The usually under-the-radar world of aircraft finance was thrust into the spotlight last week as AerCap Holdings (NYSE:AER) announced a $30 billion deal to acquire the GECAS unit of General Electric (NYSE:GE).
The deal would create a powerhouse financier, but it also adds billions in new debt to AerCap's balance sheet and dilutes shareholders by giving General Electric a 46% stake. Investors initially weren't sure what to make of the transaction, sending AerCap shares up more than 10% on the rumor but down more than 5% on the news.
Buying the GE Capital Aviation Services business certainly adds new risks for AerCap, but it is also a once-in-a-generation opportunity that will probably ripple through the industries including plane manufacturers and airlines. Here's a close look at the deal, and thoughts on how investors should view AerCap from here.
A one-stop airplane shop
AerCap and GECAS are both in the business of buying planes and leasing them back to airlines. Leasing companies first sprung up in the the 1970s but have grown more popular in recent years as airlines have embraced leasing as a way to keep debt off their balance sheets.
The deal would combine two of the biggest portfolios in the industry, growing AerCap's fleet from 1,044 planes to more than 2,000. It also helps diversify the business: The combination would have more than 200 customers and combine GECAS's North American-focused operations with AerCap's substantial exposure to Asia.
The deal is a reunion of sorts for two businesses that trace their roots back to industry pioneer Guinness Peat Aviation, which collapsed in the 1990s and was split between assets acquired by General Electric and assets that became AerCap.
In the past, a word from Guinness Peat or its archrival International Lease Finance could make or break a new plane design still on the drawing board. While AerCap is unlikely to be that powerful, its buying decisions will go a long way toward determining industry trends and an aircraft program's long-term success.
What could go wrong? Lots
Publicly traded leasing companies tend to trade at a slight discount to book value, and indeed AerCap is paying a slight discount to GECAS' book value to secure the deal. But that valuation arguably is a tad rich, especially considering the issues leasing companies have had during the pandemic as airlines scaled back flying and sought deferrals on lease payments.
Leasing companies, by their nature, carry a lot of leverage. To do the deal, AerCap is adding $24 billion in new debt on top of its $15.8 billion in total unsecured debt as of Dec. 31, making it potentially vulnerable should the pandemic cause another period of instability with airlines or send the economy into a recession.
The deal would push AerCap's leverage to more than three times equity, though the company said it expects to keep its investment-grade credit ratings. AerCap believes it can quickly move back to its target of having debt at or less than 2.7 times equity, but investors will be eager to see the company follow up on that pledge.
The nature of the deal also adds a GE overhang on the shares. Terms call for General Electric to be subject to a staged lock-up agreement allowing it to dispose a portion of its 46% stake after nine months and the entire stake after 15 months. Given GE is in a period of restructuring and has been looking to raise cash, there is reason for concern that the company, when allowed, will sell into any appreciation in AerCap shares, potentially limiting the upside momentum for some time.
Finally, AerCap was seen as the premier stock among aircraft lessors because of the quality of its portfolio. AerCap has focused its investment on newer, latest-generation technology that tends to be easier to place elsewhere if an airline customer goes into default. GE's portfolio is a broader range of assets and could, at least temporarily, dent the premium perception AerCap has earned.
AerCap will fly higher
There's risk with any transaction, but AerCap is set up well to deliver on the potential of this deal. AerCap's management has significant integration experience, vaulting to the upper echelon of the industry via a 2014 purchase of International Lease Finance from AIG.
Post-deal, AerCap's fleet will still be relatively young, with an average age of about 7 years and 56% of the portfolio considered new tech. AerCap's management team in the past has proven itself as skilled sellers of aircraft, part of what has kept the portfolio young, and should be able to sell off some of the GECAS portfolio it finds less desirable.
The combination also reduces customer concentration risk. Following the deal, AerCap's top 10 customers will account for about 30% of net book value, compared to about 40% previously. And the company's average remaining lease term is 7.1 years, giving AerCap plenty of time to sort through the portfolio and to plan for the future.
Prior to the deal, I had called AerCap the single best way to invest in an eventual aviation recovery. Post-pandemic, airlines are likely to have to depend on aircraft lessors even more than they had before because of the billions in added debt taken on to survive the crisis.
AerCap is adding risk taking on such an ambitious deal in the early days of an aviation recovery. But landscape-changing opportunities like this don't come along every day. I'm bullish that AerCap stock will be able to fly through this turbulence and gain altitude in the years to come.