Law360 is providing free access to its coronavirus coverage to make sure all members of the legal community have accurate information in this time of uncertainty and change. Use the form below to sign up for any of our weekly newsletters. Signing up for any of our section newsletters will opt you in to the weekly Coronavirus briefing.
Sign up for our Aerospace & Defense newsletter
You must correct or enter the following before you can sign up:
Thank You!
Law360 (December 7, 2020, 4:18 PM EST) --
 |
| Matthew Herman |
 |
| Amna Arshad |
 |
| Max Sanders |
In August, we sought to predict the pandemic's long-term impact on the industry. Now, with approval and distribution of vaccines and other therapies in 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.
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 the International Civil Aviation Organization, airlines across the globe are expected to suffer up to a $392 billion loss of gross operating revenues in 2020.
This in turn has been felt among all industry participants — including original equipment manufacturers, or OEMs, and their supply chains; lessors and financiers; airports; maintenance, repair and operations, or MRO, businesses; and all of the other verticals that touch the sector.
Although a widely distributed vaccine would spell the end of 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 order books and fleet compositions.
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 — wide-body 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 wide-bodies 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, The Boeing Co. and Airbus Group SE, have reason to be optimistic, for different reasons.
The grounding of Boeing's 737 MAX by the Federal Aviation Administration provided Airbus with a unique opportunity to gain share in the single-aisle market. 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. This 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 dropoff 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 after 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 travelers' 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 a 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 — and, until recent technological advances, 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, 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 U.S. Transportation Security Agency 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 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 startups are reportedly partnering with major corporations, such as Merck & Co. Inc. and Wal-Mart Stores Inc., to distribute vaccines and other medical supplies to rural areas. The success of these trials could serve as proofs of concept for startups seeking to gain public and governmental support to deliver broader categories of cargo using drones.
Financial Well-Being
No issue is more top of mind to participants in a pandemic-ravaged industry than financial stability and well-being. 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 SA and Aeromexico — and financial distress.
This 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. Potentially anti-competitive 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.
With additional government support packages now in question, industry participants are under more pressure than ever to cut costs. Whether they 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, including aviation, 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 aircraft types. 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 current conditions.
Governments' Key Role
Aviation is one of the most regulated industries in the world. Governments play a key role in safety, security and oversight of the 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.
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 has endured, the less state financial support for carriers has been available. 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 by imposing travel, route and quarantine restrictions, while upholding open skies agreements requiring open entry and route rights.
While these tensions are unavoidable, we fully expect that after the vaccine and the opening up of travel, we will see 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 for travel.
While they have shown mixed success, the rise of travel corridors or bubbles between countries, allowing movement between nations without a quarantine requirement, are one way governments are partnering with the industry and one another to provide opportunities for travel. Industry and government partnerships will be key in determining 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.
Some pandemic-driven changes will outlive the crisis. These include the size of industry players — with the larger, better-capitalized and better-managed ones displaying greater resilience to the systemic shock — the makeup of fleets — whether repurposed, refurbished or retired — and updated processes — newer tech, greater disclosures and differing customer experiences.
But demand will eventually return, and the sector will recover. And due to the necessity of travel and tourism in the global economy, we anticipate that this recovery will take place faster than many expect.
Matthew F. Herman is U.S. managing partner, Amna Arshad is special counsel and Max Sanders is an associate at Freshfields Bruckhaus Deringer LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
For a reprint of this article, please contact reprints@law360.com.
