Surrogate supply

By Gunter Endres in London

Wet-leasing of aircraft has been around for almost as many years as airlines have been flying, primarily as a means of overcoming temporary shortages to maintain scheduled passenger or cargo services. What is different in today’s competitive environment is the number of carriers that focus entirely or almost entirely on providing a full wet-lease service, including aircraft, crews, maintenance and insurance (ACMI). All but one has come into existence since 1990 and according to ACMI specialist Air Atlanta Icelandic, traffic carried by wet-lease providers since then has been growing by 18% a year.

So, how did this occasional business turn into a full-time and profitable enterprise? The answer can be found in the relentless drive by airlines to cut costs and to better match capacity to demand. Airlines can no longer afford to invest in high-capacity aircraft, staff and infrastructure, when the expected returns are uncertain, or at best minimal. Opening a new route is a typical example where ACMI is used to minimise risk. “With a fixed block-hour rate based on certain minimum guaranteed hours,” says Hafthor Hafsteinsson, chief executive of Air Atlanta Icelandic, “airlines using ACMI find themselves in a more secure environment, allowing for a more precise budgeting of their operations.”

This same security is also craved by the ACMI provider, which prefers longer-term contracts of two to three years or more, to ensure stability and a continuous revenue flow. “We would not add an aircraft to the fleet today,” Hafsteinsson insists, “unless we have a commitment for a minimum 12-18 month contract. The preferred would be 24-36 months.”

Robert Dahl, of Seattle-based consultancy Cargofacts, says: “But in reality, [typical] contracts are from three months to a year, and all incorporate a get-out clause should circumstances [of the customer] change dramatically.”

Not surprisingly, airlines and providers are unwilling to reveal costs. Typically, ACMI providers charge a rate per block-hour, based on a number of guaranteed hours per month. “If excess hours are flown above those guaranteed,” says Hafsteinsson,” we will charge an excess hourly rate, which is slightly lower. Aircraft are dedicated to customers, except for replacements during heavy maintenance visits.”

Market recovery

The market underwent a slump in the three years after the September 2001 terror attacks as airlines dramatically cut back capacity to account for reduced demand. But now, results from the leading ACMI providers suggest a renewed upturn. “Freight demand is picking up again,” says Dahl, “and airlines [in this business] should be doing fairly well.” Although block hours in the first three months of 2006 at both Air Atlanta Icelandic and Atlas Air, the two leading providers, are down, not too much should be read into these figures, as the first quarter is typically the weakest. Air Atlanta Icelandic claims that its entire fleet (both passenger and cargo) is fully committed for summer 2006.

Since joining with Islandsflug under the newly formed Avion Group in January 2005, Air Atlanta Icelandic, founded in 1986, has been challenging for the leading position, claiming a single-minded focus on the ACMI concept. “Air Atlanta has been true to its ACMI business model since day one and has not been competing with its customers by offering seats or cargo space in the market under the Air Atlanta brand,” says Hafsteinsson. “We have always felt concentrating on ACMI would give us a strong foothold and reputation in the market, which has been the case.”

In its financial year to the end of October 2005, the group had operating revenues of $1.4 billion, of which $500 million was generated by aviation services (primarily Air Atlanta Icelandic, split 60% cargo and 40% passenger). Net profit came to $43 million and pre-tax profit was $59 million. The weak first quarter was also influenced by a fleet restructuring, which involved the phasing out of five Boeing 737 passenger aircraft, the transfer of four 757-200s and one 767-300 to Excel Airways, and the placing of one passenger 747-400 into cargo conversion in November. Total block hours decreased by 14.8%. For the full 2006 financial year, Avion projects an increase in revenues to $2.1 billion.

High fuel prices have accelerated the group’s move towards a more fuel-efficient fleet, especially designed to replace the older 747-200s in the Air Atlanta Icelandic fleet. In September 2005, Avion placed an order for four 777F freighters, and signed up in December for another four, with deliveries starting in February 2009. In March this year, Avion Group purchased seven 747-400s (six passenger models from All Nippon Airways and one freighter from Cargolux), and four passenger-to-cargo conversion slots with Boeing. The remaining two passenger aircraft are due to be operated by the Excel Airways Group. The total value, including the conversions, is approximately $405 million and will be financed through equity and debt.

The first 747-400CBF (Boeing Converted Freighter) is scheduled for redelivery from conversion in August 2007, with the remainder due in 2008, 2009 and 2010. Avion has also acquired three Airbus A300-600 passenger aircraft, which are being converted into freighters by EADS company Elbe Flugzeugwerke in Dresden, for delivery in 2006 and 2007. It also has purchase rights for two further aircraft. The value of the contract is around $40 million. This activity highlights the increased emphasis on cargo within the group’s fleet renewal, which envisages a 39-strong freighter fleet by 2009. The fleet currently comprises 26 passenger and 22 cargo aircraft; more than half are 747s.

New York-based Atlas Air, part of Atlas Air Worldwide Holdings, also claims to be the world’s leading provider of ACMI cargo services. Founded in April 1992 by the late Michael Chowdry, the airline took full advantage of the availability of early model 747-200s, which were being replaced in mainline fleets by new technology, often twin-engined aircraft. These were later supplemented with 12 new 747-400Fs, which brought the fleet to 36 aircraft by the end of 2000. The result was a steady increase in revenues, until the downturn in the market after 2001 pushed the airline into Chapter 11 bankruptcy protection in January 2004. However, a successful restructuring saw it exit from bankruptcy just six months later, with lower operating costs, $600 million less debt and more cash. It had not even touched its debt-in-possession (DIP) loans.

Excess capacity

Its post-bankruptcy refocus on charter operations produced an 18.2% increase in 2005 revenues for the holding group, which also includes scheduled cargo operator Polar Air Cargo, to $1.62 billion, and a net profit of $74 million.

There was less good news in the first quarter of 2006, with Atlas Air blaming excess 747-200F capacity and a reduction in military charter activity for a small loss. First quarter block-hours decreased by 15.7%. While the first quarter is traditionally weak, Atlas Air is pinning future profitability on a major fleet restructuring. “Given shifting market dynamics, we are reducing non-essential capacity in order to sustain and improve our profitability,” says retiring chief executive Jeffrey Erickson. “At the same time we are formalising our plans to order new, leading-edge freighter aircraft with better range, capacity and fuel efficiency.

“To those ends, we have begun to cull older, under-utilised aircraft from our 747-200 Classic fleet, probably a bit later than we would have done, were it not for the relatively full utilisation of our available aircraft during 2005,” Erickson says. In May 2006, the fleet comprised 14 747-200F and four 747-400 freighters. According to chief financial officer Michael Barna, these cost-savings, together with revenue enhancements including expansion of its operations in China, are envisaged to benefit the airline by $100 million over the next three or four years.

To ease its way into the European market, Atlas invested in a UK-based all-cargo company, Global Supply Systems, and provided it with aircraft that were put on the UK register. GSS, established in April 2001, is majority owned by UK entrepreneur John Porter, with Atlas Air Worldwide holding a 49% stake. Since starting operations with a single 747-400F in June 2002, the carrier’s entire capacity, now comprising three 747-400Fs, has been contracted by British Airways.

In March 2006, Washington Dulles-based ACMI provider Gemini Air Cargo announced a successful completion of its negotiations to restructure all of its senior secured debt with nearly 93.4% of its lenders, including affiliates of Bayside Capital, a private investment firm focusing on middle market companies. To implement the restructuring the airline filed a pre-negotiated, voluntary petition for protection under Chapter 11. Gemini has also received a commitment for a $10m DIP facility and exit financing.

In the meantime, it is “business as usual”, stresses Sam Woodward, chairman of Gemini. “By significantly reducing our debt, Gemini will emerge from this process a stronger and more competitive company.” Good news has come in the form of a two-year contract, from South African Airways, which recently made a decision to re-enter the cargo business.

Mixed fortunes

Gemini, since 1999 majority-owned by the Carlyle Group, a Washington-based private equity firm, has had a topsy-turvy few years. The slump in the market after 2001 forced it into a major restructuring and retrenchment in December 2003, which included the forgiveness of bank debt, the return of some leased aircraft, and an infusion of cash by its major shareholder. The airline was founded in 1995 and claims to be operating the world’s largest DC-10-30F and MD-11F fleet on ACMI contracts, now comprising seven DC-10s and four MD-11s. While ACMI accounts for virtually all of its operations, Gemini also services blocked space agreements, code-sharing and ad hoc charters.

At the other end of the scale, an interesting newcomer is Dutch-based Denim Air, which in October 2005 announced its decision to focus its business entirely on regional airline ACMI, following its acquisition by Panta Holdings. Denim has gone one step further by launching its ACMI Plus service, which offers start-up airlines full operational support, including ACMI, interlining, sales distribution and marketing support.

Its first customer was Italy’s Voli Regionali, which started flying one Denim Air Fokker 50 at the end of September. Apart from providing aircraft to airlines in Europe, Denim Air has also won contracts in Africa, which helps to utilise capacity during the quieter winter months in Europe. The resurgence of the turboprop is providing steady business for its 10 Fokker 50s and five Dash 8-300s, but Denim is looking to add more Dash 8s, as well as regional jets, with the Fokker 70/100 and Embraer 170/190 under consideration.

But while there are few that focus almost entirely on the ACMI business, those incorporating ACMI as just one part of a diversified business portfolio, are much more numerous. “Most companies are quite creative in finding ways to keep their aircraft in business to generate revenue,” says Dahl.

Established longest in this business is World Airways, whose history goes back to 1948. While it has ventured from time to time into scheduled services, and has endured a period in Chapter 11, it has largely remained faithful to its three core businesses: charter, ACMI and government contracts. It presently operates one DC-10-30 and nine MD-11 passenger aircraft, together with two DC-10-30F and two MD-11F freighters. Other major exponents of the ACMI concept, along with charters, are US carriers Evergreen International, Ryan International, Kalitta Air and Southern Air; Turkish airline MNG Kargo; and South Africa’s Safair.

The world’s major airlines clearly rely on just a handful of ACMI providers, which over the years have proven their reliability and safe operation. Their position is likely to be strengthened further, making it more difficult for newcomers to enter this still growing market. While there is provision for passenger and cargo services, the trend is definitely towards cargo. Today the market is strongly dominated by Europe and the USA, but Hafsteinsson predicts that future growth will be “first and foremost in the Middle and Far East”. ■

Source: Airline Business