Engine Lessors Weigh Vertical Integration Strategies

Speakers at Aviation Week Network’s Engine Leasing, Trading & Finance Europe event in June suggested that more engine lessors might start integrating MRO and parts services into their platforms to ease transitions, boost material supply and maximize the end-of-life value of their assets.

U.S. lessor and maintenance provider FTAI Aviation has built its platform around an integrated module exchange and engine leasing operation. Yet this model is not easy to replicate. Alun Roberts, head of engine leasing for FTAI Aviation, said his company is so focused on providing 5,000-cycle CFM International CFM56 engines that it removes 10,000-cycle modules from engines it acquires and bolts on a 5,000-cycle replacement.

Fellow panelist Graeme Crickett, chief technical officer of SMBC Aero Engine Lease, joked that the financial complexities of this arrangement must require FTAI to “give its accountants Valium.” Roberts agreed that it is a “very interesting and creative model.”

“We have a certain book value in that asset, so when we remove an LPT [low-pressure turbine], that LPT will have an assigned book value, which will then be transferred over to the next engine,” Roberts said. He also noted that FTAI’s engine-leasing strategy meant it preferred to offer lower lease rates in exchange for longer terms and the company taking all the maintenance associated with the engine.

Between FTAI’s complex maintenance-leasing model and pure-play asset managers lies plenty of room for lessors to add various levels of technical support to their core leasing offering.

GETTING TECHNICAL

In September, Japanese conglomerate Itochu diversified its commercial aviation business by acquiring Dublin-based Killick Aerospace, which specializes in used serviceable material (USM). In doing so, Itochu became the latest lessor to add aftermarket capabilities to its asset management platform. It noted that Killick fits into its strategy of identifying and investing in “downstream” profit opportunities.

“By creating synergies between Itochu’s capabilities and Killick’s aftermarket services, the partnership will deliver high-quality, customer-focused solutions that meet the evolving needs of the aviation industry,” the Japanese company said.

Itochu also cited an Acumen Consulting report predicting the USM market would grow roughly 50% in the next eight years to reach $11 billion. “Utilizing USM not only reduces costs for airlines but also shortens lead times for parts procurement and supports environmental sustainability,” the company said.

While Itochu leases aircraft, engine lessor ELFC made a similar acquisition last year, completing a full purchase of U.S. parts specialist Inav. “Moving into the parts side of the business was a natural evolution of ELFC’s model,” Joe Hussar, head of portfolio for the lessor, tells Inside MRO.

“Prior to entering this business, after monetizing the on-wing value of the engine through leasing, we would sell the unserviceable engine to the wholesale parts market,” Hussar says. “By vertically integrating with a parts subsidiary, we have the in-house ability to capture all possible value out of our asset investment.”

Hussar says Inav also enhances the asset management side of the business by giving ELFC a more granular understanding of engine value down to the piece part level. “In addition, having the ability to break engines ourselves was a major advantage during COVID-19 as the liquidity of engines was nonexistent,” he says. “Rather than sell the engines at a significant discount or explore a third-party consignment, we were able to break the engines ourselves and have that material ready to go once the market had recovered.”

ELFC competitor Willis Lease Finance (WLFC) has a longer maintenance pedigree, having owned an engine overhaul facility in the 1990s and several other technical services providers since then.

“We have seen the value of combining services and leasing for a long time,” says WLFC CEO Austin C. Willis. “Although each of our service sectors has its own unique story, a common thread runs through them all: Our strategy has been to acquire or launch businesses that enhance our control over our products and allow us to manage costs more efficiently—both for ourselves and for our customers.”

These cost efficiencies might stem from the cheaper parts that WLFC can provide or from the company taking control of engine maintenance management. “With leasing and services as our core focus, we are often more adept at reducing maintenance costs than airlines,” Willis notes.

The company’s engine aftermarket capabilities include Willis Engine Repair Center (WERC), via MRO facilities in the U.S. and UK that specialize in swapping modules and repairing engines quickly to avoid expensive and protracted shop visits. “This enables us to bridge engines from one lessee to the next with minimal cost and downtime,” Willis says, noting that nonlessee customers take advantage of this service, too.

There is also Willis Aeronautical Services, which feeds USM and modules into WLFC’s maintenance operations and external providers. “This facilitates throughput in a supply-chain-constrained environment and enables us to provide a tangible benefit to our third-party customers at WERC,” Willis says.

At lessor Rolls-Royce & Partners Finance (RRPF), meanwhile, one might expect less pressure for vertical integration given the lessor’s links to the OEM. However, RRPF Chief Strategy Officer Ben Hughes notes the company sources engine shop visit slots and parts from the OEMs on terms similar to other leasing companies. “We are, however, a significant owner of Rolls-Royce and IAE engine types, so we naturally receive good support from those OEMs,” he says.

Furthermore, RRPF has had parts trading capability since 2015, first for IAE V2500 engines and then extended to the Rolls-Royce Trent lines. “Our parts trading experience has generally brought us even closer to our customers and enabled us to create more value for them,” Hughes says.

SUPPLY CHAIN ADVANTAGE?

With lead times for many OEM parts still prolonged, difficulties sourcing USM due to fewer teardowns and stretched global engine maintenance capacity, lessors with in-house service capabilities could enjoy an advantage over their pure-play competitors.

“Vertically integrated lessors tend to have an advantage due to their greater buying power, which can result in better turnaround times for engine shop visits and parts repairs,” says Tony Whitty, senior vice president of aircraft and engine procurement at AJW. “This enhanced efficiency can be particularly beneficial when MRO capacity and the supply chain are under strain.” AJW’s services include engine leasing, management of engines on lease for third parties and oversight of shop visits.

“Airlines and aircraft operators are looking for ways to reduce operational costs and improve efficiency,” Whitty continues. “This has led to a greater demand for integrated service providers, such as AJW Group, who can offer a one-stop solution for parts provision, engine leasing and management services.”

Hussar at ELFC also touts the advantages of vertical integration. “We can offer more services to our customer base, such as exchanges of run-out engines for a strong serviceable unit to avoid a shop visit, supplying USM or acquisition of surplus assets our customers may be looking to liquidate,” he says. “These advantages will continue once the supply chain issues are resolved.”

“We have seen parts supply delays, which has resulted in us waiting for shop slots to come available and delayed turnaround times,” RRPF’s Hughes says. “We can mitigate some parts delays because we have our own stock of used serviceable parts internally that we can tactically use to support our own lease engine portfolio as needed. We have also seen customers across most engine types requesting additional spare engine capacity because of maintenance delays that are affecting them.”

“Pure-play lessors will always have a role, but those with a services-enhanced leasing strategy can provide real cost savings to customers,” Willis of WLFC says. “We believe that this is a value that survives changes in market conditions.”

WHY STAY PURE-PLAY?

Not all lessors have pursued vertical integration. Amsterdam-based SMBC Aero Engine Lease (SAEL) is now a pure-play engine lessor, after launching in 2013 as a partnership with engine maintenance provider MTU.

“When SAEL was incorporated, we were somehow involved with teardown, spare parts, module exchange and maintenance through our partnership with MTU,” says Roger Welaratne, SAEL managing director. “What we have found is that each of those businesses require very specific expertise and know-how. That is what drove our decision to focus on our expertise.”

Now owned solely by Japan’s Sumitomo Mitsui Financing and Leasing, the lessor built up a portfolio of roughly 100 engines worth more than $1 billion.

“We have adopted a highly focused approach so far, and I believe being a pure leasing player has been key to making what SAEL is today,” Welaratne says. “I also believe that the focused approach was what helped us navigate through the biggest crisis in our industry when we were still a small lessor.”

He also notes that while the current supply chain crisis has generally been good for engine lessors, as airlines scramble for spare engines to cover extended maintenance times, it has also brought complications.

“Like everybody in the industry, supply chain issues have significantly impacted SAEL,” Welaratne says. “If one of our engines needs to be overhauled, then we face the consequence of long [turnaround times], too. We understand that engine lessors are benefiting from the appreciation of engine values driven by the current environment, but generally, we like more stability.”

Welaratne also leaves the door open to a shift in approach. “As SAEL looks into writing the next chapter, we definitely need to look at adjacencies, and we will be seriously evaluating which of those segments are aligned with our strategy,” he says. “But we are not going to add different services just for the sake of playing everywhere.”