“Aviation is a hard business where only the best survives, and I mean the best managed”Christopher Brown, former GPA employee
If you haven’t already noticed, I enjoy reading about corporate failures. This is not because I revel in seeing other people/companies fail. I am actually an optimist. Rather, it is because reading about failures allows you to learn vicariously from the mistakes of others, tuition free.
GPA (Guinness Peat Aviation) was at a time the worlds largest commercial aircraft sales and leasing company. The book is written as a diary by a former employee of GPA during its growth and subsequent implosion. The company ultimately failed because of the poor health of its balance sheet. This was the proximate cause of failure. The ultimate cause of failure is management since they control the levers of the balance sheet.
So what parts of the balance sheet exactly caused the main problems?
1. Excess inventory of questionable quality
GPA grew big very fast. Some of the planes they purchased to be leased could not be easily leased.
“First we have ordered a huge number of aircraft – too many. Some types will not be leased easily. The md-80 series in particular concern me. These are old technology aircraft which barely meet the current noise regulations and there is only a small customer base worldwide for these aircraft.”
An acquisitive company that holds a lot of inventory that it cannot easily move or is at risk of becoming obsolete creates two main problems. First, it may exaggerate the value of its inventory on its books, which will make the company appear statistically “cheap”. Second, aircraft need to be maintained, even when not in use. You need to pay for parking, insurance and storage maintenance. Even after all this, the slow passage of time will eventually make the aircraft less fuel efficient, less compliant with new regulations and eventually become obsolete. Time is not on the side of the company that carries illiquid and potentially obsolete inventory in excess amounts.
2. Uncollectible receivables & poor credit quality of customers
Many of the airline’s GPA leased planes to had poor credit quality. Running an airline is already notoriously hard to do. The history of corporate finance is littered with failed airlines. If an airline goes bankrupt, the aircraft leased to them by GPA may be held up in bankruptcy proceedings unable to be repossessed or earn money. In this case, GPA was essentially acting like a bank lending money to sub-prime borrowers at high rates. When times were good, GPA prospered but when a recession occurred, GPA suffered
3. Excessive debt and default covenants that incentivise poor decision making
Restrictive covenants put a limit on the number of aircraft that could be on the ground at any time. Since GPA already had excess capacity, it had to lease aircraft to increasingly unreliable airlines so as not to breach the covenant. This meant it was likely that the receivables from these airlines would be increasingly fictitious.
4. Cash not really cash
GPA’s stated cash on its balance sheet was not really cash that could be redistributed to owners of the company. A large portion of it actually belonged to the airlines it leased its planes to.
“When GPA says today that it has $510 million in cash, $500 million of it is really the airlines maintenance money we are holding”.
While much of the press coverage at the time painted the collapse of GPA as a rapid implosion, it was actually a story of long-term decline. A lot of GPA staff held stock using borrowed money. Some paid as high as 21% interest on loans to purchase stock. This is usually a bad sign because once the company experienced a downturn, employees were not only at risk of losing their jobs but also at risk of defaulting on their loans. An employee who has to worry about their job and the possibility of defaulting on loans used to purchase now worthless stock is likely to be a very unproductive employee.
Ultimately, this was a good book on understanding the airline industry and how difficult and competitive it is to survive as an airline. The CEO of GPA, Tony Ryan, went on to start Europe’s most successful airline – Ryanair.