Business aviation: Come fly with PE

Business aviation in China is still in its nascent stages, but the enormous potential for growth is already drawing in big hitters from overseas. Cue billionaire businessman Warren Buffet. Netjets, a portfolio company of Buffet's Berkshire Hathaway, arrived in the country last month and announced a joint venture with two local private equity players.

It's no secret why Buffet is here. China's rapid economic expansion over the past decade has spawned a legion of millionaires who might want access to private jets for practical or vanity purposes. The country is now home to the world's fourth-largest population of high net worth individuals (HNWIs) - defined as people with investible assets in excess of $1 million - after the US, Japan and Germany. In 2010, the total number of HNWIs reached 535,000.

While there were fewer than 20 business jets in China during the mid-2000s, the number is expected to reach 200 at the end of this year. By 2030, it is expected to be 2,470, based on compound annual growth of 15% over the next 20 years.

"There are more Chinese billionaires and entrepreneurs who understand the business benefits of travelling by business jet," says Chris Buchholz, CEO of Hongkong Jet. "When we look at the 11,000 business jets in the US at the moment, it is pretty clear that there is still ample room for growth in China."

Netjets' partners in China are Hony Capital and Fung Investments, a private investment arm controlled by the families of Victor Fung and William Fung. With an operational base in Zhuhai, at the heart of the Pearl River Delta - home to many of the entrepreneurs who have successfully leveraged the China growth story - Netjets plans to introduce the service standards for which it is known in Europe and the US to China.

It is not the only foreign operator looking to corner an underserved domestic private aviation market, but the process is not easy.

In China, most of the private jet companies are braches of state-owned airlines or companies based in quasi-offshore cities like Hong Kong and Macau. Foreign participation is limited - joint ventures are the only way in and the domestic partner must hold at least 51% of the entity - while the regulatory and operational environment is more complicated than in the West.

In this context, NetJets will likely look to Hony in particular to open a few doors. More importantly, a private equity firm is considered a more desirable partner than a local airline because it is largely financially-driven and less likely to be weighed down by internal bureaucracy.

"It is logical for NetJets to partner with Hony because they are a known entity to both Fung and NetJets and they're also valued for their local expertise and influence," says Jay Shaw, managing director of Seacor Capital, a corporate venture capital arm of marine and aviation operator Seacor Holdings."Hony is not likely to interfere with the operational strategies of NetJets, who are the experts in running business aviation. They also don't operate any other aviation businesses, so there's no risk of undue influence by an existing aviation culture."

Flying funds

In addition to foreign market entrants, several domestic aviation-focused private equity funds have also been launched. China Construction Bank (CCB) was the first mover, establishing AVIC Fund of China in partnership with China Aviation Industry Corp. in 2010 to invest in the latter's affiliate interests, including pilot schools, fuel transportation and infrastructure firms. The fund has already raised RMB1 billion ($159 million) and is expected to reach RMB20 billion. Chinese carrier Hainan Airlines also launched an aircraft leasing private equity fund, with a target size of RMB5 billion.

"Forty-eight private jet charter start-ups are now awaiting approval to enter the market and some of them have been established by private equity," says Jenny Lau, CEO of the Hong Kong-based Sino Jet. She adds that as long as China continues to exhibit strong demand growth for private jets, PE contributions will keep rising.

Even so, most of the participants in the capital-intensive business aviation sector are backed by enterprises or aviation groups. Private equity plays a relatively small role, largely due to the fact that infrastructure inadequacies and regulatory hurdles mean the returns are limited.

While the US has more than 5,000 airports, China has only 200 in China - and many are not accessible for private jets. Furthermore, 70% of China's airspace is still controlled by the military, which restricts the capacity for the expansion of private jet services. Standard commercial services are already frequently delayed. The market still needs years to redress the balance between a growing appetite for air travel and the infrastructure available to meet these needs.

"I'd say the industry requires infrastructure first, capacity second and financial returns comes the last," Mike Walsh, CEO of Asia Jet, tells AVCJ. "As Chinese business aviation market is still in its infancy, you may need to hire as many as a hundred people to get one maintenance license, it's never easy-money-in, easy-money-out."

Other shortcomings undermine the primary rationale for flying private - flexibility. Securing flight permission in China takes days, not hours, because the local authorities aren't keen on last-minute changes to schedules. It takes less than 24 hours to obtain landing permission of a non-scheduled chartered flight from Hong Kong to Singapore; in China, it is two days or more.

"The government is opening up the landscape though," Walsh adds. "Four years ago, we needed to take seven days or even weeks for a landing permission of a non-scheduled chartered flight, now we only need three days."

Realism required

Despite this reason for optimism, the Chinese government currently has no plans to open up the market immediately - or even within the 3-5 year investment period typically employed by private equity funds. It is questionable whether any private aviation company could scale up in the medium term as an attractive M&A target.

"The Chinese regulations only allow for up to 30 business operators by 2015, up from the current 12-15," says Seacor's Shaw.

Even Hony, which has hedged its bets by partnering with one of the world's most reputable business aviation providers, must take a realistic view. No private aviation company globally has achieved an IPO and the trade sale market in Greater China is quiet. Prior to industry consolidation and regulatory relaxation, both of which are long-term goals, there is no guarantee that a strategic sale would generate either interest or a good financial return. As in many industries, ancillary services may be the best bet.

"From a private equity standpoint, it's difficult for business jet operators to make high returns from only an operational business without significant scale in non-capital intensive aircraft management," says Hongkong Jet's Chris Buchholz. "Supporting industries such as maintenance services or fixed-base operator can further enhance returns, since this type of support and infrastructure is critical in the development of business aviation."

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• Topics
• Support services
• Greater China
• Consumer
• China
• Consumer
• Transportation
• Joint Venture
• Hony Capital