Emirates is currently negotiating with Rolls-Royce for its next batch of A380s. Bloomberg had a report yesterday on the latest development that the airline and Rolls-Royce have hit a “snag” in their negotiations. The report further mentions potential delivery delays and the possibility that the deal may be canceled.
Our view is that the deal is possibly at an impasse. Emirates has a choice: Go with the GP7200 but pay a higher price. Or squeeze Rolls-Royce even more because it needs to compensate for the higher MRO costs.
There are other complications.
- Engine Alliance has not built a new GP7200 in the past year. Moreover, the tight supply chain means that restarting the GP7200 line will be complicated, and the initial lead time deadline is approaching soon if deliveries for 2020 were to be on time. This may be why Engine Alliance is holding a firmer line on price. Engine Alliance has nothing to lose.
- Rolls-Royce, on the other hand, is facing engine trouble across the board, and its share price reflects the uncertainty. We understand that Emirates’ potential claims on warranties for the Trent 900 are “severe”. Neither the engine maker nor airline has said anything in public. Rolls-Royce has a lot on the line and may prefer Emirates to walk away from the A380, as it stands to lose less that way.
- Airbus is facing a precipice on the A380 program. We understand the program has no interest among the lessor community to fund the Emirates A380 order. Financiers see the A380 as having insufficient residual value to finance. Even if Airbus could persuade Emirates to consider the A350-1000 as a stopgap, it too comes with Rolls-Royce engines. Airbus must keep a key customer happy and does not have many options. Their new CEO will face some interesting decisions as he walks into his new office.
- Emirates may be under less pressure on their A380 decision because they are possibly going to add ten A380s to their roster if they absorb Etihad. The Etihad A380s have the GP7200 engine. The airline also has other options, like the 777X and 787. But it has built its business on the A380.
Airbus and Rolls-Royce both have problems they need to solve. An order from Emirates would “kick the can down the road” in terms of difficult program decisions. But Emirates wants a bargain if it needs to buy aircraft that the market believes has limited residual value. Negotiations have apparently stalled. If Emirates doesn’t order the A380, it is likely that both Airbus and Rolls-Royce would need to cancel their programs and take massive write-downs, not what shareholders are looking for. The key question, as with most negotiations that are at an impasse, is who blinks first?
As a reminder, when the airline first selected the Rolls-Royce Trent 900 for the last batch of engines, most industry observers wondered about the deal. After all, Engine Alliance had advised AirInsight that they made an offer “at cost” to win the deal, yet Rolls-Royce undercut that with an even lower price. Bear in mind that the Engine Alliance consists of GE and Pratt & Whitney – not exactly neophytes to the game of bidding on important orders and pricing to the point of economic indifference.
Rolls-Royce faced a dwindling market for its Trent 900 as the only remaining airline committed to the A380 has been Emirates. The airline built a tremendous global footprint based on its ability to successfully deploy the A380 in markets that other airlines have been unable to accomplish. Moreover, Emirates has shown that its business model works profitably. Its president has been an avid A380 booster: “We need the A380s big time,” Tim Clark has said. “It gives me huge flows across the hub to feed multiple city pairs. As soon as you start compressing that, your hub starts to implode, and that’s a big problem for us. That’s where the essence of our profitability remains.” As recently as April 2018 he was still championing the A380. The ultimate question he has often asked: “It always baffles me that we can make them work profitably [when] others can’t seem to.”
This is not the kind of language one expects from an airline that is ready to walk away from the A380. Airbus doesn’t want that either, particularly given the massive write-off that would ensue should the program be canceled. However, what we do know is that the last offer from Engine Alliance wasn’t at a low enough price for Emirates. Rolls-Royce did nobody any favors through “buying” the last order. Rolls-Royce created a new floor and now Emirates wants to go even lower.
Why would Emirates want to do this? We understand that the airline’s Engine Alliance A380s perform better than those with the Rolls-Royce engine. Specifically, the GP7200 has a better fuel burn and stays on wing longer. We understand the Trent 900 has, on occasion, stayed on wing only about one-sixth of the time of the GP7200. Because the Trent 900 has a smaller diameter, it does not have enough debris margin for the dusty conditions in Dubai. As the Trent 900 “eats” more dust, it needs maintenance and cleaning more frequently. The Trent 1000 on the 787 also suffers from “environment degradation” issues. Recently a young Rolls-Royce powered A350 had an in-flight engine shutdown, causing further concerns of potential problems across the Trent family. Is this another Trent problem about to emerge?