You would think that an airplane-leasing company that calls itself International Lease Finance Corp. would make its money by leasing airplanes to its customers. But you would be wrong. International Lease, in fact, makes most of its money not by leasing airplanes, but by selling them.
Combine that information with the fact that changing just one number can send International Lease's reported profits rocketing up to the stratosphere, and you begin to see why American International Group (AIG), the huge insurance holding company, has the hots for International Lease.
AIG is forking over more than $3 billion -- $1.3 billion to International Lease's stockholders and assuming $1.9 billion of debt -- to get into the airplane business. But airplanes are notorious for being, if you can forgive the pun, an up and down business. And the down part of the cycle seems to be starting. Prices of some used airplanes are starting to slide. Some U.S. airlines are starting to weaken.
And if the deal goes through, AIG will be on the hook not only for the $3.2 billion it's spending to buy International Lease, but also for $15 billion or so worth of planes that International Lease has committed to buy over the next 10 years. Committing billions to the airplane business in this market makes about as much sense as buying a lifetime pass on Frank Lorenzo's airlines. Unless, of course, you're very clever -- and AIG is nothing if not clever.
Part of the reason AIG is buying International Lease, of course, is that AIG believes that the airplane market will be so strong in the next few years that it will make a fortune because International Lease, the world's second-largest plane leasing company, ordered its planes at cheap prices.
Another part of the reason, which emerges only when you massage some numbers, is that AIG is an almost sure bet to have higher earnings with International Lease than without it. How? By changing the way that International Lease charges its earnings for depreciation on its planes.
Here's how it works. A company like International Lease has to charge its earnings for the fact that its planes get closer to the end of their useful lives with every passing year. You've heard of this before -- it's depreciation. It's what happens to your car as you get more miles on the odometer.
Airplanes can become old rustbuckets, too, but companies can't just put a bumper sticker and a piece of Fiberglas over the holes; they have to account for it on their financial statements. Say International Lease spends $100 million for a plane. It charges its profits $4.5 million a year for depreciation and decreases the plane's value on its balance sheet by that amount.
International Lease makes its profit when it comes time to sell the plane; the profit is the difference between the depreciated value of the aircraft and the price for which it's finally sold. International Lease makes big money on sales -- which means that its depreciation charges have been higher than they had to be. In 1988, for instance, International Lease made $36 million (before income taxes) by selling planes, compared with $20 million for leasing them. In 1989, it was $53 million vs. $20 million. In the first quarter of 1990, the numbers were $14.9 million vs. a loss of $7 million, compared with $2.5 million vs. a loss of $10.1 million a year earlier.
So AIG could cut the depreciation charges and give International Lease's earnings a real boost. The company would report smaller profits on sales of planes, but who cares? AIG's reported profits from "financial services" would be up, and everyone would be happy.
AIG Vice Chairman Edward Matthews says that changing the depreciation numbers "is under active consideration," but he wouldn't be drawn into a discussion about it.
Say International Lease depreciated planes the way the world's biggest airplane lessor, GPA Group, does. If you take that difference and apply it to the $10 billion fleet that International Lease will soon have, reported earnings increase $90 million a year at one stroke. That's a much easier way of making money than actually earning it. And $90 million a year is about what International Lease's whole operation earns now.
If the deal takes place, it should be fun to watch. The companies couldn't be more different. Not only are they on opposite coasts -- AIG in New York, International Lease in Beverly Hills, Calif. -- but AIG's 27-person tax department is almost as large as all of International Lease, which has just added its 28th employee.
AIG, as an insurance company, likes to eliminate risk. International Lease relishes it. The company simultaneously juggles currencies, interest rates, projected airline prices in the 21st century and the financial outlook for foreign airlines so obscure that few Americans can pronounce their names, let alone figure them out.
The idea is "synergy." AIG talks about using its group of trading whizzes to hedge International Lease's interest rate risk. International Lease talks about some incomprehensible plan to do something with planes in Indonesia to take advantage of Indonesian tax credits.
It all sounds wonderful -- but then again, it always does. Whether this deal makes economic sense for AIG won't be clear for several years. But AIG's ability to play games with depreciation means the deal will make earnings sense. These days, you take what you can get.
Allan Sloan is a columnist for Newsday in New York.