Thursday, June 13, 2013

For Airbus and Bankers, Big A340s Pose Sizable Risks: Airlines Shun the Jets, Citing Operating Costs; Financing Terms Threaten Losses

Updated June 13, 2013, 6:50 p.m. ET


The Wall Street Journal

As Airbus prepares to celebrate as early as Friday the first flight of its A350, which already has attracted more than 600 orders, the European aircraft maker and its bankers are facing what could be hundreds of millions of dollars of losses on the new airplane's failed predecessor.

In 2002 Virgin Atlantic Airways Ltd. founder Richard Branson unveiled the first big Airbus A340 jetliner at a glitzy spectacle, with supermodel Claudia Schiffer on hand to draw attention to the $200 million plane.

Last fall, however, Virgin sent the huge jetliner back to Airbus, with its metallic silver-and-purple exterior repainted generic white. Now, Airbus is negotiating to sell the plane to a Maltese leasing company for less than $20 million, a steep markdown, according to people close to the talks.

Virgin isn't alone in ditching its big A340s. Leading airlines from Canada to China have unloaded the massive planes after just a few years of use, and new takers have been few. The four-engine intercontinental jets cost too much to operate, the airlines say.

"Unfortunately," says Akbar Al Baker, chief executive of Qatar Airways, the A340 isn't an old car "that you can just throw away." He said a deal to shed the four A340s that Qatar owns collapsed because the potential customer wanted extra cash to take the planes.

Plunging A340 values are hitting major European banks that finance many Airbus sales. More than 10 European banks are pressing Airbus to compensate them for losses on A340 deals or do more to find homes for unwanted aircraft, according to people close to the talks.

While Airbus, a unit of European Aeronautic Defence & Space Co., EAD. and U.S. rival Boeing Co. have both suffered recent setbacks in advanced technologies and manufacturing, the A340 faces a more-classic business problem. Airbus relied on aggressive sales campaigns and generous financing terms to close deals, say financiers involved and former Airbus officials. Now, hidden costs of those deals are coming due.

Airbus executives say the A340's current situation simply reflects market conditions and that the planes will find new users.

Airbus is financially exposed to A340s largely through guarantees it gave customers on the future value of its planes. If the resale price of the planes falls below certain thresholds, Airbus may need to make up the difference.

Nigel Taylor, Airbus senior vice president for finance, says the big A340s "got more intense financial support than other Airbus aircraft," partly because of weakness in the trans-Atlantic market after 2001, when deliveries began.

EADS has set aside more than $1 billion to cover guarantees on its products, the company said in its 2012 financial statement. It also said Airbus is "taking mitigation action to reduce the impact of asset-value guarantees falling due in the coming years relating to A340s in particular."

The continuing losses from those price guarantees come on top of the money Airbus spent developing the A340, which it stopped building in 2011.

Airbus doesn't disclose the financial performance of its individual models, but it defends the A340. The big planes "delivered the required capabilities to the operators who needed the payload and range," says Chris Emerson, Airbus's senior vice president for marketing.

Boeing also has faced headwinds selling a competing ultra-long-range version of its popular 777 model, but the U.S. aerospace company has been more conservative in the financing it offers, according to aviation bankers.

Airbus, too, has grown more cautious, partly because of the A340 debacle, current and former executives say. But the company continues to sell new aircraft aggressively, and banks facing losses on A340s complain that the new sales undercut the value of planes that they helped Airbus sell just a few years ago.

"Some of the banks involved in financing see a conflict of interest in Airbus's role as manufacturer, remarketer and financier," says Owen Geach, commercial director at IBA Group Ltd., an aviation consulting firm advising banks on A340 deals.

Airbus has tried to defuse such tensions in part by tapping a veteran salesman to focus on finding homes for returning A340s. Airbus officials concede that this may mean accepting low prices.

The A340 once looked like a low-risk project. In the 1980s Airbus developed two initial versions. By the 1990s it wanted bigger versions to compete with Boeing's new two-engine 777. In 1998, Airbus decided to expand the A340 with two larger, longer-range variants, the A340-500 and A340-600. It invested roughly $3 billion, including roughly $600 million in preferential government loans, to stretch the plane's body and develop giant new wings, Airbus and other industry officials say.

To woo hesitant customers, Airbus offered unusually generous guarantees and other terms that today are allowing airlines including Virgin, Singapore Airlines Ltd. and Dubai's Emirates Airline to walk away from dozens of the planes, executives at the airlines say. Airbus and its bankers face obligations of potentially tens of millions of dollars per plane.

"It's a sad case," says Emirates President Tim Clark. Airbus must take back Emirates's 10 big A340s because it is "locked in" to the planes' financing, he said.

The plunge in A340 values has disrupted the usual trajectory for aging jets, which are traditionally traded down the food chain from major airlines to lower-tier carriers over a period of about 25 years. But the owner's ability to finance the planes depends on expected resale prices. If demand for a particular model collapses, its owners must write down the value of the planes.

Airplane-valuation specialists say big A340s are now valued at below $20 million. But some owners carry those jets on their books at between $40 million and $140 million apiece, using traditional financial models and judgments of professional airplane appraisers, people involved in the issue say.

EADS, which had revenue of roughly $75 billion last year, says the potential hit to the company is "manageable." Its exposure is limited partly because the A340s flopped. Airbus delivered only 131 of the larger derivatives, far fewer than expected. Rising fuel prices and the Boeing 777 had killed demand by 2005.

The 777 is "a much better airplane," Airbus Chief Commercial Officer John Leahy conceded at a conference earlier this year.

EADS hasn't disclosed the financial performance of the big A340 derivatives, but outside analysts estimate that little of the initial investment was repaid.

These days, Airbus is pinning its hopes on the new A350, which appears to be on course for commercial success. But, as part of a deal in October to sell A350s to Singapore Airlines, Airbus agreed to buy back the carrier's 10 A340-500s, both companies say.

Singapore Airlines had leverage because Airbus in 1998 guaranteed the planes' resale price, and by last year their market value had sunk below the guaranty level, according to a person familiar with the deal. To cover the difference, Airbus took back the planes and compensated the carrier, this person says.

Airbus isn't the only company buying back A340s. China Eastern Airlines Corp. last year persuaded Boeing to buy its five A340-600s as part of a deal to sell it 20 new 777s. The airline said the planes had a book value of about $142 million apiece. The complex transaction with Boeing will help China Eastern avoid having to declare a substantial accounting loss, according to a person familiar with the deal.

Boeing plans to sell the decade-old A340s as scrap, this person says. In 2011 they carried a catalog price of about $275 million each, but most big A340s sold for less than $150 million, according to people in the industry.

Virgin can shed its 18 A340-600s, because it merely leased them. While leasing airplanes is common, Virgin's first several A340s were leased through Airbus itself, rather than a third party, something the manufacturer hasn't widely acknowledged.

To lease the A340s to Virgin, according to documents reviewed by The Wall Street Journal, Airbus established a company called Avaio Ltd. in the Isle of Man, a tax haven between Britain and Ireland.

Airbus limited its exposure by persuading a group of European banks to finance the Virgin deals. As an incentive, Airbus guaranteed minimum future resale prices for many of the planes. The banks are now pressing Airbus to pay up on those guarantees, people involved in the talks say.

Airbus executives say they are addressing the issue but won't discuss details.

Virgin, meanwhile, is shifting to smaller models from Airbus and Boeing. "The A340 didn't turn out to be as successful as we thought," Virgin's Mr. Branson said in a recent interview.

—Marietta Cauchi, Jon Ostrower and Joanne Chiu contributed to this article. 

A version of this article appeared June 14, 2013, on page B6 in the U.S. edition of The Wall Street Journal, with the headline: Big Jets Threaten Airbus, Bankers. 


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