Interview with Valentine Flynn

Director of Aldus Aviation Fund

Aldus is an aircraft leasing business. This isnt something we hear much
about.
Thats not an uncommon response from investors because it isnt a business that
people encounter in their daily lives even though they all fly from time to
time. Commercial aircraft are expensive items that require financing and
increasingly that finance is provided by leasing companies that specialise in
aircraft. Airlines are in the business of selling seats and moving people and not
owning aircraft and whilst they typically own some of their fleet an increasing
proportion of the planes they employ will actually be owned by leasing
companies.
Why is that?
Airlines make money by flying passengers. They do not necessarily need to
own aircraft they know what planes they require for which routes and when.
A leasing company is in the asset owning business and will buy, lease and sell
planes all the time and therefore has a remarketing ability and as airlines
inevitably need to change the mix of fleet from time to time they need the
flexibility to do so, and leasing provides them with that capability. Leasing
companies are also typically more efficient at financing themselves than many
airlines and leasing has accounting and balance sheet advantages. About 40% of
the global fleet is leased and that figure is rising. Think about office buildings.
Most businesses need one but they dont need to own them to do what they do.
So why dont we hear more about this business?
Again the answer is pretty simple. Most leasing businesses are owned by
financial institutions so investors have only very limited opportunity to make a
direct investment and gain exposure to the sector. There are some listed aircraft
leasing companies however we are not convinced that this is a public business
or indeed that a listing is needed. Indeed the performance of some listed leasing
businesses hasnt been that impressive largely because they are listed. Leasing

is a long term business (most leases are 8 years or longer) and this does not sit
very easily with short term trading in public stocks.
Is it a good business to be involved in?
We think so - provided you have a strategy. Over the years it has been one of
the most consistent of investments. This may come as something of a surprise to
people however there is plenty of available data to prove that aircraft leasing
has outperformed many other investment classes. Air travel is a massive and
growing global industry (with airlines being the most visible part) which will
continue to expand for many years the planet has a population of 6bn yet only
1bn fly. Increasing numbers of aircraft are needed and with the banks
effectively dormant leasing has become a very important part of the finance
supply chain.
It sounds very technical and complex. How does an investor get to
understand it all?
There is a short answer and a long answer to that question. The short one is the
investor doesnt need to. Im sure some of your readers own shares in drug
companies. Im equally sure these investors know nothing about drug design they rely on the performance of the products and make a judgement. Likewise,
an investor should look at our management team and its track record just like he
would any investment manager.
The longer answer is this: one of the interesting things about the business is
explaining to investors that it is actually very straightforward to understand.
There is no great mystery - nor any need to be an aeronautical engineer.
Think about it for a moment. There are 3 or 4 manufactures producing a small
number of aircraft types (models that are typically leased that is) for some 400
customers across the world. These are mobile, liquid assets with a working life
of 25 years or more that hold value and can be employed anywhere in the world.
There is good visibility around the business and in some senses it is easier to
predict what an aircraft will be worth in 5years time than any given bond or
share or indeed property for that matter. Of course the industry is cyclical but
managed properly a leasing business should generate returns through the
business cycle. Most of it is common business sense and we apply four basic
rules make sure we buy the right planes at the right price, look after the

aircraft properly to maintain values, lease the aircraft to better quality airlines
and make sure that financial risk is managed.
If its so simple and profitable why isnt everyone doing it?
The reason is that leasing companies need access to capital and to get that
access they need to be of sufficient scale which is why the larger leasing
companies tend to be part of, or associated with, financial institutions and thus
out of the public eye. These companies place large orders with Boeing and
Airbus and own a variety of different aircraft models bought from these two
manufacturers. In the main these companies are driven by scale and that is their
principal strategy - size. In our view there is no reason to invest capital in
aircraft leasing unless you have a strategy that differentiates your business from
the bigger players. We would not contemplate attempting to compete with these
businesses in the Boeing and Airbus markets. We have a differentiating strategy
and that is why we have succeeded in establishing Aldus as a relatively small
specialist leasing business. I hesitate to use the word unique but we do
genuinely have a very different approach.
So tell us about Aldus.
Thank you. Id be delighted to I thought you were never going to ask!
Rather than going into the usual this is who we are and this is what we do Ill
start with a quick story which really explains more about the business than any
spread sheet or power point presentation might do.
That makes an interesting change.
Back in 1999 Steve Gorman our now CEO bought some aircraft from a
relatively unknown manufacturer to lease to an airline. The manufacturer
explained that they had a plan to design and build a completely new aircraft
type being a series of jet aircraft that could carry between 70 and 120
passengers. Steve, Phil and Ciarn , now our Chairman and COO respectively,
followed the process from design, to prototype to the plant being built and the
first plane being delivered in 2004 and realised that this was something special
an industry game changer that not even aviation insiders such as airlines and
bankers had fully appreciated.
As importantly they also realised that this was an excellent asset to own and
lease - for reasons Ill come onto in a moment. They were convinced that this

plane was going to be a great success and that the aircraft leasing community
were not alert to the opportunity. They were right on both counts and so Aldus
was created to be a dedicated owner of these aircraft.
The manufacturer was Embraer of Brazil and the plane the highly regarded E
Jet. Since 2004 the E Jet has gone on to become one of the most successful
product launches in aviation history exceeding even the Airbus A320 in sales
growth and with over 1000 ordered the E Jet is now employed by 60 airlines in
40 countries and flown by the majors such as BA,KLM, Air France and
Lufthansa amongst others.
What is so special about the E Jet?
Embraer analysed the aviation market and realized that 70% of take - offs
globally carry 100 people or less. There were no modern aircraft designed for
that particular market place. Existing types were either heavier (larger) aircraft
which were shortened to fit that market place, or lighter types stretched to take
more passengers. The result was heavy and fuel inefficient planes, or
uncomfortable aircraft with operational limitations.
Embraer decided to design a brand new plane, the E-Jet, which first took to the
skies in 2004. The E-Jet is an aircraft optimally designed to fly 70- 110
passengers. It has become a once in a generation event namely a successful
brand new commercial aircraft design.
The E- Jet represents state-of -the-art aviation design and technology. It offers
great passenger comfort with two and two seating, (doing away with the
unpopular middle seat) and spacious luggage compartments. Most importantly,
it is by far the most economically efficient alternative in its market segment
When this aircraft arrived was it was a completely new concept and many were
surprised at how quickly it became a success. However in the financial turmoil
following the Lehmans crash and as fuel prices went up and passenger numbers
declined the airlines began losing money. They clearly had a problem.
Embraer said you have to buy the right airplane for the right route. To be a
profitable airline you have to be clever in what equipment you deploy. And for
so called long thin routes (intra continental for example) there is really nothing
to beat it and nor will there be for some time to come.
The E-Jet is now seen as a standard component of an airline fleet. At one level
its an aviation industry story and that its a great success story is not in

question. However the key issue here is what does it mean for the investors?
The first point is that the E-Jet is an aircraft in high demand with limited
competition. That means that if one airline lessee is having problems we wont
be stuck with an airplane that we cant reemploy. Its a good product to finance.
The other point is that the banking crisis is resulting in a lack of finance in
aviation, perhaps even more so for a new product like the E-Jet. If we are in the
market with capital available, we can secure good lease rates from operators and
thus good returns for our investors.
To summarise, its a very good aircraft and more importantly a particularly
good product to be financing. We have strong credit support, good earnings and
the ability to reemploy the planes in case of a problem with a lessee.
You actually say in your business plan that you welcome competition?
Maybe we should rephrase that. The point is that we arent worried about
competition. When we started the business it was pretty much just us, nobody
was specializing in the same way. This was our strength and continues to be so.
Competition does not really impact us because we have most of our leases in
place or they will be in the very near term, and equally the more players who
are involved in the market, the more activity and liquidity there is. We have a
quite limited target of 30 aircraft in the portfolio which we will achieve this
year, and we can't see anything stopping us from getting to that target. We have
good debt facilities and a pipeline of aircraft coming through and there is room
for more leasing companies who wish to buy E jets which they are now doing.
What are the principal risks in this investment?
As management we are obsessed with taking as much risk off the table as
possible. I think we have largely achieved that, however we are not complacent.
We as management are in this business alongside investors and are equally as
keen to minimise risk. I mentioned four basic rules. They are obvious rules that
could apply to any investment in physical assets. Dont overpay, make sure you
have the right planes, look after them and get your financing structure right.
I hope Ive managed to explain why we believe that in backing the E jet series
we have chosen an asset that takes a lot of risk out of the equation. We have
been and will continue to be careful in selecting our airline customers and with
a spread of 30 E Jets across 12 airlines in 10 countries will have significantly

diversified our credit risk. If we do happen to get a default (and we

traded right through 2009/10 when issues did arise and were managed) we
should have little difficulty releasing or selling because the planes are and will
continue to be in demand. We have a policy of not leasing more than three
aircraft to any individual airline, and we spread ourselves across different
countries to minimize country risk. We do not lease into the US because of
Chapter 11 issues.
Our maintenance procedures are very precise, and all our aircraft have to be
kept in full life condition which means that when returned to us they are
essentially as good as new. Airlines are obliged to pay us cash maintenance
reserves to collateralise this obligation.
Our capital structure is also well managed. We have match funded leases to debt
so that we have no refinancing exposure and no currency or interest rate risk
either. We have only very limited banking covenants.
Im not saying we are risk free. No investment is but we have taken as much
risk out of this as we possibly can and on a risk adjusted basis we think the
returns we offer are really double digit income for single digit risk. Thats not
very scientific but we have delivered 11-12% cash dividends since Q12008 with
no volatility in the price of our planes and I think that is pretty good testimony.
There arent too many fund managers that can say that whatever the asset class.
Lastly, we have a pool of existing investors that includes some very successful
private and institutional equity. These people are smart investors and we have
been subject to considerable scrutiny and due diligence as regards both our E jet
strategy and our management and reporting infrastructure.

Talk about the specifics of the investment.

Aldus is headquartered in Ireland (where some 50% of the global aircraft leased
fleet is owned and 9 of the top 10 leasing firms located) with a representative
office in London and has a total staff of 14.
Aldus was established in 2007. It presently has a fleet of 19 E Jets with three
deliveries pending. It has good quality long term debt facilities to facilitate
growth to 30 aircraft and has a pipeline of leases in negotiation.

New shareholders joining now get into an existing business with start-up risks
and costs absorbed and a strongly performing portfolio in place. Existing equity
gains from expanding the portfolio because of greater scale and diversification
of risk and both gain from the enhanced possibility that as other leasing
companies move into E Jets a buyer will bid for the book at a premium. They
might do so because frankly assembling a portfolio like ours is quite hard work
and the bigger leasing companies prefer to place large orders.
Aldus is very precisely governed. We are an illiquid investment and in
recognition of that we have introduced an unusually high degree of governance
and transparency to protect our shareholders.
What this means is that the business model cannot be varied in any material way
without 75% shareholder approval. We exist to receive rental payments from
airlines, pay down debt and distribute surplus proceeds to shareholders. As
aircraft come off lease they will be sold and capital returned unless shareholders
vote otherwise. Management gets paid after the fund is wound up and
shareholders return targets met.
This is very important for shareholders to understand. We have created a fund
not a leasing company and this is a very precise and transparent vehicle. We as
managers have no ability to suddenly decide to pursue some other strategy or
retain dividends to expand the business. We exist as a stream of fixed
predetermined cash flows.
What returns can investors expect?
We have paid cash dividends of 11-12% for the last four years and we see no
reason why this will not apply for the duration of the fund. As debt is paid down
and the value of our fleet increases relative to debt we will see returns of 15%
which is in line with what has happened to date. If a buyer bids at a small
premium that might well go to 20%. For the time being we are focussed on
paying dividends of 10-12%.
Investors should really think of us not as a business as such but more as a fixed
income bond with predetermined cash flows with upside equity potential. Some
might say like a real estate investment but I think we are actually better than
that because we have a pretty unique position in a special asset class. We are not
correlated to the equity or bond markets, we are globally diversified with a

liquid and mobile asset and have performed exactly in line with expectations
despite the onset of the financial crisis in 2008 when we had just started.
Management has demonstrated judgement and execution capability in
establishing and expanding Aldus in challenging financial markets and with a
good investor base being a mixture of high net worth investors, family offices
and more recently institutional investors and first class term debt facilities I
think we have done reasonably well.
If you were to leave investors with one thought what would that be?
Business people look for market gaps to exploit or they create demand for
something that didnt exist before, like Apple with the I Pod.
Embraer did a bit of both in developing the E Jet to fill a very clear gap being
the need for up to 300 mid-sized aircraft a year for the next decade. There is
insufficient manufacturing capacity, existing or planned, to meet this need.
Aldus identified a different gap being the need for finance. We dont see that
gap being filled in a hurry either. The combined effect will see Aldus continue
to make returns for its shareholders with a business model underpinned by good
quality, in demand assets. Weve not changed our views since we conceived
Aldus in 2006 and see no reason to do so now.

Thank you to Valentine Flynn of Aldus for coming to see us.

Thank you.