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Ernie Arvai, President of AirInsight Group and Michel Merluzeau, who heads AIR (AirInsight Research) discussed the future and lasting impacts from the Pandemic and the nature of changes to the industry we might see. The focus was on changes – permanency vs temporary – and what we can expect over the next few years. This article summarizes their “fireside chat” conversation. Merluzeau is immediately concerned by the current situation: “the world has been affected by this once in a generation event. There are plenty of issues that have surfaced and even violently emerged” but remains positive about the adaptability of society and business in general with ” the new tools to compensate for business travel in an environment in which negotiations are not necessarily discussed in person. As we’ve discussed many times, Ernie, the question is whether this is going to be here stay, or return to normality in the next 2-3 years. That is the over-hanging question and is the Damocles sword for airlines.” Arvai is more constrained about the evolution of the recovery: ” we will see some changes that will be sustained, including a change in the ratio of leisure to business traffic. I see companies being more comfortable with employees working from home, leading to changes in demographics and where employees live, and we also will see corporations working quite effectively internally and with customer with tools like Zoom that could have a long-term impact on the demand for business travel“. Generally, Arvai and Merluzeau agree that the impact on business travel is still a bit of a moving target with Arvai suggesting that ” whether that is a 5%, or 10%, or 25% impact will have a huge impact down the road for airlines, so that will be a key element to watch, given the different levels of yields for business and leisure travel and the impact that mix has on airline margins and profitability.“ Merluzeau sees both sides of the coin as well but generally wants to remain bullish about the recovery and the creation opportunities rather than the substitution presented by tools like zoom ” The arguments from Zoom proponents is that the tool is only going to get better, and the workforce will become more dispersed, so the use of Zoom will become an everyday tool. Business travel proponents underscore that man is a social animal and that social interaction is essential — so it will have to return. I believe that we’ll get to 80-90% of business travel volume by 2023, but it will take time for corporate balance sheets to return and businesses to stabilize, assuming we don’t have another crisis.”sees both sides of the coin as well but generally wants to remain bullish about the recovery and the creation opportunities rather than the substitution presented by tools like zoom " The arguments from Zoom proponents is that the tool is only going to get better, and the workforce will become more dispersed, so the use of Zoom will become an everyday tool. Business travel proponents underscore that man is a social animal and that social interaction is essential -- so it will have to return. I believe that we’ll get to 80-90% of business travel volume, but it will take time for corporate balance sheets to return and businesses to stabilize, assuming we don’t have another crisis." Changes to air travel and airplanes themselves will be gradual and borderline on the reactive necessities driven by the pandemic, Merluzeau believes in a tiering of design changes, particularly when it comes to interiors and the passenger experience: ”In the near term, we will see changes, but not necessarily airplane specific. I think we will be looking at the permanency of UV lights and fogging as preventative measures for some time”. More fundamental design opportunities will come later he believes, and that will have to come with a new generation of airplane interiors ” we’re not going to see too many radical changes in the way aircraft and interiors are designed for the time being. For future aircraft, like the MAX and A320 replacements in the 2030 timeframe, we’ll likely see large scale usage of newer antimicrobial surfaces and improved touchless experiences with hands-free tools in high traffic areas like the lavatories and tray tables. There will be a profound transformation of the passenger experience driven by the excessive use of the “safe travel” terminology which is in itself an illusion and does not exist but is designed to address the “emotional” needs of individuals who are too dependent on the notion of safe spaces. I really like the Boeing terminology “confident travel”, that goes in the direction of “safer travel;” but there is no such thing as “safe travel”, this is a fallacy of presumption. He emphasizes the misinformation and use of incorrect information by either biased academics or opponents of air travel “The air quality in the cabin has been subject to a lot of misinformation recently. We’re currently "near operating room" air quality in airplanes today, and fundamentally, while we can always do better, we are pretty good. The state of the art is currently seen in business aviation with very high-level systems that will migrate to commercial aviation. Gulfstream has set the bar high in this regard with their 100% fresh air system.” For airlines, both agree that for the time being, the CFO remains the king in the airline world. How will the importance of finance evolve as we move forward? Merluzeau strongly agrees with the obvious: " The CFO is ever more the king, and we see the compression of the return on investment calculations on any new investment. With the balance sheets we have these days and the recovery over the next couple of years, carefully analysis will need to apply to most decisions, and may differ whether airlines foresee capitalizing on new opportunities or avoiding risks." Arvai agrees " I think the treasury function will become more important as carriers need financing sources after being saddled with so much debt. Financing becomes a critical element of moving forward." Merluzeau raises the following point to Arvai and asks " Is financial risk management assessment every more important because the level of exposure of an airline is immense, even if we are recovering?", to which Arvai responds " It’s huge, and I think it is very important, particularly if we have another shock to the industry. Can the industry survive another shock like this one? Some players probably will and some will not. We’ve seen events before that generated fundamental changes. Deregulation was one, and we saw some of the big names die. Where are Pan Am, Eastern, TWA, Braniff and others today? Will there be a similar kind of shakeout in the future? That remains to be seen, but I think that risk management and being prepared for the next crisis is key for airlines." Both see a lot of uncertainty in the near to medium term driven by government intervention, Merluzeau is particularly cautious about the next 12-24 months: ” I think a lot of issues, largely driven by necessary government bailouts to save the jobs in North America and Europe particularly, are still to come because we haven’t seen the full effect of true market forces at work in the past year. What has so far struck me personally is the level of intervention to control and prevent market forces doing their natural job in times of crisis.’ The past 12 months have witness such a shock on the system that this interruption of the crisis economics patterns seems logical, however more is to come. “The question is do we come out of this crisis and when is the necessary re-shuffling of the cards going to take place? Do we need consolidation and some zombie organizations to go? Business abhors a vacuum, and if somebody goes, their traffic will be picked up in due time. We have some zombie companies in the aerospace supply chain in specific isolated cases, do we also have zombie airlines? Do we have airlines who were struggling before the crisis and have not made the margins the mighty CFO wanted that are vulnerable? I’m perplexed.” Arvai is on the same wavelink and suggests that "we may, but as you mentioned, nature abhors a vacuum, and there are new entrants coming into the market. David Neeleman has Breeze ready to start service, a new airline Avelo is introducing low fares from Provo to Burbank on their first route. At any rate, we’ve got new entrants coming in to exploit niches and gaps and opportunities they see in the market." Merluzeau points out that ": I still find the name Avelo funny, because in French it means riding a bicycle. This should be the airline of choice for Greta Thunberg and the watermelon ecologists" he jokingly remarks. Arvai suggests that the " new players need to take that traffic from someone else. unless they can grow new markets organically. I personally don’t see the growth in some of these new markets, as they haven’t been exploited before because carriers didn’t believe those routes could be profitable. Again its down to the CFOs and the LCCs and ULCC’s making their cost structure work." He is also very confident about the new Breeze, driven by experiencee and the right fleet mix " Neeleman has been through the process before, founding 4 prior airlines including Morris Air, JetBlue, WestJet and Azul, and now with Breeze and has the credibility of someone who knows what they are doing and can exploit new opportunities. We’re going to see new players in the market, perhaps with stronger balance sheets that the existing players." But on the issue of finance there is some level of concerns from Merluzeau again: " Are we overestimating the health of the capital markets to support lessors and new entrants? Fundamentally the real issue here is active versus reactive. The bailouts were reactive. We tried to preserve an industry, to preserve jobs in a strange election year." Market volatility, particularly with widebodies is an issue that remains a significant risk factor according to both Arvai and Merluzeau, Merluzeau wonders if “practically speaking should lessors be ready for rapid repositioning of their assets if somebody goes belly up, especially if there are a lot of resources in the international market should assets not go back to the same operator? In the international market, travel may return in different ways and faster in some parts of the world than others. For the lessors, their ability to reposition assets to where they could get a good rent may mean that we could have a chaotic two to three years?” Arvai agrees “I think we’re going to see a very chaotic two to three years are were already seeing the first signs with LATAM and their A350, fleet which they are giving up on an standardizing on the 787-9, the former LAN airplanes instead of taking the TAM A350s, which they are putting on the market and returning to lessors. There’s a young fleet of 10 A350s that needs to find a home.” Arvai expects more transactions to take place: ”deals need to be done with lessors, and I’m sure Delta doesn’t want to pay full price for those A350s, as there really is nowhere else for the lessors to put them, as there are very few takers right now in a market where international travel is still subject to closures and wide-body aircraft are being moved to domestic routes. So we’re seeing disruption in the marketplace, we will see disruption in the capital markets, and we could probably spend another hour on government debt and economic structures but that’s beyond the scope of what we want to talk about today.” Merluzeau emphasizes that” while I’m not a huge fan of government debt or intervention, I see it as a necessary and sometimes uniquely powerful economic and regulatory agent, but you and I and many of the people reading this are going to pay for this intervention – we’re still paying for the last ones from 2008-2010?. An overarching issue remains one year into this crisis according to Merluzeau: ” are we more vulnerable or are we more resilient? When we weigh the two issues, to some degree we have developed some stronger capabilities to become more resilient. We have demonstrated the incredible capacity of this country (US) and this industry to adapt its operating mode and to become more resilient.” but he emphasizes the other side of the story “in a way, this crisis, and the absence of international coordination and the lack of transparency and cooperation of some of the actors has made us critically more vulnerable. It has also revealed significant holes in some critical capabilities, I am not sure that Canada, the UK and France will come out of this crisis gloating about their resilience and decisiveness, both countries have turned out to be inefficient nests of scared wobbling bureaucracies” He sees a fundamental change in the world order after the COVID-19 pandemic ” fundamentally I see with the world at Covid t+1 year and after as not as open than it was before Covid. The growth after the re-opening of air travel and individual movements is not going to be the same. I think this is the first casualty of the Covid crisis. There is perhaps more that divides us after this crisis, rather than binds the world together unfortunately.” He remains cautious about any shock that may materialize too soon and the ability of the system to absorb it “Personally, and because we have had such a financial shock, any other crisis that comes in the next five years is going to have more dramatic consequences, even if it is regional, more localized or more compressed in duration. This World patient had and survived a massive heart attack, but the patient may not be able to withstand another severe cold. Stability and careful management of international relations are going to be key.” Arvai is generally in agreement but suggests that” I think to some degree the industry is resilient and will bounce back, and we’ve got some airlines who will turn a profit in the second quarter and positive cash flow, paid for by the US government, but it is not sustainable. How long can we do that is the real question.” Merluzeau remains cautious” geopolitically, If anything happens in the next 24-36 months, the segment that is likely to suffer is international travel, currently badly affected by the pandemic. Any further shift to regional travel will put all sorts of wide-bodies under additional & excessive pressures.” He also suggests that OEM aircraft portfolio could be even more critical “ This makes Airbus look better from a product mix standpoint than Boeing. If US-European travel remains strong at the expense of transpacific, then A321 will likely pick up more shares in that market, Airbus currently has an advantage against the MAX and there is no much needed NMA at Boeing to compete efficiently with Toulouse“. Arvai is perhaps more concerned than Merluzeau about the Boeing situation and exposure “ I don’t see this as being beneficial to Boeing or the Boeing supply chain. The 787 has been mostly -9 and -10 and the 787-8 is the right size for what airlines want, but that is a very different airplane from the 9 and 10. The 777X is delayed. There really isn’t a lot to offer that fits the bill for Boeing to offer right now.” Merluzeau suggests that ” based on our work at AIR, any near term significant event will likely produce more impactful effects on our analysis equation & scenarios because the velocity of these events will be greatly compounded by the current exposure of the market and perhaps even into segments of society. Consequences could be more profound and destabilizing. The ability of the industry and supply chain to absorb another major event could lead to, for example, the entire suspension of a program. What will be the trigger? Assume for a moment that we have a relapse of the trade war with China, or a military incident in the South China sea, or in the Middle East, or even in the Aegean. I mean, any event, even a localized one, could have a major impact on programs like the 777X or the A330neo…I think it is important for people to realize that to fully exit from this crisis is going to take perhaps a decade, until the next one…” Arvai shares this perspective: “whether we’re reactive or proactive, we are more vulnerable, despite our resiliency. We have to more than ever anticipate events, and have plans to mitigate risks. It is much more important than ever before to look ahead, examine alternative scenarios and forecasts, and determine what might happen in order to plan and react to it quickly, as reaction time may be the difference between survival and bankruptcy.” Merluzeau concludes: “ We have to stop thinking in 90 day increments if we are going to thrive as an industry and think more strategically as an industry and as a society, from climate change to corporate strategy”.

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