Interview: Pachinko money slots into aircraft leasing.
Bet on Dynam Aviation
Dynam is the latest company to seek to put its money to work in the aviation market. Airline Economics speaks to James McCarthy of Dynam Aviation.
Pachinko is akin to a hybrid of pinball and the slot machine in the Western world. It has been popularly played in Japan for more than 80 years and every year it is estimated that over $200 billion is spent playing the machines.
Dynam Japan is one of the largest operators of pachinko in Japan and runs more than 400 halls across the country. It is listed in Hong Kong and books revenue of approximately $1.5 billion a year. Such a successful and large-scale company has been very profitable over the years and has compiled significant cash reserves. However, Japan’s passion for pachinko is not growing. Younger players are enticed away from the parlours to video games which they can play on their smart phone anywhere anytime. As a result of this changing environment, Dynam is seeking other areas to put its money to work – one of which is aviation.
In January 2019, Dynam Aviation was set up in Ireland as an Irish-registered, subsidiary company of Dynam Japan. The team, headed by Chief Executive Officer, Katsuhiko Ando, is building out its office in Dublin with the long-term vision to create a fully integrated aircraft leasing platform. Parent company Dynam Japan has committed $300 million in equity to build a portfolio of approximately 20 aircraft over the next three years.
Dynam Japan is part-owned (c. 35%) by the Sato family, which has set up Sato Aviation Capital as a family office to also invest in the aviation industry. Dynam Aviation is concurrently working with Sato Aviation to support them in building up a separate portfolio of ten aircraft over a similar timeframe.
In the ten months since its inception and despite the crowded marketplace, the venture has started strongly.
“We’re up to six aircraft across the two portfolios,” says McCarthy. “Dynam has acquired two aircraft so far this year – we closed the second one in October – and there are now four aircraft in Sato Aviation. We have a strong pipeline with deals that are at various stages of completion and I anticipate that we will close two more aircraft before the end of this year, one for Dynam and one for Sato.”
Dynam Aviation is focused on acquiring liquid, narrowbody aircraft types. The fleet today consists of two A320ceos on lease to Vueling, one A320ceo with Volaris, one 737-800 with KLM, one A320ceo on lease to Wizz Air and one A320neo with IndiGo – all of which are four years old or younger.
“Our focus will remain on young narrowbody aircraft and we are acquiring them through a mixture of novations and sale-leaseback transactions,” says McCarthy. “I imagine, if we achieve our target of acquiring ten aircraft in the coming year, the majority will come from novation, probably six or seven, with the remainder coming from sale-leasebacks.
The sale-leaseback market is fiercely competitive but for McCarthy no more competitive than portfolio sales.
“Many lessors are using the strength of the market to dispose of assets, both new and old,” he says. “They request blind bidding and it’s so competitive now that the prices we see in portfolio sales are incredibly high. I think, for a time, many in the industry have been saying that SLBs have become too competitive, but actually at the moment I don‘t see much of a difference between sale-leaseback and portfolio sales because the way the bidding process is working, sellers of aircraft are achieving really phenomenal prices.”
There is a growing sense in the market that some aircraft investors are likely to be stretching their residual value assumptions when assessing potential investments because they are offering such low pricing and bidding is very aggressive. Airlines have become accustomed to the competitive market and have a range of financing channels open to them, which has allowed them to play different methods of financing off each other.
“In some cases, airlines are directly competing bank debt with operating leases, which means that some airlines, especially those stronger credits in better jurisdictions, have been able to dramatically reduce lease rates as well as bank pricing in recent years,” says McCarthy. “Because investors still want to deploy capital and acquire aircraft, the competition between different financing channels maintains pressure on the banks”.
“Dynam’s advantage is our very low cost of capital that enables us to be quite aggressive, but at the same time, we’re being pragmatic. We will not buy aircraft just for the sake of it; we’re trying to ensure that the investment case makes sense.”
McCarthy is aiming to build up relationships with airlines around the world and is planning to expand Dynam’s marketing team in the near future to better cover all regions. Although the prime focus for acquiring aircraft will be from airlines, realistically many will still come from novations, but the team is averse to acquiring a larger portfolio.
“Most of our aircraft acquisitions to date have been individual deals from a variety of lessors. Although we look at all of the portfolio sales that come to market – and usually bid on some aircraft from each sale - I don’t think we will be acquiring a large portfolio in one go because at the moment, I feel you typically overpay doing it that way,” says McCarthy. “Also, for portfolio sales, ‘sweet and sour’ prevails - you likely have to take a few aircraft that might not be exactly what you want in order to acquire the whole package, which is something we don’t want to do.”
For McCarthy the market feels too active – with lessors eager to sell aircraft for profit but equally eager to reinvest into more aviation assets.
“Virtually everyone has capital to deploy,” he says. “and there’s a constant balance between wanting to sell and book profit but then needing to find somewhere to reinvest. For the larger, and especially listed, lessors that typically achieve growth through a mixture of channels, it’s unattractive to risk diluting returns by reinvesting capital from existing assets into thinner priced deals. It’s a constant battle, but I expect a lot of the portfolio sell down from the larger lessors is actually more about managing risk and balancing concentration. Obviously, there’s a lot of activity and I think most people would agree that we are at the top of the cycle. I agree with the view that there is more consolidation to come. At the moment, it’s not directly affecting us, aside from the way it may motivate companies to divest further assets, and of course that’s where the buying opportunities are.”
Despite talk of headwinds and a downward turn in the aviation industry cycle, McCarthy is optimistic.
“We have a shareholder that is really behind our business and understands that this is a very long term and ultimately cyclical industry. We’re at the top of that cycle now. Really, the only question is how long that will go on for. But any kind of downturn for us, with committed equity, will present us with buying opportunities so we’re actually quite optimistic”.
For its recent aircraft acquisitions, Dynam Aviation has used bank debt to finance purchases, however they will look at all portfolio financing options as the book grows but the company – as an Irish entity – will not be taping into the Japanese Tax market.
“Our shareholder is Japanese, but we are not exactly Japanese,” stresses McCarthy. “Our company is Irish, our team is in Ireland and as we grow, we’ll be recruiting in Ireland. We aren’t obligated to work with Japanese banks, although we are of course talking to those Japanese banks that are active in the aviation market, but we’re not doing any tax investments; we’re not doing JOLCOs. Our parent company is in Hong Kong and is listed, so tax investments wouldn’t work. Of course, the irony is that in the future, we could consider using JOLCOs as a financing mechanism! But we would never invest in JOLCOs; that’s not our business.”
The parent company’s listing in Hong Kong does throw up the possibility of placing aircraft assets under the new Hong Kong tax regime, which is something the company has considered, but for the future.
“We may consider booking through Hong Kong; It could be very attractive for China and some other Asian markets, so we’ve assessed it and we will keep it under review for the future.”
Although the team is committed to fulfilling its mission of creating two aircraft portfolios, other aviation assets could also appeal in the future.
“Personally, I like the idea of looking at other assets in the future and engines could be of interest, but for the moment we will be sticking to narrowbodies. Then we would most likely look to add different types of aircraft, widebodies for example, and then possibly in the future we could consider other assets including engines.”