Mubadala takes flight in aviation support

As airlines seek less costly solutions for their maintenance obligations, the Abu Dhabi investment giant sees an opportunity to expand.

Mubadala wants to focus on high-value industries such as the maintenance, repair and overhaul of aircraft components.

Mubadala Development's aerospace division seems to be on a bull run. It has already launched Strata, a business in Al Ain to make fuselage parts for the world's biggest aeroplane makers, and signed co-operation agreements with a who's who of the top-tier aerospace and defence companies from Europe and the US to pursue joint ventures in Abu Dhabi.

With names such as Rolls-Royce, GE, Boeing and Sikorksy, the partnerships Mubadala is forging will ensure aerospace will be an important driver in Abu Dhabi's future economy. Its latest initiative, Sanad Aero Solutions, was launched at the Singapore Airshow this month and demonstrates the kind of advantages that Mubadala brings to the aerospace industry - insight and capital. Sanad will provide financing assistance for engines and components to airlines that are under contract with Mubadala's two maintenance firms, Abu Dhabi Aircraft Technologies and SR Technics, based in Europe. Already, the investment company has wrapped up its first two deals worth a collective US$130 million (Dh477.1m) to Etihad Airways and Air Berlin for financing engines and components.

Mubadala knows full well that the airframe maintenance, repair and overhaul (MRO) business is a low to no-margin business. It is essentially a commodity. The costs to entry are low and the job is labour-intensive. Anyone can buy the tools easily, build aircraft hangars for a few million dollars and set up shop, from Moscow to South Africa. As a result, airlines have been drifting to newer maintenance centres offering the lowest cost.

Most of the remaining onshore centres in Europe remain as units within large airlines such as Air France and KLM Royal Dutch, and these are operated as loss-making enterprises. This is not the kind of business on which Abu Dhabi wants to base its diversification strategy away from oil. Instead, the emirate is identifying industries with high barriers to entry that are capital and often energy-intensive. It wants to leapfrog the labour-intensive stage of industrial development and focus on high-value industries. With a relatively small population of 5 million in the UAE, Abu Dhabi prefers businesses that require fewer, highly skilled employees.

The maintenance and repair of components offers more potential. Aircraft used to be controlled by mechanically actuated hydraulic or pneumatic systems, but modern systems are digitally controlled. There are computers for the engines, and virtually every other control is electronic in one way or another, including gear boxes, hydraulic pumps, generators, air valves, heating units and landing gears.

The cost for a facility to maintain these systems is much higher - diagnostic machinery alone can cost millions of dollars. Repairing these high-end components requires less labour but more investment in training and information technology. Mubadala is positioning its two MRO subsidiaries to do more of this work, and this should only increase through the financing support of Sanad. Currently in a down cycle, airlines are losing billions of dollars worldwide. But even during the good times they have never relished owning and maintaining spare parts.

Spare parts and engines account for 8 to 15 per cent of an airline's fleet costs, said Donal Boylan, the acting chief executive of Hong Kong Aviation and a former aircraft leasing banker at the Royal Bank of Scotland. This is an extremely heavy burden to shoulder. Most of an airline's aircraft purchases are financed through bank loans, with a small percentage paid for by the airline's own capital. This means airlines sometimes have put as much money into components as they have into the aircraft themselves.

Banks have so far been unwilling to lend money to airlines for components purchases, Mr Boylan said. "Banks like the idea of financing an entire airplane, and can't cope with the idea of components coming on and off planes. So airlines have to buy these components in cash." By purchasing all the spares that an airline will need, Sanad frees up cash for the carrier. By servicing a large number of airlines, Sanad would also be able to realise the economies of scale to be derived from efficiently storing and managing large numbers of parts together.

This new company may set up pooling centres of spare parts around the world and in the process pioneer a business model. That's because in the past, only the makers of these components offered financing. Before that, when technology was less electronic, some companies would even purchase older planes, strip them and sell the spare parts, Mr Boylan said. Mubadala is not the first to offer components financing, "but they are probably doing it in quite a different way", he said. "It has used its time in investing in its MRO subsidiaries to actually establish a role that will be very appreciated and can be very global and significant."

Other service industries could follow in Sanad's footsteps, as Mubadala looks to fulfil a greater role in the outsourcing trend in civil and military transport. One example would be Al Taif, a Mubadala subsidiary that maintains the UAE Army's fleet of land vehicles. Al Taif, too, hopes to have a larger role in managing the military's supply chain. Similarly, Mubadala is setting up a military aviation maintenance company with Sikorsky, and it remains to be seen what type of supply chain management is built into that business model.

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