Passion Investments: Aviation
High-Flying Gamble
Michelle Seaton
10/01/2004

The Eclipse 500 ultralight exists only as a prototype; it will not be commercially available for at least two years, if ever. But the jet’s uncertain future has not stopped Ken Ross from buying and selling five of them—at a handsome profit—already.

LOFTY AMOUNTS of money can be made—and lost—when gambling on aircraft prototypes. Cessna, maker of the Citation CJ2, wants nothing to do with the practice.
Ross, president of North American Jet, an aircraft management company in Chicago, does not typically trade in phantom aircraft, but Eclipse offered a compelling opportunity. Four years ago, the company’s ultralight personal jet was in the design stage. To raise the capital it needed to go from blueprint to blue yonder, the company, based in Albuquerque, began selling “delivery positions” for $155,000 each. These offered buyers the right to purchase one of the first models to roll off of its assembly line—if and when that occurred. Eclipse accepted 160 down payments from individuals such as Ross for what it called Platinum Positions, which guaranteed a price of just under $1 million for the aircraft, and assured holders of a delivery date during the first year of production. By the time Ross was ready to sell his positions several years later, the going rate for them had risen between $300,000 and $400,000 each.

Buying an option secured only by the seller’s intent is a highly speculative move. The money Ross invested was nonrefundable, and did not go into an escrow account. Moreover, there is no firm guarantee that the Eclipse 500 will ever move beyond the design stage. “This type of investment is not for the faint of heart,” Ross admits. “You have to be able to lose everything, and you have to be able to let it sit for five or six years.”

Selling delivery positions allows manufacturers to raise the capital they need to develop new lines, and it enables early buyers to lock in attractive prices on airplanes that are years away from production. Some buyers, such as fractional companies or private aircraft enthusiasts, may acquire early positions fully intending to take possession of the planes. Other investors hope to sell, or flip, early positions when their price rises. Manufacturers may sell hundreds of early delivery positions. Eclipse has sold more than 2,000 on various aircraft.

VALUE JUDGMENT
Purchasing delivery positions on aircraft in the design or prototype stages secures us an attractive price and an early delivery date. We may also be able to sell our positions on hotly anticipated models at a premium. However, the risks of investing in delivery positions—manufacturer bankruptcy, FAA censure and design problems among them—are substantial.
With some popular aircraft models, there is a significant gap—sometimes years—between order and delivery dates. When this occurs, the early delivery position becomes a very valuable commodity. “The buyer says, ‘I’ll get this plane cheaper now than what it will sell for, and I’ll get it sooner,’” explains Walt Lamon, president of Wyvern Consulting, a New Jersey-based aviation consulting firm. For example, if we tried to order an Eclipse today, we would take possession of it no earlier than 2010, and would pay nearly $200,000 more than the price paid by the Platinum Position holders.

If we time our purchase correctly, the reward can be impressive. In 2000, entrepreneur Lee Morse was planning to create a regional airline in Maryland. He bought one of the first 100 positions on a Cessna Citation CJ2, then a highly anticipated $5 million light jet prototype. When Morse changed his mind about the purchase, a broker friend found a buyer willing to pay a hefty premium. Morse cleared $300,000 on the deal. “The base price of the plane had gone up $600,000,” Morse recalls. “The buyer got the plane he wanted right away, at a great price.”

Crash and Burn
Not all position traders succeed. Morse sold his CJ2 position during the general aviation boom, when manufacturers saw order backlogs of two and three years. Within a month of Morse’s deal, however, the aviation market hit a slump. Buyers evaporated, forcing early position holders who needed to sell to do so at face value, or even at a loss.

There is also a significant risk of total loss. It is possible that some of the manufacturers competing to roll out popular ultralights in the cutthroat, capital-intensive personal aircraft industry will go out of business. “It’s very tough to get your deposit back unless they scrap the project,” explains Steve Lockshin, CEO of Lydian Wealth Management in Washington, D.C. “In most cases, you are bankrolling the company.”

Designing and manufacturing a new aircraft is a speculative venture. Industry experts estimate that bringing a new jet design to market can cost from $250 million to $300 million, and can take years. Sino-Swearingen, a U.S.-Taiwanese joint venture based in Texas, has been trying to bring a $5 million light jet to market since 1995. It had to discard its first design, and FAA certification for its second design, the SJ30-2, is years away.

Even if a manufacturer stays afloat and its design does not become entangled in FAA red tape, the company may still face financing snafus or supplier delays. Eclipse has delayed production several times, once to shop around for a new engine. Early position holders will have little recourse but to wait for their airplanes.

THE ECLIPSE 500 is only a prototype, but investors selling their delivery positions are flying high.
Design details may evolve over time, so Ken Hoffman of Greenberg Traurig, an aviation law firm based in Miami, advises us to seek guarantees from the manufacturer that the delivered aircraft will meet the speed, size and payload specs set forth in the position contract. All too often, as an airplane moves closer to production, its frame grows heavier, its top speed drops and its cabin and cargo areas shrink. “You can end up with an aircraft that’s not what you ordered,” says Hoffman. Some manufacturers mock up an entire family of new aircraft to sell, then, after accepting deposits, decide which one of them to fast-track through the approval process.

Owners of early delivery positions also face practical concerns, such as whether the company will be able to service the aircraft. This affects the value of our delivery positions, particularly when the airplane is finally in production. We should also take note of where we stand in the delivery queue. Ross reveals that his buyers wanted to know exactly what position numbers he owned. Were they among the first 50 aircraft? In the first 100? Being first in line is not necessarily the most advantageous spot. David Lee, president of Air Shares Elite, a regional fractional aircraft company based in Atlanta, is hoping to buy 10 to 15 ultralight jets. He wants first-year delivery positions, but he does not want to buy any of the first 50 aircraft produced by any company. “The first 50 serial numbers in any manufacturing line are likely to have significant shakedown problems,” Lee says. Morse agrees, noting that the buyer of his CJ2 was happy that he held position number 62. “It was definitely an early position, but not too early.”

Unwelcome Advances
Although the aviation market has a long history of selling early delivery positions for profit, some established manufacturers frown upon the practice—and even go so far as to forbid it. FalconJet, for example, provides a frosty response to those asking how positions are trading on the 7X, its latest offering in the large business jet range. FalconJet spokesman Ralph Aceti explains that customers can put down a refundable deposit of $5,000 to $10,000 to secure an early position on this $37 million aircraft until the specs have been set. At that point, customers must sign a purchase agreement and secure it with a $3 million payment. “If you decide afterward that you don’t want that airplane, you don’t get your money back,” Aceti cautions.

Some manufacturers discourage flipping positions by stating that their warrantees are not transferable prior to delivery, or that the delivery contract itself cannot be sold. Aceti will not confirm that FalconJet has ever made such declarations, but he does confess that the idea of a customer becoming a dealer is justifiably off-putting to manufacturers. “What if you sell your position to someone in Africa? In that case, we’ve lost our ability to service the end user, and that is not a good thing.”

Cessna wants nothing to do with the practice. “We don’t sell delivery positions. We sell aircraft,” spokesman Mike Pierce asserts. When asked if customers are trading positions on the new Mustang, Cessna’s entry into the ultralight jet market, or if they have been trading on the wildly popular CitationJet 2 or the new CitationJet 3, he claims, “It doesn’t happen.”

Actually, it does happen. Morse declared his position on a Cessna CJ2 the sole asset in a limited liability company, then sold the company and the aircraft it owns prior to taking delivery. The new owner then put his name on the title at delivery. Morse was careful to secure Cessna’s blessing (however reluctantly it was bestowed) before making the sale. “They knew that I had intended to take delivery of the aircraft. I’d even gone out and paid to learn how to fly it myself,” Morse says. Knowing that Morse had good intentions, and believing that he would one day be a Cessna owner, the company went along with the deal. However, according to an aircraft broker who asked to remain anonymous, this type of transaction is rare. Industry insiders generally understand that if we flip a position against the wishes of the manufacturer, we will do it only once. Some manufacturers have blackballed pure speculators on occasion, the broker says.

Eclipse’s view of the practice is in stark contrast to the conservative position of older manufacturers such as Cessna. Eclipse President Vern Raburn can barely contain his glee when discussing the $200,000 premium that early position holders on the Eclipse 500 now demand. “We regularly get calls from people looking for a seller,” says Raburn, who adds that the company has even brought buyers and sellers together. Eclipse also held back about 20 early positions that it plans to auction off once production begins. In essence, the company will be flipping its own positions during the first year of production. Far from being squeamish about the notion of customers making a profit on his product well before he does, Raburn seems thrilled that early investors are receiving what he sees as just rewards. “Those first 160 buyers were real risk-takers, and there is no way you could characterize that risk as rational,” Raburn says. “They took a chance on us, and we love ’em to death.”