Reference no: EM133085880
Fate of Dry-Leased Aircraft
1. XYZ Airlines, one of the growing airlines in Asia, as part of its routine network expansion programme, widened its horizon to new destinations through dry-lease of couple of B 737-700 aircraft. Finding the lease rent reasonable, XYZ has extended lease term twice and now the question came to redeliver them when the Lessor "ABC Leasing House", a renowned leasing company came forward with another offer. The case in brief is as follows:
2. On 17 September 2009, XYZ Airlines signed an agreement with ABC Leasing House for 02 (two) 737-700 (MSN 68325 & 68326) aircraft for 06 years on Dry Lease basis. At that time two leased aircraft were 06 years old. The average operating life of an aircraft is considered 23-25 years as per the industry practice. So, taking all aspects into consideration both parties agreed on a rent of USD 240,000/month/aircraft as basic lease rent. In addition, the Maintenance was also to be paid. At the end of lease term, the aircraft are to be redelivered as per agreement (Mirroring the delivery condition). The aircraft were delivered to XYZ Airlines on 25 March 2010 & 05 April 2010 respectively.
3. After 06 (six) years of operation, ABC Leasing House offered XYZ Airlines for lease extension for 04 (four) more years. Although some aircraft delivery to XYZ was in the pipeline, they were not delivered on time. XYZ Airlines agreed to the offer made by ABC Leasing House considering aircraft demand, crew and maintenance availability of the aircraft. Initially, ABC Leasing House offered a rent amount of USD 230,000/month/aircraft for the next four years. However, after a couple of rounds of negotiation, both parties agreed on an amount of USD220,000/month/aircraft for the next 04 years after the end of the current lease term. The extension agreement was signed on 20 December 2015.
4. During the 2nd term of lease, XYZ Airlines was able to add some brand new aircraft to its fleet as per purchase agreement signed 06-07 years back with an aircraft manufacturer. Still compared to the demand, XYZ fell short of aircraft due to its extended operation to new destinations and increased frequency to the existing destinations. Importantly, the aircraft were required to maintain On Time Performance (OTP) by the airline and also for maintaining the schedule during Hajj season when aircraft demand is at its peak. So, at the end of the extended lease term, XYZ once again opted to extend the lease term of the 02 (two) 737-700. A new agreement was also signed on 18 August 2018 between the parties for 03 more years after the end of the second lease term. The monthly rent was set at the amount of USD190,000/month/aircraft.
5. As the extended lease term was approaching to its end, it was necessary for XYZ Airlines to decide on what to do next regarding these two aircraft. On one hand, expansion of network and lack of aircraft were two burning issues, on the other hand, the aircraft age was a big question. Also the COVID-injured cash flow made the situation even more difficult. After assessing XYZ airline's current position on fleet and routes, ABC Leasing House once gain came forward with some proposals along with redelivery option as per agreement.
Option 1: Sale Price to be paid: $20 Million for Both Aircraft on as-is, where-is basis.
- Sale to be transacted on or before 31th December 2021 unless mutually extended;
- If a sale-purchase decision is made, XYZ is to make $5 Million advance payment / purchase deposit on or before 31st December 2021; Rest of the money is to be given in two equal installments in January and February 2022.
- All the money in terms of Maintenance Reserve and Security Deposit lying with ABC Leasing House would be lying with them only and it is equivalent to 7 Million USD in total.
- For any delayed payment, XYZ has to pay 2% + LIBOR as interest.
Option 2: Lease Extension Offer:
- 1 Year Extension: $150k monthly rent; or
- 2 Year Extension: $145k monthly rent; or
- 3 Year Extension: $140k monthly rent;
In all cases a MR @ 70K USD is to be deposited till the lease term ends. After 3 Year aircraft may be returned back on "as is where is basis".
Option 3: Keeping the aircraft without Engines.
The ABC Leasing House will take all the four engines leaving rest of the aircraft to XYZ for which some price should be offered. It is to be noted that all the 4 engines are recently shop visited at a total cost of 24 Million USD.
Option 4: Redelivery as per Agreement
If XYZ redelivers aircraft, about 7 Million USD would be required. The engineers are very confident that the redelivery cost would not cross this amount. However, the redelivery has got some inherent risks. First, if it can't be delivered in time then for every additional month XYZ has to pay 200% of the lease rent. Besides, very inspection may be delayed by the lessor to realize extra penalty from the airline.
Option 5: Commercial Settlement of the Redelivery
XYZ may also explore the opportunity of redelivering the aircraft with some money with fixing the aircraft. This would benefit the lessor by some cash and good for the airline since they can use the aircraft till the last day and don't waste engineering effort for the redelivery process.
Dilemma: Purchasing the aircraft will require a huge sum of money in this COVID affected economic situation. Lease extension will be a temporary solution with two very old aircraft where customer satisfaction would be at stake, as presumed. On the other hand, redelivery will result in aircraft shortage since the industry is showing some sign of rapid improvement. Besides, new type of aircraft (Airbus for example) would require new type of crew and engineering set up. All these issues have created a complex situation for the decision makers. Importantly, as you discover that the engines alone are worth of 18 Million USD considering its remaining hour and cycle. There is also strong demand that the aircraft can be used as P2C aircraft removing all economy seats to carry about 14 MT of cargo in a 4-5 hour one-way flight where you can generate USD 22K per leg making USD 44K from the return flight. Any earning more than USD 34,000 is the contribution to Direct Operating Cost.
Assignment: You are Director Planning of XYZ airlines and have to do some quick staff work for the Board of Directors to make some decision by 31 December 2021. You have time till 05 December 2021 to study and make your preference. Based on your understanding of the above mentioned case, answer the following questions.
1. Write down the pros and cons of all the options?
2. What is your preferred option and why? Highlight Cost-benefit, ease of maintenance, market demand, ease of operation, uncertainty of meeting the redelivery deadline, media repercussion, prospect of cargo transportation etc.
3. Can there be any other viable option that would benefit both?