As we reach the halfway point of the year, Airbus is reporting a record backlog of nearly 7 years’ of production, with Boeing closing in on similar record levels. But how firm are these firm orders? And what about options, purchase rights, and contracts with contingencies? Let’s try to straighten out some definitions:
Firm Order: A signed contract between a customer and an airframe manufacturer for delivery of an aircraft at an agreed price, at an agreed delivery time. Typically, firm orders require some down payment, and progress payments leading up to aircraft delivery.
But there are variations on a “firm” order.
The “Specify Later” order: Many leasing companies, for example, will order the smallest member in a series, retaining the option to switch upward to a larger model closer to delivery. So that order for an A319neo or -7MAX could really be for an A321neo or -9Max later on. The reason is clear – progress payments are smaller for the smaller model, which typically carries a lower price – and the OEMs are happy to place orders with leasing companies and will accept that lower revenue to secure the order — as after all – the leasing company doesn’t require a lot of “concessions” in the deal, whether in the form or spare parts or training.
The “Firm Order with Contingencies”: The recent 100 aircraft order for Embraer 175E2 jets from Skywest included 40 firm order, and 60 orders subject to a successful capacity purchase agreement with a major airline, which are not quite as firm. While they are likely to convert to firm orders, there is an “out clause” for the buyer – so should they be counted as absolutely firm, or closer to an option? But this order also had 100 options, in case they need more aircraft. Should we call this order 100 firm +100 options, or 40 firm +160 options?
The “Modified Firm Order”: Firm orders can also be modified – as we recently saw, one carrier change an order for wide body aircraft into narrow body aircraft as their strategy and competitive position changed. The change, of course, continued to benefit both parties, but caused a blip in the firm order totals in each column – one going down and the other going up. It does make keeping track more fun.
“Speculative Orders”: Speculation also rears its head periodically in the industry. Back in 1989-1990, carriers were rushing after delivery positions, some speculating on them to sell to others, before the bubble burst with the inevitable industry downturn. Whether the Gulf War, SARS, 9-11, or economic recessions, there always seems to be an event that will burst any bubble. Today that speculation is in massive growth orders for some airlines.
Lion Air in Indonesia is an example – with more aircraft on order from Boeing and Airbus than the entire fleet of all Indonesian airlines combined. Either Lion Air will be a stock that I will regret not having purchased, or some of those orders will never be delivered. Only time will tell if all of these orders will be delivered, or merely a portion of them. Combine Lion Air with Air Asia and Tiger, and even with the highest growth rates on the planet, it will be difficult to take all of the aircraft on order.
Traditionally, an option is the right to purchase additional aircraft at the same price and terms negotiated in the original contract, likely with an inflation escalation built in. That has the benefit of assuring the airline that aircraft will be available should it successfully continue to grow, and ensures the manufacturer that those aircraft won’t be purchased from a competitor. And with most aircraft orders, we see firm plus options from the major players. Options may have a time frame associated with them, in terms of potential delivery positions.
But the game appears to be changing, and some OEMs no longer report options in their numbers, which is a shame because it helps analysts gauge the popularity of a particular program.
More recently, we’ve seen a new element introduced – Purchase Rights – which are apparently less firm than an option, but grant the purchaser the right to purchase additional aircraft should they be needed. Recently, we’ve seen some 10+10+10 contracts, with orders, options, and purchase rights.
As far as we can tell, a purchase right is an option that the OEM added to the deal to enable the airline, should it decide it likes the aircraft, to acquire more at the same price – just like an option, but perhaps without the commitment of potential delivery time frames. As a result, with purchase rights, the carrier needs to move them up the food chain in order to secure deliveries.
The Bottom Line
It’s beginning to get harder to tell what’s real and what isn’t in today’s market. Is a contingent order worth more than a purchase right? Can we trust a massive order from an emerging carrier as really going to be delivered? Unfortunately, we’ll need to make the best of a situation that appears to be growing more confusing.