October 31, 2017
In any merger or acquisition, determining a proper valuation requires a combination of certain expertise and skills. Knowledge of the relevant industry. An understanding of tax ramifications. Familiarity with the nuances of deal structuring. Experience in technical accounting and financial reporting. And the more complex the industry, the more often companies need help navigating the pitfalls and generating the highest possible returns.
Consider aircraft leasing – a highly specialized, global, capital-intensive and asset-driven business. Over the next 20 years, for instance, Airbus and Boeing forecast a need for 35,000 to 40,000 airplanes valued at more than $5 trillion.
Today, aircraft operating leases account for more than 40% of the world’s commercial aircraft. Leasing provides increased flexibility for airlines, which can move aircraft around the world in response to demand and trends. Whether an airline is looking to replace part of its fleet with newer, more fuel-efficient models, expand service or simply downsize, leasing is a viable option. Aircraft leasing firms can provide additional planes or find homes for older aircraft at other airlines. They also can provide access to aircraft for airlines that don’t have the cash, financing or access to capital. This allows investors to benefit from the growth of aviation with less risk than investing directly in aircraft.
With any investment such as aircraft, proper due diligence is the linchpin in any major deal. But the need to establish a solid valuation remains long after the ink dries on a contract. After all, you’re investing with the anticipation of future returns, not just current value.
Here are some due diligence and post-transaction challenges with which private equity companies, asset management firms, and aircraft and engine leasing companies may want to seek help:
- Aircraft value includes a thorough review of fleet listings, lease terms/rates, lessee profiles, aircraft model/engine types and return conditions. Valuation relies on major technical assumptions such as residual value, discount rates, half-life or maintenance adjusted value, lease-encumbered value and residual value forecasting. A lease-encumbered aircraft also includes intangible value such as any above- or below-market lease rates and the maintenance right intangible.
- Maintenance reserve analysis covers a review of the maintenance program, procedures and records, including maintenance planning documents, verification of airframe and engine shop invoices, and life-limited parts disk sheets. There’s a need to identify any potential maintenance reserve shortfalls and accounting requirements, along with spotting large gaps in the return condition as noted in the contract.
- Return condition reduces the risk that an aircraft could be returned in less than a desirable condition, with the lessor ultimately responsible for the maintenance costs of an asset that can’t be remarketed. Without close monitoring of the fleet, assumed minor losses could skyrocket to levels that significantly affect portfolio performance.
- Impairment analysis includes the development of assumptions and inputs such as current market value, future lease period and rates, total life, and residual/scrap value. US GAAP reporting specifies the carrying amount of an aircraft is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the aircraft’s use and disposition.
- Accounting depreciation life analysis should include recommendations on useful lives, residual values and base asset determination. This can be aided by identifying industry standardization of depreciable assets, changes in the depreciation curve affected by changes in the recent markets and new aircraft products.
Other areas to consider include a fleet/ lease assessment, which requires a comprehensive analysis of the fleet’s portfolio; an above/below market lease analysis where a full review of the leasing terms are reviewed; the maintenance right intangible, which includes a review of the current aircraft and engine condition; aircraft transition costs, which cover a review of potential costs in case the lessee defaults; and end of lease procedures, which include the analyses of return conditions and calculations for compensation.
To be sure, deals in any sector have their own complexities. But one factor that remains consistent is the need for insight and expertise from professionals with experience in the relevant industry. When you can enlist objective voices that know how to capture the anticipated value of a transaction, then your deal is clear for takeoff.
Contact a member of PwC’s Deals Team to learn more about the diligence, post-deal transaction and on-going reporting requirement needs in your industry.