Frost & Sullivan Market Insight: Helicopter Market Trends

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Helicopter demand from both military and civil end-users is still strong; the issue is about funding and finding the relevant business model to acquire new rotorcraft. New solutions are emerging with commercial models being leveraged within the military segment.

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Frost & Sullivan Market Insight: Helicopter Market Trends

  1. 1. “We Accelerate Growth”Helicopter Market Trends: Finding Suitable Business Models for Military Helicopters AcquisitionAlix Leboulanger­—Defence Research Analyst
  2. 2. Helicopter Market Trends: Finding Suitable Business Models for Military Helicopters AcquisitionMarket Insight© 2013 Frost & Sullivan Page 2IntroductionSpring 2013 has been an interesting season for helicopters. Weekly news on rotary wing market development has often beencontradictory. Is the market going up or down? Have we reached the renewal cycle peak and do we now expect orders to fall?Sequestration has not only already impacted Chinook and Apache upgrade plans, causing significant delays, but also put theUH-72 Lakota program on hold. In Europe, economic uncertainties also impacted the military NH90 TTH program in Francein April 2013, with 34 unconfirmed orders, and Eurocopter Executive Vice President Dominique Maudet announcing that adelayed contract was still better than an early terminated one. At the end of May 2013, the NH90TTH deal was finally inked inFrance and lobbyists in the U.S. raised hopes that a deal for Lakotas would be revived.The uncertainty surrounding Western military programs and the resulting pessimism is in stark contrast to commercialhelicopter developments. The industry is buoyant, optimistic and orders are on the rise, with the most notable order atHeliExpo; Milestone Aviation placed a $1.75 billion order for 74 platforms. More recently, MSD Capital, L.P., Soros FundManagement LLC, and Cartesian Capital Group have secured $375 million of equity growth capital toWaypoint Holdings, whichowns Waypoint Leasing, one of the biggest helicopter lessors.For many observers it would be easy to conclude that commercial helicopters are flying toward new optimistic skies, whilst themilitary helicopter market is stagnating between delays and cancellations. When combining military and commercial helicoptersrevenue, there would not be any ups and downs, just a flat trend in a grey world.But the reality is different. Helicopter demand from both military and civil end users is still strong; the issue is about fundingand finding the relevant business model to acquire new rotorcraft. New solutions are emerging with commercial models beingleveraged within the military segment. Furthermore,beyond traditional government-to-government and government-to-industrycontracts, end users from emerging powers have developed new financial approaches to keep their military fleet renewed.Transposing Commercial Business Models in the Military WorldApart from traditional fixed-price and cost-plus contracts,military procurement agencies are increasingly interested in platformssold off the shelf: the Commercial-Off-The-Shelf (COTS) business model inherited from the commercial sphere has broughtflexibility to military end users across a market suffering from severe budget cuts. Providing an efficient way to bridge the gapat a lower cost between old platforms getting retired and upcoming ones, COTS contracts are a salutary option for stretchedfleets and urgent operational requirements.However,COTS contracts have inherent downsides:with little room left for platform customisation,they reduce the operationaladvantage of armed forces if platforms are not tailored. The value for money is there, but not the tactical benefit. Of course,further modifications can still be made at the platform level to keep the strategic upper hand but at a higher cost than theoriginal investment price, as illustrated in 2007 with the United Kingdom Ministry of Defence upgrading eight of its Mk 3Chinooks. So, the question is whether there is any financial interest for end users to acquire through COTS advanced militaryplatform. Probably,but then only in the perspective that COTS are a satisfactory solution to be used when acquiring non-criticalcombat complex platforms, otherwise the financial gain is cancelled by expensive new customised requirements.To solve the challenging money-capability equation,organisations should consider long-term leasing agreements,another popularcommercial model. While Western commercial end users are also heavily impacted by the financial downturns, leasing allowsthem to reduce capital expenditures and stimulates their operating profits.Lessors are forecasting a growing demand for leasingmedium helicopters, as illustrated by recent Waypoint Aviation and Milestone Aviation deals.Long-term leasing agreements are flourishing among the Oil & Gas and business aviation sectors, where the demand is stableand operating profits are predicable. If the original prerogative was to stick to productive private markets, lessors have recentlytaken more risks with a focus on the public sector. The taxpayer can easily get used to the idea that the government will payless for acquiring and sustaining helicopters to be deployed for Emergency Medical Services (EMS) missions, police duties orfirefighting operations. The $2.40 billion contract for United Kingdom Search and Rescue Operations awarded in March 2013
  3. 3. Helicopter Market Trends: Finding Suitable Business Models for Military Helicopters AcquisitionMarket Insight© 2013 Frost & Sullivan Page 3to American Bristow Helicopter illustrates this new trend. In order to meet SAR mission requirements, Bristow has announcedthat the majority of its dedicated fleet will be leased. Private equity groups investing in helicopter leasing have more thanwelcomed this news. Fulfilling essential services can be the sign of long-term and steady engagements with governments, whilethe administration may perceive leasing agreements as a holistic solution to solve their lack of finance:• Reducing upfront acquisition costs• Improving new systems integration spending• Having a positive impact on the total lifecycle management of the fleetParapublic helicopters are performing extremely demanding missions in very short turnarounds; they are hence having a usagerate much higher than Oil & Gas helicopters and consequently a lower financial value after 10 years of service and depreciation.Unless the leasing terms and conditions are specifically tailored for parapublic missions, standard leasing agreements with sales-back option can be risky for governmental entities. Indeed, it is frequently observed that commercial leased helicopters aregenerally sold to the lessee at a higher price than their acquisition one. Consequently, if the government has committed itself tobuying the platforms at the end of the lease, the lessee’s full attention should be dedicated to initial agreed terms, such as salesfixed-price and maintenance requirements during the lease, in order to keep leasing agreements as a viable solution.Moving forward, could government adoption of leasing models for emergency services be the start of a broader trend thatincludes the leasing of rotorcraft to military end users? This seems bold but is already happening in Australia, where the Navyis operating three training helicopters leased from Raytheon Australia.Australia also leased in 2012 several helicopters to PapuaNew Guinea Air Force. Whilst military leasing contracts are not uncommon—for obvious and sovereign reasons long-termleasing agreements will stay confined to the military training world for a long time—military end users are getting familiar withthe concept of outsourcing to the industry, and yet they remain fundamentally reluctant to it. The growing adoption of C4ISRcapabilities and tactical data management airborne systems prevents expansion of leasing agreements to military helicopters.Since each of these solutions from the commercial side is not providing a full and efficient acquisition business model, is thereany experience from military end users that could be leveraged?Alternative Military Business Models: A BrazilianTaleLeading military powers facing budget threats could take inspiration from transitioning economies as these nations are alsolooking to find the right balance between finance and capabilities. Considering the acquisition contract by itself and regardlessof offsets or Foreign Military Sales, recent Brazilian procurements provide an interesting example with loans. In 2009, whenBrazil signed for the license to locally produce 50 Eurocopter EC 725s for $2.40 billion, six French banks were financing thesecontracts. History repeated itself a few years later in 2012, when the U.S. Export-Import bank accorded a $75.7 million loan tothe Brazilian commercial operator Lider Taxi Aero SA when it acquired three Sikorsky S-92s. Finally, in April 2013, the Brazilianstate of Para contracted a credit loan toward the National Bank for Social Development to buy two Helibras AS350 Squirrelsto perform Homeland Security missions.Conversely to the previous business models highlighted above, contracting loans to acquire new capabilities is less challengingin terms of available platform and customised mission requirements. It provided enough financial visibility to both the OEM andthe end user, with fewer risks of program cancellations and reduced orders.On one hand, by time of crisis, late payments sound better than no payments, to paraphrase Dominique Maudet. This approachis flexible enough to stand various volumes of orders, and also spare OEMs backlog and revenues management. But on theother hand, pessimists and rigorous budget holders will disapprove credit loan and helicopter mortgages, especially for defencepurposes, since military power cannot be subject and dependent on financial vagaries, and even less on foreign currency.But then, it is a question of doctrine, of government choices and of assets diversification to reduce risks.
  4. 4. Helicopter Market Trends: Finding Suitable Business Models for Military Helicopters AcquisitionMarket Insight© 2013 Frost & Sullivan Page 4Nevertheless, since a few financial firms are also becoming indirectly helicopter OEMs, such as the American investment fundPatriarch Partners owning MD Helicopters or the Chinese Chongqing Helicopter Investment Co. that has recently acquiredEnstrom Helicopter Corp., it would not be surprising to witness the creation of internal, innovative and complex financialvehicles to theoretically ease helicopter acquisition and new, emerging helicopter markets. If current helicopter trade patternsare not there yet, it would be worth it to keep in mind this potential new approach.ConclusionWhile the U.S. has unexpectedly postponed the Armed Aerial Scout Helicopter Program decision to late summer 2013 andGermany has drastically reduced its initial Tigers and NH 90s orders, there is still an urgent need to upgrade ageing militaryhelicopter fleets; military end users could then potentially find alternative acquisition business models, depending on theirinternal strategic plans and defense requisites.Figure 1: Standard and Unusual Contracts for Military HelicoptersModel Strength Weakness Opportunities ThreatsFixed-TermContractMost standardizedacquisition businessmodel and henceremains the bestway to ensure enduser’s independenceDoes not offer sufficientguarantees to customerswhen acquiring a newun-built helicopter type(i.e.,Canada CH-148 Cyclone)Most suitable forsmall and mediumvolume of orders andurgent operationalrequirementsNot flexible enoughto stand paymentdelays and newplatform extrarequirements notsubmitted initiallyCost PlusFeeContractProvide holistic framefor new platformdevelopment whencapability requirementsare not fullydetermined originallyThe OEM is toodependent oncustomer end-product(subjective) appreciationand fee determinationStimulate growingand/or strugglingdomestic industrialassetsDiminishing defensebudgets are less ableto stand programoverruns and delayedplatform availabilityLong-TermLeasingContractDrastic reductionof price acquisitionand total platformcost ownership, withclear advantagesfor helicopterfleet sustainmentLack of visibility on certainreimbursement termsand conditions in caseof platform destruction,casualties, etc., andconfidential security dataprotection managementduring and after contractDepending onsales back optionagreed term, it canbe a good fleetmanagement andrenewal tool to keepa modern advancedhelicopter fleetNeed to be tailoredto meet fleetavailability high ratein order to meetdemanding missionsand around-the-clockrequirementsNo profit margin tobe expected whenplatforms sold back(if military)LoanContractProvide moreflexibility in thepayments termsand a good timemanagement visibilityfor both partiesEnd users, especially ifmilitary, may lose theirfreedom of action whilereimbursing the rentMake possiblesignificant volume ofnew procurementsMilitary statesovereignty does notnecessarily marrywell with creditpayments obligationsand timeline
  5. 5. About Frost & SullivanFrost & Sullivan, the Growth Consulting Company, partners with clients to accelerate their growth. The company’sGrowth Partnership Services, Growth Consulting and Career Best Practices empower clients to create a growth-focused culture that generates, evaluates and implements effective growth strategies. Frost & Sullivan employs morethan 50 years of experience in partnering with Global 1000 companies, emerging businesses and the investmentcommunity from more than 40 offices on six continents. For more information about Frost & Sullivan’s GrowthPartnerships, visit http://www.frost.com.www.aerospace.frost.com877.GoFrost (877.463.7678) • myfrost@frost.com • www.frost.comCONTACT USHelicopter Market Trends: Finding Suitable Business Models for Military Helicopters AcquisitionMarket InsightAs a result, standardized business models are not sufficiently equipped to stand drops in funding and scared budget holders,whereas common practices in the commercial helicopter market are not (yet) built to meet Homeland Security and Defencetactical and strategic operational requirements. This may be a question of time, as it has been initially the case for Performance-Based Logistics/Contracting for Availability agreements to ease aircraft sustainment costs. Additionally, private finance initiatives(PFI) could also be the way forward, depending on country budget organisation and private available resources. But then again,there would still be an inevitable obstacle, state sovereignty, which restrains private initiatives in many regions around the globe.So instead of thinking of transposing commercial business models into the government world, helicopter OEMs have to beprepared for military end users only looking to consolidate their existing assets: recycling and upgrading old choppers that haveproved their efficiency. Surplus, second-hand platforms and low-cost helicopters will be another fight, but this is another story.To learn more about this report, please contact Andrew.Thorndyke@frost.com or Alexander.Woods@frost.com.

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