The HNA Group has agreed to sell a 30% stake in aircraft lessor Avolon Holdings to Orix Corp of Japan for US$2.2 billion, and this move represents another important element in the group's ongoing programme of debt reduction. Other commercial advantages are envisaged for the tie-up.
Despite this need to rein in debt, the move was still considered a surprise in some quarters, since some analysts regard aircraft leasing as one of the core activities of the HNA Group. However, the sale of the stake helps with the company's deleveraging process while still maintaining control of Avolon.
Avolon had been a wholly owned subsidiary of Shenzhen Stock Exchange listed Bohai Capital, which was 52% owned by HNA Group. Trading in Bohai Capital shares was suspended in January, and when trading began again in late July they suffered a big drop in price.
In 2015, Bohai acquired Irish lessor Avolon for US$2.5 billion. The following year, in 2016, Avolon agreed to acquire the commercial aircraft leasing arm of CIT for US$10.4 billion. This created the world's third largest aircraft lessor, with only General Electric unit Gecas and Amsterdam-based (though US listed) AerCap ahead in the rankings.
Although the sale of a stake in Avolon has been driven by pressure to deleverage the HNA goup, the tie-up with Orix does have some strategic advantages.
These benefits were articulated by Avolon CEO Domhnal Slattery during an interview on Bloomberg TV. He insisted securing an investment grade rating was imperative, and that having Orix as a new shareholder would accelerate the move to investment grade.
Indeed, as soon as the transaction was announced, Moody's Investors Service began to review for upgrade the Ba2 corporate family rating of Avolon Holdings Limited and the Ba3 senior unsecured ratings of its subsidiaries Avolon Holdings Funding Limited and Park Aerospace Holdings Limited. Slattery also pointed out that the $2.2 billion proceeds would be used at Bohai Capital level, rather than flowing through to HNA. This would result in lower leverage at Bohai, which in turn would help the Avolon rating, he insisted.
He views the new 70:30 shareholding structure operating for the long term, since HNA has said that it has no desire to sell a controlling stake in what it views as a core segment of group strategy.
Over the past twelve months Avolon has appeared well insulated from the problems at HNA, pressing ahead with new syndicated bank loans and bond offerings. However, last year analysts raised concerns about a $365 million intercompany loan from Avolon to Bohai Capital. Nevertheless, this loan was quickly repaid, and Avolon made it clear to bank lenders and bond holders that further intercompany loans were not envisaged.
Avolon has a fleet of 890 aircraft, with a focus on new aircraft. The Orix platform differs by focusing more on mid-life aircraft, so the two separate patforms have little overlap. And there will be opportunities to collaborate in the Japanese Operating Lease (JOL) market, sourcing aircraft from the fleet that can be sold to corporates and institutional investors, as well as Japanese Operating Lease with Call Option (JOLCO) products for SMEs and High Net Worth Individuals.
This business model featuring JOLs is already being employed by rival lessor SMBC Aviation Capital, which is owned by Sumitomo Mitsui Banking Corporation, Sumitomo Mitsui Finance and Leasing Company and trading house Sumitomo Corporation.
Tokyo headquartered Orix provides aircraft operating leases to airline companies around the world, and provides a range of aircraft lease investment services to customers who are interested in aircraft investment, from contract procedures through to management during the contract, and divestment activities. Orix is also active in shipping.
The surge of Chinese money has been the main driving force in the global aircraft leasing market in recent years, so the problems at HNA have given Japanese lessor Orix the opportunity to make a rare push in the opposite direction and buy a stake in a Chinese business.
The problems at HNA stem from the spending spree during 2015 to 2017, when the company amassed huge debts, totalling US$93 billion at their peak. Under pressure from the central government in Beijing, HNA has been undertaking a programme of asset sales, and has had the good fortune of selling into a rising market in most asset classes.
Disposals include stakes in Hilton Grand Vacations, Park Hotels and Hilton Worldwide, and plots of development land at the former Kai Tak Airport in Hong Kong. Also, in early July, Gategroup Holding AG, the world's largest provider of airline catering and on-board retail, announced that Temasek and RRJ Capital had joined HNA Group as investors. Singapore-based Temasek has an investment portfolio of around $200 billion. RRJ Capital is an Asian investment firm focused on private equity investments in China and South-East Asia, with nearly $11 billion assets under management. Temasek and RRJ Capital have subscribed to a five-year mandatory exchangeable bond which, upon conversion, will result in up to 49% of the share capital of Gategroup.
Turning once again to a possible Avolon upgrade, in a statement Moody's said that the review was based on the significant investment commitment by Orix, a strategic investor with a strong credit profile, as well an expected reduction in Avolon's governance risks relating to its financially weaker parent, Bohai Capital, and its controlling shareholder, HNA Group. Orix's influence on Avolon's strategy and operations - through its appointed directors on Avolon's board – will also be factored in.
Additionally, Moody's expects that Orix's investment will lead to business and funding synergies. This assessement is based on Orix's established strength in aircraft finance through operating subsidiary Orix Aviation and its relationships with investors and airlines. The ratings review is also supported by Avolon's franchise strength as the third largest company in the commercial aircraft leasing sector, as well as its solid profitability, effective liquidity management and capital strength.
Moody's wrote that the Avolon minority interest sale would result in a reconstitution of Avolon's board of directors to include representation by Orix, and this would provide an effective counterbalance to the influence of Bohai and HNA over matters of concern to Avolon's creditors.
Orix will name two directors to Avolon's new seven member board, while Bohai will name three directors; Avolon's chief executive Domhnal Slattery will serve as executive director and the shareholders will agree on the appointment of an independent director.
Voting will be categorised into board reserved matters, requiring a simple majority vote, and shareholder reserved matters, requiring unanimous consent of shareholder directors regarding items including budget and business plan, financial transactions and expenditures above certain limits, and related party transactions. Moody's also expects that the transaction will improve Bohai's financial condition, further reducing risks to Avolon's financial stability.
Moody's anticipates that Bohai will use proceeds from the transaction to repay debt issued by intermediate holding companies that constitutes double leverage. Moody's also believes Bohai will continue to pursue other initiatives to improve its funding structure and reduce leverage. Orix's established operating expertise in aircraft finance and strength of relationships with airlines and investors globally is expected to provide Avolon with new leasing opportunities and enhanced access to capital in the Japanese financial markets.
Orix oversees a portfolio of $10 billion of leases on 200 aircraft, approximately 75% of which are managed on behalf of others. Orix maintains customer relationships with airlines that have above average credit quality, reflecting its investors' low credit risk orientation. Importantly, Moody's believes that Orix is strongly committed to Avolon achieving an investment grade financial profile.
