Will Li Ka-shing's move into aircraft leasing pay off?

December 10, 2014 19:32

Cheung Kong group chairman Li Ka-shing appears to have taken a leaf out of the book of late shipping tycoon Pao Yue-Kong with regard to moving into a new business when the need or opportunity arises.

Li, Asia's richest man, recently unveiled a big bet on aircraft leasing business, involving investment of at least US$2 billion.

Pao made his fortune in Shanghai in the first half of last century, even before he turned 30, in the financial sector. However, he later decided to switch to shipping as the Communist Party began nationalizing private assets and confiscated land.

The timely move helped Pao build his empire and develop into what it is today, with interests in shipping, retail, transport infrastructure and other fields.

The beauty of shipping business is that all your assets float on ocean, and it operates with global rules, and hence cannot be easily grabbed by others, a commentary in the Hong Kong Economic Journal noted Tuesday.

Now, Li is venturing into a new business as he senses a big opportunity in aircraft leasing, a market estimated to be worth about US$200 billion globally.

Li is snapping up as many as 160 aircraft from various parties. However, the two biggest players in the aircraft leasing sector, General Electric and International Leasing Finance Co. (ILFC) boast 1,700 and 1,000 airplanes respectively. Thus, Li still has a long way to go, the article noted.

In the past decades, the majority of Li's investments were in businesses with stable cash flow. The aircraft leasing foray may be small relative to his group's overall size, bit it nevertheless represents a strategic move and has three-fold benefit.

First, Li may not get the blessing from the local government if he pursues mergers & acquisitions deals in a foreign nation. However, aircraft leasing industry works under the Cape Town Convention, meaning there is no territory limitation. Thus, Li does not have to rely too much on governments.

Second, aircraft leasing management is much less complicated than operating an airline. For example, ILFC has less than 300 employees.

Third, Cheung Kong (Holdings) has very strong balance sheet and low financing costs. Aircraft leasing would offer lucrative interest rate arbitrage. That’s why the founder of ILFC has agreed to cooperate with American International Group Inc. (AIG).

Currently, the financing costs for aircraft leasing is roughly Libor plus 400 to 500 basis points, and companies can earn around 8 to 10 percent interest by leasing aircraft.

Leasing price has fallen around 20 percent in the two financial crises in 2001 and 2009. But long-duration aircraft leasing terms would offer steady cash-flow.

More importantly, aircraft leasing operators are able to borrow 70 or 80 percent of the aircraft value from banks using the planes as collateral, and can then expand the return on equity. Therefore, the key to running the aircraft leasing business is finding cheap money.

While a record number of aircraft are expected to come on stream in the coming years, emerging economies can absorb a lot of the capacity. With budget airplanes expanding their presence in various markets, it also bodes well for the leasing business.

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Freelance journalist