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Siren
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Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Tue Nov 14, 2017 9:44 pm

Every time an order from a carrier to a manufacturer occurs, there's always a number of words thrown in, and I've never been entirely clear on the process itself, or how these things work behind the scenes. Often times, we'll hear about an LOI - Letters of Intent signed by airlines to order a specific type of aircraft. The popular one today seems to be EgyptAir and the CS300.

What exactly is a "Letter of Intent", and what does that set in motion? Obviously it announces to the manufacturer that the airline intends to purchase a certain amount of planes, but are issues like pricing and financing of these frames discussed in the LOI, or is that determined at a later time? Are the engine manufacturers a party to the LOI, or are they brought in at a later time? Is the engine selection typically made this early? Do manufacturers reserve delivery slots when LOIs are signed?

I suppose I have the same questions for an MOU... the Memorandum of Understanding. I'm going to guess that it is a little bit firmer than an LOI, in that both parties have in principle agreed to the terms, but the order itself isn't 'firm' - ie: no formal contract has actually been signed. The MOU is an 'informal contract'? Am I right in that the reason for using this sort of agreement would be to firm up the terms while financing is arranged? Or other things that have to line up on the carrier side, before they can commit to a truly firm order...

Firm orders - contract signed. I've heard that airlines sometimes make down payments on the aircraft, is that correct? Some sort of pre-delivery or pre-build payment to the manufacturer... I can imagine that for large orders, this can be a very substantial sum of money. How much are we talking about? Example, 20 A350-900s, or 20 787-9s... how much money would that be in down payments? Of course, the airlines and manufacturers have substantial leeway in structuring a deal, so in some cases, there may be no payments, but I would reason that the pre-payment issue might be one of the reasons for an MOU in lieu of a firm order?

How do options typically work? When an airline commits to 20 firm aircraft plus 20 options - those options are basically committing the manufacturer to allow them to purchase 20 more airframes at the same price and/or terms. What other stipulations would there be, though? With options, is there typically an expiration date - ie: you must exercise these options by 2025 or you can't have them? Also, if options are exercised, are the delivery slots typically negotiated in advance? ie: If Airline A exercises its options, will it bump Airline B's delivery back? I suppose that depends on the contract terms...

I suppose what I'm looking for is... what are the industry standards, insofar as they exist? I know there's lots of custom things done for big customers, but assume this is just an average sized airline making an average sized order. The manufacturer isn't going to bend over backwards to win this order. What sort of terms would we see here for this average airline making an average order?
Siren: 32 year old single white female based @ KLAX. Aviation nerd, political wonk, disability rights activist, German car enthusiast, Californian Independence leader & evangelist
 
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lightsaber
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Tue Nov 14, 2017 10:45 pm

LOI might or might not include the engine makers. Usually, those are signed long before financing and other details are firming up. There is no deposit, but it obligates the buyer to not shop around for some time frame and the seller to hold slots for a short time.

The MOU is a step further. More details are hashed out and there is more committed to by both parties. But to hold slots, money (refundable usually) will trade hands. Both LOIs and MOUs expire, so a purchase contract must be signed or the process starts over (although airframers will happily extend if they like the terms).

There are firm orders with no pre-payments. But no one likes those sales...


Firm order- a deposit is put down, with conditions allowing the buyer to back out. If the buyer backs out there are penalties. However, if the planes are late, the deposits are refunded. There is also a payment schedule for deliveries (not everything is paid at the end). When deliveries may be delayed, inflation adjustment terms, and when the supplier or buyer may delay without penalty. Firm orders can include put options. For example, Boeing recently forced Delta to buy additional 737-900ERs per the contract. A firm order is a signed contract. Perhaps not all the details written out, but there is enough of an outline.

Options are production slots held for a small to zero cost further in the future. Options usually must be firmed 2 to 3 years before the delivery date. They are firmed by making progress payments and committing to deliveries. For example, EK just negotiated 60 options with their qty 40 787-10 purchase. They will have dates they must commit/pay buy for a delivery on a certain month. However, there is more flexibility. If Airline A's delivery will bump B, Boeing will be allowed to smooth the slots. For example, Airline B's contract might allow for a 1 month bump with a $100,000 penalty. If Airline A excercises options, they might be told there is a 2 month delay unless they pay $250,000 extra.

There are so many terms in a contract it is mind boggling. The option expiration depends on 1) how good the options are (lower prices have firmer expiration terms).

There really are no standards on options. They all very. For your average order: Every purchase contract delivery dates usually allow for a 1 month slip with no penalty, 2 or 3 months with a trivial penalty, and then a pretty low maximum penalty. There might even be terms (puts) to force early delivery, but at a discount. There will be terms if the airline supplied equipment is late, but an average order might not have any airline supplied stuff (or it might, it really varies).

So the after airline might say buy 20 aircraft. They want the aircraft early, let us say:
Year 1: 6
Year 2: 7
Year 3: 7
Year 4: 7 options, 18 month lead (all options)
Year 5: 7 options
Year 6: 6 options

But near term slots are valuable, so since this isn't a 'bend over backward' order

Year 1: 4
Year 2: 5
Year 3: 5
Year 4: 5
Year 5: 1 (makes twenty) with 4 options that must be exercised in year 2
Year 6: 5 options (must be exercised in year 3)
Year 7: 5 options (must be exercised in year 4)
Year 8: 9 options (because the buyer won't be willing to go past 8 years typically)

Now, less popular models will have shorter option exercise time frames. 18 months being the shortest (the time for long lead parts).
For example, right now if you wanted an A330 or a 77W/777F, you would be front loading and the options lead time would be shorter.
The more money an airline is willing to pay, the earlier the deliveries (and some of the money goes to pay penalties for delayed airlines).

I'll use the G650 as an example.
4 years ago, if you wanted to buy several G650s (we'll use 20 again). you would have had to wait 3 years and the deliveries would have been split over 3 years.
Today, if you wanted to buy twenty G650s, you would receive a few next year (there are customers willing to delay deliveries or transfer orders), perhaps 10 in 2019, and the rest in 2020 at a lower price per aircraft.
But if you wanted a Global 7000, the first delivery would be in 2021 and you would have to take deliveries even later for the bulk.

Take Allegiants order of A320CEOs. CFM was holding unsold slots for the CEOs. So Allegiant was 'wined and dined'. So they get a dozen A320s with short lead times, but Allegiant had to pick overhead bin, Lavatories, and seats based on price/availability (no Zodiac?). But they were able to get the colors they wanted (skipping most options to save money and get stuff in time). No options as these are end of line airframes.

The options almost never have to be exercised at once. See my timelines above. Once an option is exercised, a delivery slot is assigned. However, with the provision that the slot can slip with penalties paid. Now options can be stretched out further, but there will be provisions that these expire when the line is closed. An airframer must give customers a few months notice if the line is slowed. Usually, the airframer will discount the option closing price to avoid slowing a line...
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Caryjack
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Tue Nov 14, 2017 11:18 pm

When these types of questions come up I refer to this time tested post.   
----------------------------------------------------------------------------------------------------------------------------
"Hamlet69 From United States, joined Mar 2000, 2306 posts, RR: 56
Reply 32, posted Fri Aug 3 2007 02:44:27 your local time (2 years 3 months 1 week 6 days 11 hours ago) and read 9427 times:

Below you will find a list of common steps or mini-steps taken in purchase negotiations:

Firm: The purchaser makes a percentage deposit guaranteeing price and delivery slot(s)

Option: Purchaser makes a marginal, refundable deposit guaranteeing price and first-right of refusal for specific delivery slot(s)

Purchase Right: Purchaser makes a marginal, refundable depost guaranteeing price point

Letter Of Intent: Purchaser makes formal commitment to order certain frames at agreed-to price and delivery timeframe without placing deposit

Memorandum Of Understanding: Nearly identical to LOI (above)

Everything else: This is everything else that one hears about. From public statements declaring the purchaser's intent (but without formal commitment) all the way down to closed-door requests to discuss certain aircraft, whether instigated by the buyer or seller (actually happens alot, on both sides)

Note that a firm order can come from any one of these steps, and by no means does a buyer need to go through all steps in order to make a firm order.

Regards,

Hamlet69 "
-------------------------------------------------------------------------------------
Thanks,
Cary   [/quote]
 
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Siren
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Tue Nov 14, 2017 11:55 pm

lightsaber wrote:
Firm orders can include put options. For example, Boeing recently forced Delta to buy additional 737-900ERs per the contract..


Firstly, wow. Thank you for taking the time to write such a detailed reply - you've answered a lot of my questions about the process!

Now - I've never ever heard of put options - when did this example occur? How many 737-900ERs did Delta have to take? And I'm curious for the reasoning for contract terms like this. For a better deal on a large order, Delta was willing to gamble? I would guess that's probably what happened... an airline that had a 737-900ER on order, it was not taken up for whatever reason, and they decided to stick it with Delta, due to the contract terms? Is this a common thing in the industry?
Siren: 32 year old single white female based @ KLAX. Aviation nerd, political wonk, disability rights activist, German car enthusiast, Californian Independence leader & evangelist
 
fcogafa
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Wed Nov 15, 2017 12:17 am

A new one to add to the list, from Baltic this week was 'We have agreed to begin discussions.....!!
 
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keesje
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Wed Nov 15, 2017 12:31 am

I think the terms "commitments" and "up to" translate into "order" headlines quickly in the confused media, generating the desired perception among stake- / stockholders. The nuances get lost down the screens.

http://www.reuters.com/article/us-trump-asia-china-deals-boeing/boeing-signs-deal-to-sell-300-planes-worth-37-billion-to-china-idUSKBN1D91BZ

OE's are also increasingly getting away with "unidentified customers". If those are reduced anonymously, nobody cares. Still they are proudly included in all kinds of backlog numbers and market share calculations (11% of NEO orders, 21% of MAX orders) boosting a healthy image. Nobody wants to know how solid they are / aren't.

Also the signed contracts for lease companies can be (much) softer than they look. In the clauses can be generous cancellation terms, allowed by the OE to boost orders / marketshare, while the line between orders and options gets thin.

Recently we say an "orderplan", for "expressions of interest" "three dozen pledges to buy" that hit the wires as "orders" "dealing a blow" for eager media & a hungry target public. We want to be fooled.

https://www.bloomberg.com/news/articles/2017-06-19/boeing-set-to-commit-to-first-new-jet-since-2013-with-bigger-737

If executive salaries are strongly linked to short term stock pricing (increasingly perception based), cash flow and increasingly in-transparent backlogs, they stimulate cooking the numbers. Not by lying, but by leaving out crucial details to create perceptions. The perverse driver is that everybody with a share is stimulated to play along. Embedding.
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Planesmart
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Wed Nov 15, 2017 12:37 am

Many of these terms are interchangeable.

Deposits, and even sometimes progress payments, are not always cash.

Even firm orders are often conditional, like subject to finance (on terms satisfactory to the buyer, so a complete 'get out of jail' card).

Both A and B have made progress using standardised documentation, especially for smaller customers. For major customers, clauses in the documentation can take as long to negotiate as the aircraft specifications.

Initiated by B, and followed by A, both OEM's are taking a far firmer stance, including penalties, for customers that miss payment deadlines, seek to change models/specs, defer deliveries, etc, unless specifically permitted in the contract.
 
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Revelation
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Wed Nov 15, 2017 12:41 am

Siren wrote:
lightsaber wrote:
Firm orders can include put options. For example, Boeing recently forced Delta to buy additional 737-900ERs per the contract..


Firstly, wow. Thank you for taking the time to write such a detailed reply - you've answered a lot of my questions about the process!

Now - I've never ever heard of put options - when did this example occur? How many 737-900ERs did Delta have to take? And I'm curious for the reasoning for contract terms like this. For a better deal on a large order, Delta was willing to gamble? I would guess that's probably what happened... an airline that had a 737-900ER on order, it was not taken up for whatever reason, and they decided to stick it with Delta, due to the contract terms? Is this a common thing in the industry?


Actually it was 10*737-9ER, it wasn't a one-frame thing ( ref: viewtopic.php?t=1360539 ).

With the put option, Delta took a lower price per-frame for more frames than they originally asked for, gambling that Boeing would sell the extra frames at a better price to someone else. Delta lost that bet. Boeing can sell at lower prices with higher volume so they can offer the lower price, and if some one comes along willing to pay more than DL then they make extra profit. In that regard, Boeing also lost their bet because no one else came along, but Boeing knew they could always exercise the put option and make a sale to DL presumably still at a profit too. So now DL has more 739s in its fleet, so maybe Airbus lost a few A321 sales, so Airbus might end up being a loser too! :D
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frmrCapCadet
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Re: Aircraft Ordering - LOIs, MOUs, Options, Firm orders, etc

Wed Nov 15, 2017 1:49 am

In part it is a matter of SEC or equivalent disclosures. Orders, and likelihood of orders, are information affecting the value of the stock. They need to be reported at appropriate times.
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