft.

The deal involved Boeing, two leasing companies, two stock deals, other cash infusions and a joint venture for ATA, a quiet but huge charter operation that in recent years has begun regular service from Midwestern hubs.

Boeing's role was handled by Boeing Capital, a quiet but huge contributor to Boeing's powerful balance sheet.

With $6 billion in assets, it had the backing to make something happen, namely a deal that might have gone to Airbus.

Leasing companies had been worried about Boeing Capital as it got into the leasing business. Would it help or compete against Boeing sales? Would it use its inside track to take business from the major leasing companies?

The ATA deal eased many of those fears.

"Boeing Capital does not seem to be in the business of making speculative buys of aircraft," said Plueger, the ILFC executive.

Boullioun's Willingham agreed, saying Boeing appears to play the role of helping make a sale happen for the customer rather than competing with the leasing companies.

But the complexity of the ATA deal and its ability to vault a relatively unknown regional airline into the big leagues is seen as the wave of the future for the industry, despite some continued fears that the leasing industry would hit a wall as it approached 30 percent of the market.

Flexibility in downturns

While leasing companies aren't immune to market fluctuations, they've been able so far to avoid some of the wild cyclical downturns that airlines have faced. After the Asian financial crisis hit in late 1997, several large Asian airlines ran into problems in 1998. Delayed and canceled orders were common.

The leasing companies, however, largely survived that downturn even though they had Asian customers.

True to their business plans, they were able to shift planes from airlines that did not need them to airlines that did. The manufacturers also took note that leasing companies remained very reliable customers, placing orders on schedule because they have several options to place the aircraft--moving an order from an Asian airline to a European one, for example.

By all indications, the leasing companies and the manufacturers are seeing a modest upturn in the aerospace cycle.

"The leasing companies have traditionally been very astute and early leaders at the beginning of the cycle," said Robert Toomey, an analyst for Dain Rauscher.

"It is actually a positive sign that the leasing companies are bullish."

If the used-aircraft market holds up, the leasing companies will prosper--along with the manufacturers.

In fact, the two are now joined as never before, with lessors and manufacturers each betting on the industry's future.

Toomey sees a slowing in the pace of orders later this year; many of the year's orders, especially those by leasing companies, have been front-loaded toward the first half of the year.

But while traditional aerospace downturns may still occur, the industry seems to have found a new way to help smooth those cycles out. A lease used to be a short-term deal to help a struggling or under-capitalized airline.

That's not the case any more.

Aircraft lease deals

Here's a look at some recent deals involving leasing companies.

** GE Capital Aviation Services signs a deal for 42 Airbus single-aisle-family aircraft, including a first-time order for its latest member, the A318.

** Singapore Aircraft Leasing Enterprise (S.A.L.E.) signs for 11 more A320s from Airbus. The Singapore leasing company is the largest customer for the Airbus single-aisle product line in Asia.

** International Lease Finance Corp. (ILFC) orders 40 Boeing jetliners, including 33 of the new extended-range 777s and seven next-generation 737s. The 737 order brings the number of next-generation 737s ordered by ILFC to 211. When a definitive agreement is signed, ILFC orders of Boeing jetliners will total 644 aircraft.

** GE Capital Aviation Services places an order with Toronto-based Bombardier Aerospace for as many as 150 smaller regional jets, valued at roughly $1.3 billion.

** Boullioun Aviation, based in Bellevue, leases a Boeing 737-400 to Asiana Airlines of Korea. The multiyear lease is the first direct Boullioun deal with the Korea-based airline.

Boeing's booming leasing business.

Orders and deliveries to the top three aircraft-leasing companies.

Deliveries Orders.

1977 0 2 .

1978 2 5 .

1979 6 2 .

1980 1 2 .

1981 1 1 .

1982 2 0 .

1983 1 1 .

1984 1 11 .

1985 8 5 .

1986 8 22 .

1987 10 38 .

1988 22 119 .

1989 14 13 .

1990 20 37 .

1991 18 1 .

1992 32 57 .

1993 35 9 .

1994 40 6 .

1995 37 50 .

1996 44 161 .

1997 58 79 .

1998 67 67 .

1999 60 83 .

#2000 38 60 .

Total 518 834 .

#Through July 31

Source: Compiled from Boeing reports