In our second of a two-part series concerning the March 13- 2008 roll-out by Gulfstream Aerospace Corporation of the flagship G650 we look at some information released by Gulfstream (through its parent- General Dynamics) that sheds further light on the program and on the market for large jets in general. Some of the following information is derived from the General Dynamics July 23 earnings call- while other information was ...
Gulfstream G650 Rollout (Part Two):
The G650 program takes shape.
In our second of a two-part series concerning the March 13- 2008 roll-out by Gulfstream Aerospace Corporation of the flagship G650 we look at some information released by Gulfstream (through its parent- General Dynamics) that sheds further light on the program and on the market for large jets in general. Some of the following information is derived from the General Dynamics July 23 earnings call- while other information was gleaned during our direct involvement in G650 contracts.
To recap- Gulfstream sought letters of intent and USD$500-000 deposits- on a first-come-first-served basis. Gulfstream confirms that it received approximately 500 letters and deposits on the day that the doors opened. This exceeded Gulfstream’s expectations- and with their then-existing production schedule would have had deliveries extending beyond 2020.
To address this- Gulfstream pursued some changes in production plans and those changes have put the later deliveries at roughly 2018- assuming the 500 offers are all turned into firm contracts.
As of late July- Gulfstream had turned approximately 100 of the 500 offers into signed contracts with deposits increased to USD$3-000-000. In Gulfstream’s lingo- an “order” is booked when that contract and deposit are in-hand. It is no small task to get 500 letters of intent reduced to signed contracts- and a busy staff at Gulfstream is taking them methodically- in sequence. That leaves 400 offers that have not yet been turned into orders. (For them- my contact information is below!)
Clearly- some percentage of the 400 will not be reduced to orders- as bidders back out and get their deposits back. General Dynamics did not disclose the cancellation rate or actual numbers of cancellations- but anecdotally- we have worked with clients who have already had their delivery position accelerated. It is possible that some speculators were able to make the USD$500-000 deposit- but balked at increasing it to USD$3-000-000 - and more likely- were deterred by the extensive anti-assignment language in the definitive sales agreement that was intended to prevent formation of a secondary market in delivery positions.
At the earnings call- an analyst asked whether the purchasers were predominantly non-U.S. (in light of the weak U.S. Dollar and current financial downturn in the U.S.). Nick Chabraja- General Dynamics Chairman and CEO indicated that- of the booked orders- it was virtually 50/50 between North American buyers and others. However- he also conceded that the North American buyers may have had an advantage in the bidding process given that the sequencing of orders was determined by the date and time of the arrival of the wire transferred deposit. Thus- the early deliveries could be skewed in favor of North American buyers- and later orders will shift the balance toward non-North American buyers.
Predictably- there were many frustrated bidders who received late delivery positions or none at all.
One Gulfstream insider noted to me that the “fairness” of the allocation process was commendable- but meaningless to those bidders who were dissatisfied. Apparently- Gulfstream buyers are not appeased or impressed by the fairness of a process- as people in their position are used to getting what they want- without regard to what is fair. And- of course- there are unconfirmed conspiracy theories about bidders from certain parts of the globe who had delivery positions in-hand before the bidding even opened!
Chabraja also noted that the G650 sales had not come at the expense of the sale of the other large business jets- and that there was no effort to divert sales personnel from the G500 family of aircraft to support G650 sales. Large aircraft deliveries are all spoken for to the year 2010- and G200 sales were also reported to be strong. Moreover- profit margin on sales has increased- reflecting the well-known shortage of supply for larger business jets. Chabraja noted that Gulfstream did not have ANY used aircraft in inventory (although the company’s website suggests otherwise).
The extremely long lead-time for some deliveries- together with the fact that the aircraft has yet to be certified- raises some challenges for buyers. Consistent with prior practice- I like to log milestone dates into my calendar once a client signs a sales agreement. I was gratified to learn that I can bookmark dates in 2018. I wonder how many computers and software versions I will go through before then?
The first challenge to overcome is financing. Fortunately- for most buyers more than 90% of the purchase price will not be due until the aircraft is within a year of its delivery date. Not many lenders are going to be willing to finance 90%+ of the purchase price- so financing may not be an immediate issue. Forward thinking buyers may not want to leave the financing issue unresolved (particularly for more advanced deliveries). It is doubtful that many banks will make unconditional commitments today to fund a purchase when the first disbursement on the loan may be a decade away- but for deliveries in the next three to five years- there is a benefit in securing a commitment.
Our experience indicates that lenders will protect themselves by seeking significant buyer/borrower participation (e.g. 20%) in the purchase price. In addition- lenders will take a “collateral assignment” of the sales agreement (a permissible assignment allowing the bank to take the borrower’s position if there is a default); and lenders may be able to obtain a lien on the aircraft while it is in production- but only from the date of “green” delivery- and even that lien will be subordinated to Gulfstream’s other credit facilities.
A second challenge (particularly to non-U.S. buyers) is the exchange rate risk. For those buyers that need to convert currency to make payments- the actual cost of the aircraft at the time payments are due is largely unknown. There are financial instruments available to mitigate this risk- but for later G650 deliveries- the payment due dates are going to be too far into the future to permit customary hedging strategy. As a result- most buyers are going to bear the exchange rate risk.
Gulfstream clearly wishes to prevent the sale of delivery positions- and its standard contract has language to foreclose this as much as possible. However- when facing a period of up to ten years for delivery- it is prudent to consider changes that may require an assignment of the contract. For personal buyers- you must preserve the ability of that person’s heirs (in case of death) or personal administrators (in case of disability) to assume the contract.
Similarly- in the corporate world- there will be reorganizations- mergers and sales that should not result in a termination of the sales agreement. Gulfstream will permit the sales agreement to incorporate such changes- provided that they do not open the door to a speculative sale of positions. For U.S. corporate buyers- a bankruptcy of the buyer should not prevent the transfer of the delivery position since prevailing federal bankruptcy law favoring reorganization of companies will trump anti-assignment clauses. However- when dealing with non-U.S. entities- this issue may be relevant.
In many ways- the success of the G650 is not a fair indicator of industry trends because it is such a “breakout” aircraft. It shows that there remains a core market for the best of the best- but it does not demonstrate overall market strength. By the end of this year- we should know the real backlog on the G650 order book. Will it be 200- 300 or 400 aircraft? Obviously- for each G650 delivered- another large business jet is likely to join the used market- which has already started to cool after a torrid series of years.
The pipeline for large business jets expanded significantly in the past five years- and it is currently full of aircraft positioned for delivery over the next 18 to 24 months. Even if all in the pipeline are spoken for- many deliveries will put a used aircraft on the market.
For those current operators holding late G650 positions- there will be a question of whether they will hold their current aircraft or acquire an interim aircraft between their current aircraft and the G650. Perhaps this schedule will compel some buyers to hold longer than usual.
Will Bombardier- Dassault or Embraer attempt to one-up Gulfstream by offering something bigger- higher and/or faster than the G650 (keeping in mind that the Boeing BBJ and Airbus A319CJ are already far larger than the G650)? Can someone other than Gulfstream claim the ‘best-of-the-best’ position in this market? There are quite a few frustrated Gulfstream loyalists who might jump at a G650 competitor if they can get it in service within the next ten years.
Greg Cirillo is a Partner with the Washington- D.C. law firm Wiley Rein- LLP- representing private and commercial operators- owners- lessors and financiers in structuring the sale- acquisition- ownership- management and operation of aircraft- and providing Federal tax and state sales and use tax planning services. Greg can be reached at Tel: +1 703-905-2800- email:firstname.lastname@example.org