Bizjet Fractional Ownership Remains Relatively Strong

By By Anthony L. Velocci, Jr.
Aviation Week & Space Technology

Industry pundits who predicted a few years ago that the market for fractional ownership of business jets would remain robust in a U.S. economic downturn were wrong--but not by much, as it turns out.

The sale of shares generally has held up remarkably well, considering the turmoil that has wracked financial markets and hammered corporate profits in the last 24 months, according to several major providers.

Historically, corporate profits have tended to weigh heavily on the fortunes of business aviation, just as the growth in personal wealth has played a significant role in the purchase of aircraft by private individuals.

The recent recession and current bear market are the first since fractional ownership took off in earnest in the first half of the 1990s and drove record production and deliveries of business jets in the second half of the decade.

Since 1998 through August 2002, the fleet of fractionally owned aircraft has grown by 182%, to nearly 800; the number of shareowners (private individuals plus corporations) has climbed by 263%, to about 4,000--most were new to business aviation when they signed on--and the number of shares has risen by 255%, to nearly 6,000, according to AvData Inc., an independent Wichita, Kan.-based aviation research and consulting firm. (All data are on a worldwide basis, not just the U.S.).

Further, while the rate of growth in all of these categories has slowed, the number of new shareowners at the end of August was more than 20% greater than at the same period a year ago, according to AvData.

"In our most recent analysis, we found that fractional ownership is losing about 10% of its base every year. But providers are generating enough new business to make up for the loss plus achieve a substantial net increase."

Not everyone sees the current state of fractional ownership in as positive a light, however.

J.P. Morgan analyst Joseph Nadol, for one, believes the fractional shares business has cooled to low single-digit growth and that the profitability outlook of fractional operators leaves something to be desired.

NetJets, a business unit of Warren Buffett's Berkshire Hathaway and by far the largest of the four major players, is the only profitable one.

Companies and individuals with regional travel requirements are the "meat" of the fractional ownership market; CitationJet II is a very popular aircraft in this arena.

John Hall's assessment also is bearish. He is senior vp of sales and marketing for CitationShares, a joint venture of Cessna and TAG Aviation.

By his calculations, the sale of fractional shares in the first half of 2002 was down about 22% from the same period in 2001. "We still think there is growth in the market but not at the rate it was growing in the mid- to late 1990s," he said. "The fractional shares business is driven by the economy, and all the economic indicators are awful."

That may be true, but AvData's assessment of the overall demand for fractional shares generally is supported by the experiences of some of the other major providers.

At NetJets, for example, the number of new fractional owners and shares it has sold is up by more than 30% year-over-year, according to executive vp Kevin Russell. Flight Options' Michael Sylvester, senior marketing vp, claimed his organization's sale of fractional shares "hasn't fallen off" because of the weak economy. "We're doing very well and had a great July," he said. Flight Options is the only provider that deals in both pre-owned and new aircraft.

And at FlexJet, Bombardier's fractional ownership program, there has been a "very significant increase" in the owner base in the last year, according to president Clifford Dickman.

Moreover, the number of hours that owners flew in the first six months of 2002 was about 7% greater than FlexJet forecast last year. At the same time, prospective shareowners have canceled the equivalent of about two whole aircraft, according to Dickman. Cancellations have hit some other providers as well.

"In absolute terms, I expect the growth curve of fractional ownership to remain consistent for the foreseeable future," said John Zimmerman, who heads AvData. "It won't be able to sustain the percentage gains we've seen in the last five years, but that's a testament to how big the base will become. If anything, the weak economy has reinforced the concept of fractional ownership."

But not across the board. "The high end of the market has been hurting," Sylvester said. Indeed, the sale of fractional shares in the most expensive business jets--large cabin, ultra long-range Gulfstream IV and V and Global Express--has been depressed and continues to be sluggish.

For that reason, Bombardier Aerospace has decided to defer the introduction of the Global Express into FlexJet. "We're not seeing that much demand for it," Dickman said. Gulfstream president Bill Boisture said industry observers shouldn't expect the market for fractional ownership in general, or the demand for high-end product offerings in particular, to act appreciably different than any other market that's sensitive to economic cycles.

"The purchase of even a one-quarter share in a GIV-SP represents a serious capital investment, which has less to do with the type of airplane being purchased than the value of the transaction, and that transaction is no more or less reversible than buying a whole airplane. As the economy's growth begins to pick up, so will the sale of fractional shares in large business jets."

Nadol believes the market for business jets in general is just beginning what could be a multiyear cyclical downturn.

Bombardier recently lowered its net income target for 2002, citing "the severe downturn in the business aircraft market, which is affected by the persistent weakness of the U.S. economy."

Corporate profit growth historically has been the major driver to business jet demand and has led jet deliveries by about one year, he noted.

"With a near-term economic recovery as uncertain as ever, it's unlikely delivery growth could bottom anytime before 2003," he said. "Increased scrutiny of corporate managements is difficult to quantify, but it could be the most important driver for the industry during the next several years."

He also noted the heightened attention that the media and government have paid in recent months to allegations of fraud and corporate excess. "In this environment, corporate managements will think twice before authorizing the purchase of a $20 million to $40 million business jet."

If Nadol's assessment is even close to being accurate, that might tip the scales for companies that operate over a broad geographic area to purchase only fractions of whatever type of business jet makes the most economic sense.

Some companies also are investing in fractional ownership as a security measure and to help their executives make more productive use of their time, versus getting entangled in the frequent delays that business travelers encounter on commercial flights.

What's clear is that fractional ownership providers collectively have become an extremely important source of business for aircraft OEMs, and that without the huge backlog of aircraft they currently have on order, airframers almost certainly would be in dire straits.

Weaker demand for business jets in general has forced all of the OEMs to reduce the tempo of their operations and, in some cases, lay off substantial numbers of employees. By Nadol's analysis, the sale of fractional shares accounts for about 16% of deliveries of all new business jets.

That's consistent with AvData's figures. Its most recent count shows that OEMs delivered 351 new aircraft in the first six months of this year, compared with 349 in the first half of last year. Of that number, 54, or about 15%, went to fractional providers.

On a percentage basis, that might not seem like a large number, but consider this: fractional ownership of business jets accounts for the largest single source of sales for Cessna Aircraft, Gulfstream Aerospace and Raytheon Aircraft.

"Fractional ownership has helped us as a manufacturer expand our volume of production," said Cessna's Roger Whyte, senior sales and marketing vp. "Our fractional ownership customers have taken every aircraft ordered--no cancellations, no pushbacks--and the percentage of orders by fractional providers has remained fairly constant at 12% to 15%."

The sale of new aircraft isn't the only reason fractional providers are important to OEMs, according to some manufacturers. "They are changing the dynamics of the industry, raising the level of quality and overall delivery expectations," said Raytheon Aircraft vp and chief operating officer Robert Horowitz. "In short, they're making us better. In turn, we're going back to our suppliers and demand higher levels of performance from them."

Raytheon Aircraft chairman and CEO James Schuster said NetJets, in addition to being his single largest customer, also is their most demanding. "They push like hell because their business model requires them to market aircraft that meet very demanding customers, and we're using that as a lever for positive change, with the emphasis on speed and quality."