BOC Aviation readies IPO for takeoff

The upcoming initial public offering of Bank of China’s aircraft leasing business could help to establish a whole new asset class in Asia.

Bank of China, the country’s fourth-largest lender by assets, has started pre-marketing an initial public offering in Hong Kong of its aircraft leasing business, which could potentially open up a new asset class for Asian investors.

The launch of investor education on Monday means BOC Aviation is likely to come ahead of CDB Leasing and Minsheng Financial Leasing, which are both also preparing to float their shares in Hong Kong. 

Bankers said the equity offering could raise as much as $2 billion and will comprise new shares and existing shares sold by Bank of China. BOC Aviation will have a pre-shoe free float of 30% immediately after listing. If all goes well, the deal could see light in late May.

Despite the fact that aviation leasing companies are frequent corporate bond issuers in Asia, the business is a relatively new sector for equity investors because there is hardly any pure-play aircraft leasing company listed in Asia, in spite of the strong underlying fundamentals.

Asia is widely seen having the most lucrative prospects for the aviation industry because of its huge and growing middle class, rising disposable incomes, and growing taste for international travel.

According to Flightglobal statistics, annual deliveries of aircraft to mainline airlines totalled $100 billion for the first time last year. Asia-Pacific carriers accounted for nearly half of the 1,367 aircrafts delivered globally last year, investing more than $43.5 billion.

The expansion of Asia’s aviation industry has also led to a rise in aircraft leasing in the region. According to Flightglobal, four of the world’s top 10 aircraft lessors by fleet size are headquartered in Asia.

History

Established in 1993, BOC Aviation was formerly known as Singapore Aircraft Leasing and majority-owned by Singapore Airlines, Government of Singapore Investment Corporation, and Temasek Holdings.

In 2006, Bank of China purchased the entire company for $965 million. The transaction was the first major outbound acquisition by a state-owned Chinese bank and formed part of the lender’s strategy of expanding outside its traditional banking business.

Bank of China paid a price that at the time valued the leasing company at a hefty 27.8 times earnings. But that premium appears to have been justified because net income from the business has risen nearly nine times since the buyout, outpacing the lender’s earnings growth of about four times over the same period.

BOC Aviation has since also grown its portfolio from $3.1 billion to $10.2 billion as of the end of last year, while its fleet size has quintupled from 105 to 511 aircrafts.

It is currently Asia’s largest and the world’s fifth-largest aircraft lessor by fleet size.

Financing

Over the years BOC Aviation has adopted a strategy of acquiring aircraft at low cost during market downturns and leasing them out on long-term contracts or selling them with leases attached once the market has recovered.

Bank of China, naturally, has played a vital role in providing low-cost financing to accomodate that strategy.

According to BOC Aviation's preliminary prospectus, its parent has provided a $2 billion unsecured credit facility -- roughly one-fifth of the aircraft lessor's total asset value -- until 2022. Such a credit facility relieves a large part of BOC Aviation's funding pressures and enables it to avoid having to sell aircraft in soft markets.

Thanks to the backing by its state-owned parent, BOC Aviation has an investment grade credit rating of A- from both Standard & Poor's and Fitch. It is the second-highest credit among global aircraft lessors, trailing only CDB Leasing, which is rated A+/A+/A1.

In addition to the Bank of China credit facility, BOC Aviation uses bank loans and debt financing to help fund its operations. These account for 38% and 36% of the company's current funding of $9bn, according to its preliminary prospectus.

BOC Aviation is a frequent issuer in the debt capital markets, having raised $750 million from a five-year 144A offering in May last year and another $750 million from a 10-year Reg S/144A issue last week.

The diversified funding sources have allowed BOC Aviation to maintain a low funding cost of around 2% over the past three years. By comparison, market leading aircraft lessors such as Dutch-based AerCap and US-headquartered Air Lease have a funding cost of at least 3.6%.

Valuation

Fair value of the business is estimated to lie between $4.2 billion and $5.3 billion, according to BOC International, one of the joint sponsors of BOC Aviation's IPO. The other joint sponsor Goldman Sachs has given a wider fair value range of $3.9 billion to $5.4 billion, implying a price-to-earnings ratio of 8.0 times to 11.1 times for the 2017 financial year. 

On a price-to-book basis it will be valued at between 1.12 times and 1.57 times book value in the current financial year. 

That places BOC Aviation at a slight premium to global aviation leasing companies, which on average trade at 7.6 times 2017 earnings and 1.09 times price-to-book, according to Goldman Sachs. But assuming the IPO is priced at a slight discount to fair value, it will probably mean BOC Aviation settles at a price that is similar to its global peers.

Some analysts argue that the company's business model of asset leasing makes it a good income-generating instrument.

Based on Goldman Sachs's fair valuation, the company has an implied earnings yield of 8.6% to 12.0%. That is richer than the average 7% yield for Singapore-listed real estate investment trusts, which are often regarded as the most popular yield-generating assets in Asia.

Risks

Investment in the aircraft leasing business comes with lower risks compared with direct investment in airlines, which are prone to external market conditions such as air travel demand as well as oil price and foreign exchange fluctuations.

But BOC Aviation faces other risks including industry competition and interest rate fluctuations, according to aviation analysts.

Compared with other global aircraft lessors, BOC Aviation has a higher exposure to Asia where it generated half of its leasing income last year. Four of the company's top five customers are Asian carriers (Cathay Pacific, Qantas, Thai Airways, and Lion Air).

That exposes the company to rising competition from local Chinese lessors, potentially pushing down lease rates and thus profitability in the sector. 

According to Ascend, the number of leased aircrafts in China has grown at a compound annual growth rate of 37% over the past five years, compared with 4% globally.

Meanwhile, DBS noted that BOC Aviation is partially vulnerable to higher interest rates because it has not perfectly hedged its leases with its loans.

"In the longer term, BOC Aviation could also be vulnerable to interest rate volatility if it cannot balance fixed and floating rate debt to match its own fixed and floating rate aircraft leases," the Singaporean lender said in a company research report this week.

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