FTAI Aviation Ltd. (FTAI) Earnings Call Transcript & Summary

All right. Good morning, everyone. Bright and early here in the West Coast at 7:00 a.m., but it's already 10 a.m. Eastern. So I guess it's not so bad. I'm Kristine Liwag, Morgan Stanley's aerospace defense analyst. I'm very excited to host our next panel with FTAI Aviation, Joe Adams, CEO. Joe, welcome.

Thank you.

So before we start, let me read our disclosures for important disclosures. Please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley representatives. So with that, Joe, maybe I'll pass it on to you for some opening remarks.

Sure. Thanks very much, Kristine. Thanks for having me back again this year. I think I've been -- I think I've been coming here almost 10 years now to this conference. It's a great get together, great conference, great investors. So really enjoy catching up with everyone. And I think we met probably about 4 or 5 years ago, I think, when you had your little radio broadcast at Morgan Stanley, and we were talking about -- I think it's the first time we started talking about aerospace products that we thought we could grow it from a business that was -- we just began, which we call the module factory, which was doing about $50 million of EBITDA to $500 million of EBITDA. And I don't remember if you actually said no way, but I sensed that you were thinking no way. And now as we've grown that business this year, we're looking at doing $3.5 billion of revenues, over $1 billion of EBITDA and next year growing further to $4.7 billion of EBITDA or revenue and $1.4 billion of EBITDA. So the market acceptance and the market opportunity for that has been much bigger than we expected, and it still has an enormous potential. And essentially, what I think of it as is a better way to do aftermarket engine maintenance. It's a model where we combine the ownership of the engine with the ownership and management of the maintenance facilities and that gives us a different way of thinking about it in a more efficient way. When you're an owner, you think about maintenance differently. We've designed an extremely efficient production process. We optimize. We never -- we call ourselves the zero-waste people. We don't waste hours and cycles. We have scale, so we can buy material, which is a big part of it -- flexibly and at very attractive prices. And so we combine really the opportunity to use every available tool to reduce the cost of maintenance for the owners and the airlines. And what that means is then we can go to the airlines and the owners and say, we have a better value proposition. We can actually save you real money time and time savings so we can demonstrate a demonstrable benefits to the product. And that's what has really allowed us to grow significantly. And we started with the best engines in the world, which I think are the CFM56 and the V2500, and we will expand from there. There are other engines that the same business model will work. And so we think of this as a very sustainable and durable way to do engine maintenance. The other part of it is a couple of years ago, we realized that these benefits of owning engines and maintaining yourselves also would allow an owner like a lessor to create better returns. And so we realized that we had the opportunity to set up our own asset management business where we could show the investor we could demonstrate better returns, do all the engine maintenance through engine exchanges and allow us to increase our footprint in the industry, which means we look bigger to the customer. We look bigger to the industry. We control a lot of maintenance, and it has huge benefits and it allowed us to do it using other people's money. So it's not a capital-intensive activity for FTAI Aviation. And we think that, that combination further propels us and it gives us extraordinary leverage to continue to grow in multiple directions. And then lastly, as you know, we didn't plan on power in the beginning because we didn't know the opportunity would exist in this scale. But when we realize that there's a shortage of blades and vanes for manufacture and people can't produce them fast enough, we started thinking about, well, how could you solve that problem? And the answer to us was, well, then don't make new blades and vanes. Why don't you take an existing asset and convert it. And we looked around and said, what asset is big enough to make a difference to produce gigawatts of power in the aviation industry, and there's only one. It's really the CFM56. And so we happen to be -- it happened to be our focus engine. We owned 1,000 of them, and we said, this is something we really can do and should do. And so that became really the third part. And it's also has the potential to extend the life of this platform for 20 years and gives us an alternative use for runout engines. So it has also tremendous benefits. So all 3 of these activities really feed each other in a positive way.

That's super helpful, Joe. And I think I do -- I will confirm in our first meeting when you did say the first $1 billion EBITDA, I did not believe you. I think there's a recording of that webcast somewhere in the Morgan Stanley portal. But here you are, you're at $1 billion for aerospace product this year. So maybe we could talk about the different businesses and pieces, right? You have aerospace products, you've got a Strategic Capital Initiative. And then by the way, in addition to power, you've got PMA somewhere in there as well.

Yes.

So can we break down some of these pieces? Because from my conversations with investors and when you look at the stock, there's a lot of skepticism regarding your value add. So can we go back to aerospace products and talk about how is your approach to engine maintenance different and the discussion that's happening in the industry initially, your margins in aerospace product was 40% in the last few quarters, it's below 30%. Where do we -- and historically, when you look at traditional engine MRO shops, their margins are around mid-teens, and that's for a good shop and some of the ones that are less efficient, they might be at low double digits.

Yes.

So can you level set us regarding what exactly do you do? How is this different? What's your value add? And what is normalized margin for that business? And what do you think about market share?

Sure. It gets a lot of the things I mentioned in the opening is really to contribute. The value add comes largely from owning the engine as opposed to other people do maintenance on an engine, they do not own and people are selling parts to someone who has an engine, they don't own. And so the incentive for every other participant or many other participants in the industry is to do more maintenance, is to expand the work scope. And as an owner, our incentive is not to do that. It's the opposite. And so what we did is when we first went into the maintenance business is literally went line by line in every area of expenditure in a shop visit and analyzed how to do that better, how to create additional savings and how to not waste hours and cycles that could be used in a different combination. And so we used to lay out a slide that says a typical third-party MRO would earn a 15% margin. We believe we can get 15% to 25% additional from those efficiencies and optimization strategies and then an additional 5% to 10% from part savings just because we buy better, we have scale, we use used serviceable raw material. We're always developing repairs for our own parts to recycle a part instead of have to buy a new one. So there's a tremendous amount of savings and what I would call waste in the industry as it exists today that we've been able to identify and ring out. So the value add comes from us being the owner. And the manifestation of that is it allows us to go to a customer and say, you tell us what you spend today or have spent historically to put hours and cycles on an engine, and we'll deliver to you a price that's better than that. And in addition to being better than that, you don't have to go get spare engines. You don't have to have an engineering team monitor the shop visit when it's in the field and you don't run the significant risk that the cost ends up being higher than you thought because oftentimes, an engine goes into shop and at least half the time, the bill ends up being bigger because there's discoveries on other parts of the engine. And every airline in the world has had bad experiences with engine shop visits. So we go to them and say, we'll save you time and money, and you don't have to deal with any of those headaches, what don't you like? And the answer is people like it a lot. They say, where have you been all my life? The Strategic Capital part of it also gives you additional leverage because we then can go buy aircraft that are on lease to an airline. Let's say, an airline has 50 aircraft on lease, we buy 10 from a lessor. We go to the airline and say, great news, you never have to do another engine shop visit again. All of your engines will be supplied by us through engine exchanges. All you have to do is pay maintenance reserves in, and there's no return compensation fights. The airline says, "Wow, are you kidding? That's amazing." Why don't I introduce you to the owner of those other 40 aircraft that are on lease so that you could buy them and convert it to that model because I much prefer your model. So the value add comes from ringing out efficiencies and then delivering savings. It's a basic economics of the business. And we see it as very, very durable. Now when we started out, if you think about the entire engine market opportunity, there are easy repairs, they're light repairs, there's sometimes recombinations. And then there's full performance restorations. And when we had limited availability and a lot of capability to recombine things, we were able to bring out the highest margins available. And as we grew the business, we realized the opportunity set is for everything. We want to be someday go to a customer and say, you should never have to do another engine shop visit again. We'll do all of it for you. If a customer says that, we say, okay, we have the capability, we'd be happy to do that. And some of the bigger airlines that have large fleets are used to getting price discounts. So the combination of changing the mix and also having bigger customer -- end customers has led us to the conclusion that we can get more market share by having 30% margins than we would get if we had 40% margins. Either one is possible, but we choose more EBITDA, which we think is more valuable in the long run for the company. And so that's where we are. We think that the next 2 or 3 years, we would assume that margins are going to be steady at 30% because we have a representative mix today and a lot of large customers. And then maybe out in the future, if we have big enough market, there's an opportunity to take up price. But again, we're always looking for additional savings on the cost side, and we want to keep the customer saying, this is a great product, let's do more.

Joe, what you said about where have you been all my life comment here. I think that's where some of the investor skepticism is or industry skepticism regarding your approach. If it was so straightforward and just clear, why haven't others done it before? Why aren't they doing it now? And should they start copying your business model, what makes yours more durable than theirs?

Yes. As I said, the key to it is owning both the asset and the maintenance facility. And it's hard because a lot of people who are in the industry have done either one or the other, but not both. And so putting them together when we did that was considered risky. No one had taken the approach of I'm going to do maintenance on my own engine. Nobody developed the skill set to do that. We came -- we started from the asset management side of it. But when you look also now at third-party MROs, they don't have asset management functions internally. So until somebody puts the 2 pieces together in one company, I don't see them having the capability of doing what we do. The other thing is that if you are in the third-party maintenance business today, you have a lot of customers that you've signed up for long-term contracts to work on their engines. When we bought our engine maintenance facilities, we made a decision we were going to do no third-party work. And I remember people thought we were crazy at the time. They said, who does that? And I said no one. But the point was if we have a scarce asset, which was mechanic and we work on a third-party airlines engine, we make $1 an hour from that mechanic. If they worked on our engines, they made $5 an hour for us. So I said, help me figure this out. I'm struggling. But it was obvious that if you have a scarce resource and you have a high-value product, that's where it should go. So that decision was not an easy one, and we bought basically a whole facility, and we had no third-party customers, just FTAI.

So Joe, on this maintenance facility, I think one of the underestimated value provided is you went from an asset manager to actually owning an MRO, right? I mean owning an MRO, you get your hands dirty, you're taking apart engines, wrenches versus paper signing. But you went from 0 market share, 0 shop visits to about almost 1,000 modules this year. How hard was that journey? And for the most part, from a third-party perspective, like mine, it seems like a pretty seamless execution strategy. But can you share with us what it took to get there? And you've seen a lot of -- and I guess also in the aerospace industry, to go from 0 modules to 1,000 modules in 4 years is a speed and growth that nobody has ever heard of. So can you give us context around that?

Yes. The capacity exists. I mean when we went out and started doing this, we found that there were a lot of maintenance facilities that had been built once upon a time, either for airlines or other people who thought engine maintenance is easy. And then they found it wasn't easy to get other people's business. So there were a lot of facilities that had great tooling and no business. And we realized that we bring all the engines, so we have the ability to fill the facilities. And so acquiring the facilities at a very attractive price was not as difficult as I would have guessed. There were many locations. If you take Miami, which was a former Pan Am shop once upon a time, Montreal, which was a former Air Canada shop once upon a time, Rome, which is former Alitalia shop once upon a time, they were all empty. So we came in and said, great news, we have engines. You don't have to go chase third-party customers, we'll fill it. Then on the production side, I would say we were very concerned when we got in the business because we hadn't done it before. And so we're like, how hard is this going to be? And we sort of went back to basics and that 2 things we focused a lot on. One was standardization. So people focused -- we got rid of all the other engines they were working on. Some shops had 4 engines, 6 engines. And we said, no, no, you're just working on CFM56. And not only that, you, as a mechanic, might only work on the low-pressure turbine for the next 6 months, just one part of that engine. And then we said, and guess what, if you do well and you produce a lot of engines, we'll pay you more. It was sort of like, as I thought about Henry Ford did this 100-and-something years ago. And those 2 things are very basic, but they really work. And we doubled the productivity in Miami within a year. And then we realized, well, now the shortage is, how do we get more mechanics because we can deliver the customer a value product. They want more. We don't have enough people to do it. So we realized in Montreal, it's not hard to hire people. It was hard to get them to be productive. And so what happens is the way the system was set up is you hire somebody and within a few weeks, they have to read a paper manual and pass a multiple choice quiz to get to the next step. A lot of people who are good mechanics aren't really good at paper-based multiple choice tests. So we were losing about half the field. And so inside Montreal, people said, well, people are -- these people are better visual learners. Why don't we use virtual reality headsets to show them a step-by-step process of how to disassemble and reassemble an engine. And we did that. We developed our own product, and our yield went from 50% of the people passing to over 90%. And we said, that makes total sense. So we now have created a center of excellence in Montreal for the whole company, and we now have 1,600 employees. People go to Montreal to do some training from Miami, from Rome, soon to be Egypt, soon to be Indonesia. And these are great high-paying jobs, but there is an element of -- there's a learning curve, so you have to bring people along. And so that really became how we developed our production strategy. And the answer is we have a great team of people. It's not one thing. It's a lot of people contributing. And it also gets back to that focus question. It's sort of -- I was a big believer that if you develop this tool for one engine and you really, really get to be the best in the world, you then can be -- are convinced you could do it again. You can do it on another engine once you have that playbook but you have to focus. You can't do 4 engines at once. And so those 2 decisions we made of vertical integration and focus were critical in sort of how we've accelerated the growth.

Moving to a Strategic Capital Initiative, having -- moving the assets off balance sheet and having third-party external money was an accelerant to the business. But you thought you were going to raise $4 billion and you ended up having $6 billion for your first tranche, you're now at SCI 2. And you've always told me the second time you're raising it should be higher than the first one that you did. So can you walk us through the economics from an investor perspective of why they should invest in SCI? Because for you, the economics make sense of why you would have it. And then also for the lessors, you're acquiring assets, they're just changing owners, that seems to make sense. But why would investors give you $6 billion for that and potentially another tranche.

Yes. No, it's a great question. It's one we thought about early on because unless you have some kind of a differentiating value add, why would we be in the asset management business? And the answer was we can create bespoke engine solutions for an owner. And what I mean by that is if you go to a third-party MRO and you say, rebuild my engine, they will say, okay, I'll rebuild it to 10,000 cycles. That's what we do. And the owner is like, well, what if I want 5,000 cycles? And the answer is I can't do that unless you supply me all the parts and the material. And I was like, "Oh, okay, well, I guess I can't do that." But -- so what we've developed is we said, look, if an aircraft we buy is on lease for 5 years and the engine times out -- one engine times out in the middle of that lease, say, call it 2.5 years. The typical lessor requirement would be to rebuild that engine for another 5 years. So you put a lot of capital in, you do a full performance restoration and you have 5 years of life, but you only have 2.5 years left on the lease. So what we developed as a model said, no, let's build an engine that will last 2.5 years, so you invest less capital. And at the end of the lease, you have lower residual value risk. And what that does is produce higher returns and lower risk. And so as I've been in the business a little while, but any time you tell somebody, would you be interested in higher returns with lower risk, they usually say yes. So that really was the simplicity of it was we -- it gets back to the fundamental premise. We can deliver a product that's a better product for aftermarket engine maintenance, and it works for airlines and owners. So that's what we did. And it's sort of like once you lay it out for people like that makes total sense. Why shouldn't we do that?