A New Deal Sends This Aircraft Lessor Flying Past Its Rivals

Over the past 20 years, airlines have steadily increased the number of aircraft in their fleets through leases instead of purchases. With more than 40% of the nation's planes leased, this practice is a great investment opportunity for those in the know. With AerCap Holdings' (AER -0.06%) recent announcement that it will be purchasing American International Group's (AIG -0.27%) International Lease Finance Corp., AerCap will become the world's second-largest aircraft lessor. Though there are some initial concerns about the transaction's effects, the deal offers investors plenty of upside.

A look at leasing
The percentage of owned planes within the nation's airlines' fleets has fallen from 73% in 1990 to 57% in 2012. Some of the nation's largest airlines have continued to replace aging aircraft with leased models, instead of shelling out the big bucks to own the planes outright. Below, you can see the percentage of aircraft leased by each of the top public U.S. airlines as of December 2012.

Source: Company 10-Ks; * includes combined fleet of American Airlines and US Airways, which merged in 2013

Leasing planes allows carriers to reduce their expenses and capital expenditures, while giving them access to the newer, more fuel-efficient models being released by various manufacturers. Since fuel expenses now make up close to a third of the airlines' operating expenses, the newer model aircraft can help boost bottom lines that have been in the red so frequently over the past decade.

Delta was burned in the early 2000s after overhauling its entire fleet. The travel slump that followed 9/11 really created a difficult situation for the airline, which had just extended itself financially to improve its aging fleet. American Airlines is currently in need of a similar revamp, and like the old Delta, the company is looking to replace its fleet over a short span of 10 years. Leasing will help to reduce American Airline's capital expenditures as it makes its preparations for such a huge overhaul.

Small fish, big fish
AerCap has been considered a small fry in the aircraft leasing market. But with the closing of its deal with AIG for ILFC -- slated to occur in the second quarter of 2014 -- the little guy will be competing with the best of them.

The combined fleet of AerCap and ILFC will reach the 1,300 mark, with options to buy another 400 aircraft. For some perspective, the world's largest aircraft-leasing operation -- General Electric's (GE -0.32%) Capital Aviation Services, or Gecas, division -- operates close to 1,700 planes.

Heavy burden
After the announcement of the AerCap's deal with AIG, Standard & Poor's announced that it would downgrade AerCap's corporate credit rating from BB+ to BBB- if the deal closes. The rating agency stated that AerCap would be designated as "Credit Watch with negative implications" due to the transaction.

The S&P downgrade would be a direct result of AerCap's assumption of ILFC's large debt obligations, as well as the additional debt used to finance the deal. The lessor's debt-to-capital ratio would be pushed among the highest of eight aircraft leasing firms.

But investors haven't shed their enthusiasm for the deal, with AerCap's shares rising 40.5% since the deal was announced Monday. Though the company would certainly be acquiring a big debt burden, almost $21 billion, there are a few considerations that may make the heavy leverage worthwhile.

The small company will now have access to ILFC's little black book of customers, while assuming its current leases in place. With those leases, AerCap can expect to see profits close to the $410 million ILFC pulled in last year, depending on renewals and some other variables. Investors should know that ILFC has reported losses so far in 2013, but those are attributable to impairments for the operation's older planes.

Also included in the terms of the ILFC deal is a $1 billion unsecured revolving credit facility from AIG. The insurance giant will also be making the necessary accounting adjustments in order to impair the older models within ILFC's fleet -- preventing any such impairments on AerCap's part, which would hurt the company's shares.

Flying high
With such big benefits, the ILFC deal has to be a major win for AerCap. As a former little guy, the company has the opportunity to take over the lead within the aircraft leasing market. And though the stock has already shot upward following the deal's announcement, the closing and completed merger (profits included) could provide investors with further upside.