The Fractional Market
as the economy lurches from bad to worse news, the aviation industry is holding its breath, waiting to see how this downturn will affect the business jet market and elements of that market such as the fractional share business. Conventional wisdom suggests that fractional share owners–bound by contracts, usually lasting five years–are not as quick to unload their shares as the owners of whole airplanes might be to sell their jets to raise cash.
While this viewpoint might not necessarily hold true because share owners have the option to sell their shares back after a shorter initial period, the fractional share industry is something of a bellwether for business aviation because it is one of the early entry points for new consumers of business aviation services. In the past few years, however, jet cards have supplanted fractional shares as a key way for users of business aircraft to see if they like non-airline travel. And growth in jet cards indicates that more people who can afford private jet travel are taking advantage of this option. Jet card buyers don’t have to tie up any capital beyond the price of the card, there is no ownership interest to worry about or insure and they don’t have to feel guilty about not using an expensive asset if they don’t feel like flying for whatever reason.
The fractional share industry, however, continues to grow and plays a significant role in business aviation. And this is despite the current economic downturn, which appears to be taking its toll on business aviation.
The problem with today’s economic situation is that, short-term, it has been difficult to discern a trend.
Even before the tumultuous week of September 15, when titans crashed and U.S. taxpayers were enlisted to fork over more than $1 trillion in rescue funds, the indicators were fluctuating: one day, the news was great; the next, the Dow-Jones Industrial average dropped by 344 points (September 4), the largest drop since June 26 (358 points). In August, the U.S. unemployment rate spiked to 6.1 percent, according to the Labor Department, reflecting a continuing streak of job cuts and the highest rate since September 2003. There is plenty of gloomy talk about the economy, and within the aviation industry some concern, such as NATA president Jim Coyne saying that there is a recession in aviation. Two aircraft manufacturers–Eclipse Aviation and Cirrus Design–announced layoffs in August and September, but so far there has been no such news from other business jet manufacturers.
Technically, so far there has been no recent official recession in the U.S. economy, according to the official definition: a decline in gross domestic product (GDP) for two or more consecutive quarters. The GDP for the last quarter of 2007 was down -0.2 percent, but that decline lasted for only one quarter. (See graph 1.)
During the second quarter of this year, GDP climbed 3.3 percent, according to the government’s preliminary estimate (which could change once the final number is in), exceeding expectations.
Oil prices have been a significant drag on the economy in general and business aviation in particular. While fractional operators say that jet-A prices don’t seem to have caused a reduction in flying, they also admit that they don’t know how much more customers might have flown if fuel prices were lower.
Since reaching a high of $147 per barrel in July, oil prices have moderated to less than $100 per barrel, the level they were at in April.
Retail jet-A prices have slowly followed suit, but as of early last month many operators complained that prices still exceeded $8 per gallon at some major metropolitan airports, especially those served by a single FBO. However, average jet-A prices worldwide have dropped from their highs–by about 50 cents per gallon in the rest of the world and by as much as $1 per gallon in the U.S.–and if oil doesn’t spike again because of a hurricane or political instability, operators might find prices dropping even further.
Business Aviation Health
Year-to-date, business aviation flight operations are down 6.6 percent, according to the latest JP Morgan Global Equity Research Business Jet Monthly report: “Flight operations continue to slow. Flight operations into and out of the U.S. (takeoffs and landings) declined 10.6 percent in July, the ninth consecutive decline and third consecutive double-digit decline.” (See graph 2.)
JP Morgan sees a worrisome trend in the pre-owned aircraft market. “Let there be no doubt the used market is rapidly falling apart, which should lead to a deteriorating market for new aircraft in short order,” the report noted. Inventories of used aircraft reached the highest level in the past three years, up 80 basis points to 9.4 percent of the active fleet, “and representing the seventh monthly increase in a row,” according to JP Morgan.
As used aircraft inventories climb, prices have dropped, with average asking prices down 2.3 percent year-over-year, the fifth decline in the last six months. Heavy jet prices have fallen hardest, down 5.8 percent, although medium jets remain a bright spot, with prices up 5.4 percent.
For the fractional business, the significance of the state of the used market is that it could be harder to dispose of older aircraft, and this raises the question of whether this will affect how much share owners receive when disposing of their shares.
The fractional world, however, operates a bit independently from the rest of business aviation, according to Dan Dugger, founder of fractional share remarketing firm Fractrade of Simpsonville, S.C.
Although fractional share owners generally sign multi-year contracts, that doesn’t mean that they have no options if they want to leave before the contract is over with. Owners can sell their share at almost any time during the contract period, although they will pay the fractional company a remarketing fee and they will have to settle for whatever the fractional operator offers for their share.
Prices for used fractional shares don’t necessarily follow normal business aircraft pricing models, Dugger said. “Most fractionals follow an Aircraft Bluebook or Vref estimate,” he said, “and their values lag behind the market by about a quarter of the year.”
Dugger does think prices that fractional owners get for their shares will go down, “but the [fractionals] have a baffle in those waters, so prices don’t swing as low and high as the market would.” The fractionals can manage the flow of aircraft coming into and out of their systems by delaying or spacing out purchases of new aircraft and adjusting prices paid for ending contracts.
“Yes, [the economy] will affect the values,” agreed Kevin O’Leary, president of aircraft brokerage and consulting firm Jet Advisors of Broomfield, Colo. Some fractional companies pay relatively high amounts when buying shares back from owners, he explained. The reason they can afford to do so, at least for some fractional companies, is they have enough demand that they can quickly resell that share to another buyer.
In two examples, O’Leary saw a fractional company pay 71 percent of the purchase price for a 1998 aircraft and 81 percent for a 2003 aircraft. Both were owned for a five-year contract period. The 1998 aircraft “is a very fair number,” he said, representing about 85 percent of the Vref Aircraft Value Reference price for an aircraft with normal flying time and not the additional hours accumulated in fractional service. The 2003 aircraft, in whole terms, sold for “seven percent better than the aircraft that is going to be sold to the whole aircraft market,” he said. “The five-year fractional shares in the good companies that are going to be resold as fractional aircraft are still re-purchased for more than the whole market would pay for the aircraft with that many hours. I believe they trade above the actual value during their fractional lives.”
However, not all fractional companies treat remarketing in this manner. Some, O’Leary said, pay highly discounted amounts when buying back shares, and they might use the economic downturn as an excuse to lower the residual value of remarketed shares.
Despite the downward trends mentioned in the JP Morgan report, the total fractional fleet grew to a high of 948 aircraft year-to-date, up from 910 last year. This includes NetJets Europe’s 150-aircraft fleet. (See graph 3.)
However, the report noted, “On an absolute basis, July share sales decreased 10.4 percent compared with last month and were down 9.8 percent [year-over-year].” In its August report, JP Morgan wrote that “June share sales increased 6.4 percent from May 2008 but were down 32.5 percent [year-over-year].”
AIN has obtained data on the fractional industry from Pierre Parvaud, a France-based researcher who, in the course of studying the industry in great depth for many years, has accumulated a database on share movements and fractional aircraft purchases and sales since 1991. The following information is provided by Parvaud and is based on his extensive research using the FAA Registry as the basis for fractional aircraft purchases and sales. Many of these numbers are not normally available directly from the fractional operators, most of which declined to answer AIN’s specific questions about core fleet numbers. These do not include NetJets Europe numbers, for which information is much harder to obtain from publicly available sources. Unless otherwise noted, these numbers are current as of June 30, 2008, as the FAA Registry data showing breakdowns is not immediately available.
First, a snapshot of what the major fractional providers’ fleets look like. See charts below for a snapshot of Parvaud’s estimate of each provider’s fleet. The total differs from the JP Morgan numbers above (which include NetJets Europe’s 150-aircraft fleet but not Avantair’s turboprops), but Parvaud’s numbers are for the major U.S. fractional providers, including Avantair, and don’t include all fractional companies.
During the past year, NetJets, according to Parvaud’s numbers, tops the list in terms of the highest percentage of the total fleet sold to customers, with 95.5 percent. For such a large fleet, NetJets has a small core, only 4.5 percent of the total fleet. This is a good measure of how efficiently NetJets is operating, in that it is able to keep most of its fleet in customers’ hands, which leaves capital available for more important uses.
What is remarkable about the NetJets number is that like most other fractional companies, NetJets has reduced its outside charter needs considerably, even with such a small core fleet. Flights on subcontractor charter airplanes, according to John Colucci, executive v-p for sales, “are a tiny percentage of our flights. Our flying hours are not down at all; it’s more efficient use of the fleet than in the past.” On an average NetJets day with 500 flights, he added, it’s rare to see even one outside charter.
Both Avantair and Flexjet are maintaining relatively small core fleets, too, followed by Flight Options and CitationShares with the highest proportion of core airplanes at 22 percent. The higher core fleet numbers for 2008 over 2007 might also help the fractional companies handle demand with less outside charter.
Avantair CEO Steve Santo said last month that the company’s fleet had reached 49 Piaggio Avantis, with 42.5 sold and the remainder as core airplanes. According to these numbers, Avantair’s core fleet is 13.3 percent of the total. Avantair’s outside charter is extremely low, too, Santo said, because the company has enough airplanes and has reached a critical mass large enough to satisfy demand internally. Avantair outside charter is 0.5 percent of total flights, he added.
Outside charter hours are down to about 3 percent at Bombardier’s Flexjet, according to Sylvain Levesque, vice president of marketing and administration. Flexjet guarantees not to fly more than 5 percent of customer flights with outside charter providers, he said.
At CitationShares, outside charter is also less than 3 percent, according to president Steve O’Neill. “We use outside charter as a last resort when demand exceeds our capability.” For this year, outside charter is down from previous years, he added.
O’Neill said that the CitationShares fleet is about 90 aircraft, up from 85 last year, which doesn’t quite agree with Parvaud’s numbers, but could be accounted for in part by sales since the end of June.
Charter operator TWC Aviation of Van Nuys, Calif., believes there is more to the slowdown in outside charter than the fractionals becoming more efficient. “That’s why charter is down 20 percent,” said TWC president Andrew Richmond, “because the fractionals aren’t flying as much.”
Richmond has seen fractional hours flown decline but jet-card trips increase. “Jet cards are easy entry,” he said, “it’s not a long-term commitment. I think the fractional model may be maturing to where there’s less demand for it and more for jet cards.”
According to Jim Betlyon, CEO of Trenton, N.J.-based, CharterX-Wyvern, a major fractional operator told him that its purchase of outside charter services is only 20 percent of what it was last year.
According to the information provided by Parvaud, during the first half of this year the five major fractional industry players added a net 22 airplanes to the fleet, by disposing of 16 and adding 38. (See graph 5.) The clear winner in this segment is NetJets, with a net 18 airplanes, followed by Flexjet. Both Flight Options and CitationShares lost airplanes during the first half of the year, according to these statistics, while Avantair gained two.
During the 2007 calendar year, Flight Options sold more airplanes than it added, and during the first half of this year, it still faced the problem of having to sell five airplanes to add just one more to the fleet.
The number of equivalent aircraft (see graph 8) sold by a fractional operator is an interesting way to consider how many shares the company has sold. One equivalent aircraft is equal to the number of shares that make up one whole airplane flown for 800 occupied hours a year. For example, if a fractional operator sells 16 one-sixteenth shares at 50 occupied hours per year each, that is one equivalent aircraft. While each of those one-sixteenth shares has to be part of a real aircraft each share does not have to be assigned to one airplane. When enough are sold to add up to 100 percent, another equivalent aircraft joins the roster. In reality, fewer real aircraft are needed than equivalent aircraft because most of the aircraft in the fleet will fly more than 800 hours a year. Utility rates for fractionals average about 60 to 65 percent, according to Jet Advisors’ O’Leary.
In terms of equivalent aircraft, all of the fractionals enjoyed positive net sales for the periods in the chart, although Flexjet and Flight Options were the only operators that saw a net increase in equivalent aircraft sales during the first half of this year versus the same period last year. Gross and net sales overall were down in the first half of this year, possibly underscoring weakness in the economy.
The owner numbers (see graph 6) also signal a possible slowdown in the fractional business, although most of the companies interviewed for this article said their business is either growing or stable. High fuel prices and the economic slowdown are likely having an effect. Even mighty NetJets has seen a slowdown in the net number of new owners, to 26 in the first half of this year versus 96 in the same period last year and 69 in the second half of last year.
Both Flight Options and CitationShares were in negative territory for net new owners in the first half of this year. If high costs are a reason, then some owners who still like the idea of fractional ownership might have decided that a smaller type of airplane is more efficient. Both Avantair and regional fractionals PlaneSense and Executive AirShare, all of which fly mostly smaller airplanes, say that they get many new customers switching from larger airplanes at the major fractionals.
The state of the economy and high fuel costs have combined to drive traffic to Avantair, said Santo. Where an owner would pay nearly $2,000 per hour in fuel surcharges for a midsize jet, he explained, Avantair’s surcharge for the Piaggio Avanti turboprop is $450 per hour.
One trend that Avantair is experiencing is that fewer share buyers are new to fractional ownership and private aircraft travel. Of the Avantair share buyers, Santo said, “Seventy percent of sales are to people who are either chartering a lot or already own a fractional share.”
Flight Options is seeing customers change their flight patterns due to the economy, according to CEO Mike Silvestro, who reports customers are re-evaluating their charter use and making some changes. He used the example of a customer who typically has a share to fly quarterly to visit company facilities or customers. “What we’ve seen is if that customer went four times a year, now he’s flying three times a year and replacing the fourth trip with perhaps a teleconference.”
Business year-over-year is flat, according to O’Neill of CitationShares, but fuel prices “are not affecting our demand.” At the same time, the number of fractional owners leaving the program is smaller than expected, he said. O’Neill expects modest growth at CitationShares, with the normal 15 to 20 new airplanes continuing to be added to the fleet per year.
“We have gained five percent market share,” said Flexjet’s Levesque. “Others [fractional companies] are experiencing quite a significant slowdown. We’re growing in number of owners, hours, numbers of aircraft and revenue.” Nevertheless, he added, “the economy has had an impact that we feel.”
According to Levesque, the Flexjet fleet averages less than three years old, and the company’s target for core aircraft is 5 percent of the total fleet. “We manage that tightly,” he said, although Parvaud’s research shows that through June at least, the Flexjet core fleet grew by 50 percent or to nine from six aircraft.
Fuel prices and the economy are affecting share owner activity, he said, with owners taking more care in selecting when to fly by combining multiple trips and taking more passengers on each trip.
Overall, said Levesque, things “are going well, very profitable, and providing good returns for our parent company [Bombardier].”
At NetJets, revenue and flying hours are up year-over-year, according to Colucci. “We’re confident things are going well,” he said, “but if the economy were better, it could be better. We’re going to make money this year again.”
As for the effect of fuel prices, Colucci said, “You’ll hear people say prices don’t affect these customers. I imagine that it has.” While some customers are avoiding extra trips, he isn’t sure whether the cause is the economy or fuel prices or both.
Overall, NetJets corporate share owners have increased flying hours and shares owned, he said. NetJets Europe, he added, is doing particularly well.
NetJets expects to add 46 net aircraft this year, he said, out of a total of 60 new deliveries this year. Next year, those numbers should be slightly higher. The company has about 400 new aircraft on order for delivery during the next 10 years.
A Boon for Regional Operators
Portsmouth, N.H.-based PlaneSense is sitting pretty right now because its choice of the efficient single-engine Pilatus PC-12 turboprop means that its customers aren’t affected by fuel surcharges as much as owners of jets are. PlaneSense’s smallest share is one-eighth, which makes it easier to keep the percentage of outside charter to below one percent, according to Patricia Reed, v-p of sales and marketing. “Our costing structure has always been more economical,” she said.
Customers aren’t leaving the program due to the economic situation, she said. Rather, PlaneSense is experiencing just the normal departures due to changes in travel profiles or moving out of the coverage area, something that regional programs like PlaneSense and Executive AirShare normally face.
PlaneSense had 35 PC-12s as of early last month, and four core airplanes. Year-to-year growth has averaged 15 percent, although, Reed said, “that may be down a little from previous years. Because of the type of aircraft we’ve selected and its versatility, I think we’ve got ample opportunity for growth in geography now.”
Regional operator Executive AirShare, based in Kansas City, had a record-breaking year last year, according to Keith Plumb, president and COO, although the first quarter of this year was slower than the same period last year. The company now has 15 airplanes, and much of the growth is coming from owners leaving the national programs. If an owner is used to flying a Hawker 800 in a national fractional program, he said, “he doesn’t go back to flying Southwest Airlines. Our program is poised to take care of those clients who might scale back; we’re 20 to 40 percent less expensive than the nationals.”
There have been a “handful” of turnbacks (customers leaving the program); Plumb said, “All of them were for financial considerations, but nothing alarming compared to other years. We’ve been getting a lot of interest from existing fractional owners looking for alternatives. If there’s a slowdown, we’ve been the beneficiary of that.” Plumb expects business to pick up during the last quarter. “We’ve had a lot of existing owners buy more shares,” he said.
How the economic situation is affecting not only the U.S. but also the global economy is still playing out, and it’s too early to see the true effect on the fractional industry. The downturn in the U.S. housing market is far from over, according to many experts, and the financial industry flew into a firestorm last month. Only one thing is certain: if the economic challenges continue, the coming year will show even more precisely what happens with the fractional aircraft marketplace when the overall economic situation is weak.
“The market, just like all markets, has gotten a lot smarter,” concluded Flight Options’ Silvestro. “And there are more solutions for our customers to buy.” Ten years ago, travelers had three options: charter, whole ownership or a fractional share. “Today there still are those three, but you have a whole host of other solutions, additional providers and programs. I think the growth of the industry itself is very promising. Notwithstanding the last six to nine months, the creation of wealth in the U.S. is increasing.”