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With the growth of the freighter market, we are seeing a number of non-aviation industry players looking to invest and/or start new ventures with existing participants or participants within the same supply chain. This mismatch of financial capability and industry capability often requires participants to carefully discuss some of the more difficult questions relating to the new venture upfront. This article discusses the common issues an aviation industry participant needs to consider when making investments in or entering into a new line of business with a third party.
Freighter market focus and joint venture growth
The COVID-19 pandemic inflicted on the aviation industry is a hardship of a magnitude never seen before. Passenger travel has been largely curtailed since early 2020. Borders have been subject to multiple shutdowns and re-openings, and varying levels of restrictions, all of which have negatively impacted demand for passenger travel. The recent discussions on vaccination passports and on the opening of borders in Europe and the United States to vaccinated individuals suggest there is some semblance of demand for passenger travel returning in this part of the world. Other jurisdictions are struggling with opening up regionally. In Asia, the approach resembles a patchwork quilt of different levels of vaccination, and different stages of re-opening and/or semi or full lockdowns. Recent commentary on the forecast for moving “back to normal” suggests that passenger air travel will not return to pre-COVID-19 levels until at least 2024.
Throughout the COVID-19 pandemic, the increase in e-commerce and the need for movement of goods (including medical supplies) from one part of the world to another resulted in another area of aviation shining a bright light in an otherwise gloomy skyline: the air freight market.
Over the past decade or so, low cargo rates and the general unprofitability of the cargo business led to many airlines letting go of, or reducing, their cargo freighter fleets. Many are now changing their tune due to e-commerce sales rocketing after the COVID-19 pandemic started. This demand, combined with much of the global passenger fleet being grounded (which itself is responsible for the transportation of a significant amount of air cargo) led to a significant rise in cargo yields that has been sustained to date. Based on data from the Airline Analyst, only 21 airlines (down from 77 airlines in 2019) globally disclosed that their operating performance achieved positive operating profits for the third quarter of 2020, which is traditionally the industry’s most profitable quarter. Cargo revenue accounted for 49 percent of the total revenues, on average.
With e-commerce sales set to continue to rise, and commercial passenger flights predicted to a return only on a graduated basis for some time, the demand for freighter aircraft is forecast to remain high, supporting continued yield and profitability in the freighter sector.
Demand in the freighter sector has sparked interest from lessors, airlines, maintenance, repair, and overhaul (MRO) service providers, investors, funds, and other financial institutions. Many are keen to invest in the area to hedge their existing passenger aircraft exposure, create new business lines around it, and/or build out their existing expertise (in the case of MRO service providers and conversion specialists) to increase capacity and the range of conversion programs on offer. We are even seeing shipping companies come into the space to supplement their existing seaborne freight offerings, especially to help mitigate the current issues of congestion and delays in the container shipping market, particularly on Asia-U.S. routes where there are no land-based alternatives.
Such interest has led to a number of strategic partnerships and joint ventures over the past 24 months, with both new and established market participants entering or building out their freighter sector presence. Recent examples include:
- ST Engineering and Temasek entering into a joint venture to develop a freighter aircraft leasing portfolio.
- Hong Kong Aircraft Engineering Company Limited, an airframe maintenance and modification group, partnering with 321 Precision Conversions to provide heavy maintenance and structural modifications for its Airbus A321 P2F conversions.
- CMA CGM setting up CMA CGM Air Cargo.
- Titan Aviation and Bain Capital entering into a joint venture to develop a freighter aircraft leasing portfolio.
Collaborations often involve the meeting of partners with different industry knowledge and financial strengths. This “mismatch” between skill sets and/or financial powers can push the partners into discussions about strategies, objectives, and alignment before entering into such collaboration. There are certain salient questions that parties should consider before embarking on such a collaboration.
When structuring a new collaboration, business teams will typically meet and undertake discussions and commercial due diligence before deciding whether the collaboration will bring synergies and be financially profitable. This is paramount and is often the fundamental rider for undertaking a collaboration in the first place. However, in the midst of the urgency and excitement of embarking on a venture, parties risk failing to discuss some of the less convenient issues that should nevertheless be addressed. Our experience has shown that laying out this groundwork requires tact and sensitivity – of course, without dampening the spirit of collaboration!
Documenting some initial understandings is a common practice. In addition to this, it may be advisable to spend time addressing other issues at the start rather than during the later documentation stage.
- Address difficult commercial and legal issues early on
- A lengthy memorandum of understanding is not always a bad thing and can help flush out issues sooner rather than later
- Get your advisors involved from the start and they can help identify key legal issues associated with the sector and the specific venture