The aviation industry has endured a number of exogenous shocks in its 80-year history, but none so catastrophic and potentially long-lasting as the COVID-19 pandemic. Even with announcements showing strong progress in the development potential of vaccines and other therapies, many industry participants and spectators alike are questioning what the future of the industry may hold once the pandemic’s grip begins to loosen.
In August, we sought to predict the pandemic’s long-term impact on the industry. Now, with the approval and distribution of vaccines and other therapies in close sight, we think it appropriate to take a closer look at some of the key challenges and opportunities the industry will face in the coming months and years, as the final part of our seven-part series on aviation.
Macro Trends
COVID-19 has taken its toll on wide swaths of the economy, but the impact on aviation has been uniquely severe. According to ICAO, airlines across the globe are expected to suffer up to a $392 billion loss of gross operating revenues in 2020, which in turn has been felt among all industry participants, including OEMs and their supply chains, lessors and financiers, MROs, airports and all of the other adjacent verticals that touch the sector. Although a widely-distributed vaccine would spell the end to the pandemic (and, likely, swift changes to consumer and business behavior), due to the severity of the pandemic’s effects on the sector, we expect the shock to global air travel will continue to impact industry dynamics for months and even years to come.
Changing Fleets
The makeup, age, and utilization of airline fleets is one such dynamic. Throughout the pandemic, airlines have reassessed their orderbooks and fleet composition. As domestic travel is forecasted to rebound more quickly than international travel (perhaps due to lags in lifting government restrictions and less consumer willingness to travel abroad) widebody aircraft are likely to maintain higher levels of inactivity in the near term. Some airlines may seek to repurpose these aircraft for cargo operations (we’ve seen short-lived attempts at this by various U.S. and non-U.S. airlines); more likely, however, older widebodies will be retired early as airlines seek to simplify their fleets and take the opportunity to utilize more fuel-efficient aircraft. With more than half the current global fleet of aircraft currently parked, this trend could also extend to older narrow-bodies. Early retirement of older aircraft will likely continue to cause a supply glut of used serviceable material in the aftermarket, which will negatively impact providers of aftermarket parts and MRO services. Likewise, as further discussed below, early returns of leased aircraft may have a negative impact on lessors, particularly those that are poorly capitalized or managed. However, the growth of cargo operations during the pandemic, led in part by Amazon Air’s continued expansion, as well as the growth of private aviation (much of which has been fueled by health-conscious travelers) may be vital lifelines for the industry as a whole.
The OEM Balance of Power
Although OEMs have fared worse than many airlines during the pandemic, we think the two major OEMs, Boeing and Airbus, have reason to be optimistic, for different reasons. The grounding of Boeing’s 737 MAX, which has now been lifted, by the FAA at the time of this writing provided Airbus with a unique opportunity to gain share in the single-aisle market, as Airbus’s decision to enforce deliveries potentially pressured airlines and lessors to cancel their MAX orders in response to the pandemic. Boeing, however, has reasons to be optimistic as well, given the FAA’s recent lifting of the grounding order and signaling of imminent recertification of the MAX as well as stronger-than-expected demand forecasted in Asia. Both major OEMs, however, will need to carefully consider how to stabilize their balance sheets and revamp production when demand eventually returns, which may be challenging, as many suppliers have significantly reduced capacity in response to the pandemic.
Return of Demand?
Although COVID-19 will have many long-term impacts on the aviation industry, we think it is likely that a prolonged drop-off in consumer demand will not be one of them. Industry analysts, participants and commentators suggest that pent-up consumer demand, fewer competitors and a stable fuel-price outlook may result in a full rebound by late 2021 or early 2022. Additionally, unlike prior crises such as 9/11, which resulted in prolonged uncertainty about the safety of air travel, a widely-distributed vaccine (together with the retooling of aircraft ventilation systems and the reality that even during the pandemic airline personnel did not catch the disease in greater numbers than the broader population) may put such fears to rest relatively quickly. We think, however, there is at least one reason to be cautious. Although the pandemic has reduced travel, it has seen the revolution in connectivity become our daily reality. Videoconferencing has become efficient and inexpensive, and is now the preeminent medium for working with colleagues and communicating with family members. Businesses have been forced to digitally integrate their offices and employees to an extent never before seen (indeed – before the development of cellular networks, hardware and software, never before possible). Whether virtual interconnectivity inhibits air travel or, by enabling people to more efficiently work from anywhere, inspires it, remains to be seen. In either case, the COVID-19 digital revolution will likely be the pandemic’s longest-lasting impact on aviation.
Technology
Although certain technologies may compete with airlines in the long term, others have been successfully utilized by airlines to spur demand and broaden often narrow margins. COVID-19 has accelerated the technological revolution that had already been underway in the aviation sector. Over the past year we’ve seen airports increase use of robotic and UV cleaning systems, thermal imaging, as well as facial recognition and other touchless solutions. Airlines, likewise, have focused on enhancements to air filtration and air quality monitoring systems, UV cleaning technologies, and mobile apps (including health tracing apps) to improve the safety of passengers. Although a vaccine is now in sight, it seems unlikely that the use of these technologies will subside along with the pandemic. One reason is that health tech innovation leads to improvements in the flight experience beyond just health and safety, which can offer airlines and airports competitive advantages. Mobile credential authentication technology, which enables the TSA to more thoroughly vet passenger identification without physical contact, is a good example of this. Greater passenger health consciousness seems to be a permanent trend that will continue to incentivize the development and implementation of health-related technologies for years to come. Finally, urban aerial mobility (“UAM”) systems are being increasingly used though it remains to be seen whether increased demand for cargo transport solutions will fuel long term growth. Several drone start-ups are reportedly partnering with major corporations, such as Merck and Walmart, to distribute vaccines and other medical supplies to rural areas. The success of these trials could serve as proof-of-concept for startups seeking to gain public and governmental support to deliver broader categories of cargo using drones.
Financial Wellbeing
No issue is more top-of-mind to participants in a pandemic-ravaged industry than financial stability and wellbeing. Although the widespread distribution of a vaccine would spell the end to the pandemic, if the post-9/11 recovery is any indicator, it will not quickly remediate the distressed condition in which many industry participants find themselves. We think financial distress will continue to have several impacts on the industry, even as the pandemic begins to subside.
Distressed Acquisitions
The global slump in air travel immediately after 9/11 and during the global financial crisis tells us that the industry may witness increased consolidation and M&A activity as demand begins to return. Like prior crises, the pandemic has brought about a wave of bankruptcies (particularly among airlines, such as Virgin Australia, Avianca and Aeromexico) and financial distress, which may create buying opportunities for well-placed corporate buyers, private equity sponsors and other cash-rich suitors such as SPACs, which have grown in popularity during the pandemic (see, for example, Genesis Park Acquisition). Further, potentially anticompetitive acquisitions may now benefit from the “failing firm” defenses that were less available prior to the pandemic. This predicted uptick in M&A activity hasn’t yet materialized, likely in part due to the unprecedented uncertainty that characterizes the length of the pandemic, as well as government support and the use of creative financing options (including from direct lenders and other financial sponsor affiliates) that have enabled businesses to stave off liquidity crunches. Sellers – other than ones in financial free-fall – are also likely to be reluctant, fearing selling at historic lows. However, with greater certainty and persistent liquidity challenges on the horizon, we think the pandemic will eventually spur competitive M&A activity in a manner similar to other historic downturns.
Sources of Funding
Just how long airlines and other industry participants will be able to preserve liquidity is a key question, and one that will likely determine winners and losers as demand eventually returns. Although many industry participants have thus far managed to successfully raise enough cash to ride out the storm, most airlines have exhausted existing facilities and much of their availability of unencumbered assets and, with additional government support packages now in question, are under more pressure than ever to cut costs. Whether industry participants can bridge the gap to what may be a robust economic recovery will depend on their ability to make use of creative sources of financing (such as mileage programs) and, likely, the availability of additional government support in the near term.
New Approaches to Restructurings
One option airlines and other industry participants have invoked to preserve cash is negotiating with lessors and lenders. The pandemic has left lessors across all industries, from aviation, to maritime and real estate, with stark choices when it comes to dealing with insolvent counterparties: negotiate or try to repossess and resell in a buyer’s market. In the aviation industry, a substantial oversupply of aircraft will likely translate to a decline in value across all types of aircraft. This, combined with valuation challenges and lease rate deterioration, mean lenders and lessors will need to find new ways of working with airlines who cannot meet their financial commitments. Potential alternatives to repossession include rent reductions, rent deferrals, or a combination of the two. In any case, we expect these individually-tailored rent restructuring solutions to remain a feature of the market as airlines continue to suffer distress, likely leading to a survival of the fittest among lessors, with the best capitalized and best managed lessors able to thrive in the current market.
Governments’ Key Role
As one of the most regulated industries in the world, governments play a key role – in safety, security, oversight – in the aviation sector even in “good” times. In the current global crisis, government aid in particular has been critical in allowing many of the world’s airlines to remain solvent until this point and continuing government action in overcoming the pandemic will remain a critical factor in any meaningful recovery of the sector. In some countries, however, the longer the pandemic endures, state financial support for its carriers has been dwindling. On the other hand, the pandemic has also spurred some to call for partially, temporarily or even fully nationalizing their country’s airlines. The optimism surrounding the vaccine may provide governments with the necessary backing to bridge the financial gap in the near-term – at least through the Spring – before the vaccine is widely available and travel can open up again meaningfully. Fundamentally, however, COVID-19 has created tensions between governments in protecting the public health (imposing travel, route and quarantine restrictions) and upholding Open Skies Agreements (requiring open entry and route rights). While a necessary tension given the pandemic, following the vaccine and the opening up of travel, we fully expect a return to the multilateralism that is a defining characteristic of the aviation sector. In the meantime, governments have been playing a key role in negotiating other avenues – literally – for travel. While there has been mixed success, the rise of travel “corridors” or “bubbles” between countries – that allow entry between nations without a quarantine requirement – are one way governments are partnering with the industry as well as one another and testing opportunities for burgeoning travel. Industry and government partnership will be key in how quickly the sector can return to normal.
In sum, although COVID-19 has stymied demand for air travel, we are confident that the aviation sector will ultimately recover, and in so doing, be the lynchpin to reviving and revamping the global economy – and the related flow of people and goods – that will occur in the post-pandemic recovery. While some pandemic-driven changes, such as the size of industry players (with the larger and better capitalized and managed ones displaying greater resilience to the systemic shock), the makeup of fleets (whether repurposed, refurbished or retired), and processes (newer tech, greater disclosures, differing customer experiences), will outlive the crisis, demand will eventually return and the sector will recover. Due to the necessity of travel and tourism in the global economy, we anticipate that this recovery will take place faster than many expect.
This piece was originally run in Law360.