ENROUTEā€”an editotial opinion

Business aircraft makers and the market's fall-a growth industry interrupted

Severe and long-lasting downturn threatens innovation and new product development.

By Richard Aboulafia
VP, Teal Group


Phenom 100 light jet in final assembly-1st traditional business jet from Embraer, now fast becoming the 6th major player in the market.

As the world economy struggles to recover from the massive shock of late 2008 and early 2009, the business aircraft market has found itself in free fall.

All the leading indicators of market health-used aircraft availability, aircraft prices, and utilization-point to a severe downturn. Broader economic indicators that drive business jet demand, particularly corporate profits, are also falling fast, implying that this will be a prolonged downturn.

The market's collapse, coming after 5 years of record growth, means big changes for the business aircraft industry.

With no hope of new entrants and the real prospect of mergers, there is a good chance that this industry will see fewer manufacturers. Meanwhile, until the market recovers, industry players will have limited resources for new products.

No new entrants

In 2008 there were 5 major players controlling the business jet market.

Bombardier, Cessna, Dassault, Gulfstream and Hawker Beechcraft held 99% of deliveries that year. However, Embraer has successfully diverted resources from its regional jet business to a line of new business jets.

The first-the Phenom 100-entered service in Dec 2008. The Phenom 100 and 300, and the Legacy 450 and 500, will establish Embraer as a 6th major manufacturer, with a 7% market share by value by the end of Teal Group's 10-year forecast period.

In terms of market participants, the business aircraft industry is quite large by aviation standards. There are only 2 jetliner primes-Airbus and Boeing. Most other aviation market segments have between 3 and 5 players-but there are 6 business jet and 3 business turboprop manufacturers.

More importantly, there have been more than 10 new attempts at entering the market over the past 10 years. All have failed. The cause of these failures is the same factor that keeps aviation a relatively elite industry, with very high barriers to entry.

Enormous capital requirements are needed, not just to develop, test and build new products, but to create the elaborate sales and support networks needed to satisfy demanding customers. New companies also need to generate the cash to develop those ever important new models, and to withstand market downturns.

Due to the severity of the current downturn, the market will almost certainly not return to last year's peak for nearly a decade.

The few new manufacturers that have delivered actual aircraft have quickly proven to be unsustainable enterprises. Since 1960, only a single new player-Embraer-has succeeded as a new aircraft producer.

With that background, a plunging market removes any hopes for a new aircraft manufacturer. The prospects for new entrants have been further damaged by some recent high-profile business failures.

The most spectacular was Eclipse Aviation, which went bankrupt in 2008 after spending about $2 billion and delivering 258 jets that will now be orphan planes. The past 2 years have also seen costly business plan failures at Sino-Swearingen and Adam Aircraft.

Just before those, Aviation Technology Group and Avocet both failed, wiping out millions of investment dollars. All of these failures, but especially the very heavily hyped and vaunted Eclipse, have a chilling effect on funding for new ideas in this business.

They also reduce investment enthusiasm for the sector in general. Yet there is one exception to the bias against new players. Japan's Honda has designed its HondaJet and is building a plant at GSO (Greensboro NC) to serve as headquarters, production and delivery facility. This will be completed in 2010.

The HondaJet project is unusual in many ways. It was designed by a car company with no previous interest in aviation and it features engines mounted above the wings. This configuration hasn't been seen since the VFW614 airliner, built in Germany in the 1970s.

Even more curiously, Honda built this airplane in conjunction with its own new turbofan engine, making it the only vertical airframe/engine jet of the modern aviation era. But, most unusual of all, this project will succeed.

Unlike all the other new market entrants, Honda has the resources necessary to make this happen. The development costs are almost a rounding error in the company's finances. There have been some recent signs that Honda was scaling back its ambitions.

It had planned on an annual production rate of 100 airplanes, but in February the company reduced this figure to 70-80. Still, Honda represents the best sign that an innovative approach can work in this industry, albeit only if it has virtually unlimited resources.

Industry restructuring prospects

While we don't see any new players introducing aircraft, it is possible that new owners play a role in any industry restructuring that might take place. From an acquirer standpoint, current market conditions have created an ideal buying opportunity.

HondaJet represents innovation from a most unusual source-a car company with the resources needed to surmount the extremely high financial barriers to market entry.

From the standpoint of some business jet manufacturers, there's the strong prospect of needing new sources of capital. Looking at the restructuring question with an eye on possible target companies, there are 2 big prospects.

The first is Hawker Beechcraft, which is owned by Goldman Sachs and Onex and is deeply in debt. The weakest of the big 6 players, Hawker is also vulnerable to Embraer's aggressive moves to enter its market space.

Cessna is the biggest unknown variable. The company has first-rate management, a seamless and popular product line that allows it to dominate the bottom half of the business jet market, and an enviable track record of pleasing customers and generating profits.

Unfortunately, it is owned by Textron-an industrial conglomerate which has been rendered vulnerable by its large finance side. In January, the company's stock tumbled the most in 2 decades after executives said 2009 profits would be below expectations.

In January, Standard & Poors lowered the company's long-term credit rating to junk status. In February, CEO Lewis Campbell said the company might need to sell Cessna or Bell Helicopter to raise cash by next year.

In April, rumors emerged that Textron would be purchased by a United Arab Emirates-based investment bank. If this happened, the defense assets would be sold to other US companies, but Cessna would be retained, rapidly elevating the new investors into a strong business jet and general aviation market position.

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