JUNE 30, 2003
AFFAIRS OF STATE
By Stan Crock
Five Truths about Boeing's Tanker Lease | The Air Force contract isn't a scam -- as the critics would realize if they knew more about business practices. Still, it's not so smart
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If Washington has to be prepared to wage war in places far from friendly military bases, a reliable fleet of airborne-refueling tankers is critical. Neither long-range bombers nor shorter-range fighters can make extended journeys without mid-air refueling. But the current fleet of 545 KC-135 tankers are an average of 43 years old. Corrosion, maintenance costs, and long periods when they're out of service are all mounting.
Trouble is, the solution the Air Force, Congress, and Boeing devised was to insert stealthily in a defense spending bill language explicitly handing Boeing a lease deal for 100 new 767s. That has produced outrage in some circles in the nation's capital. (see BW, 7/7/03, "Inside Boeing's Sweet Deal"). But the critics of the transaction -- a series of six-year leases totaling $15.5 billion, plus a $4.1 billion option to buy -- are getting hung up on the wrong questions. Let's take a look at some of the canards:
Lease vs. sale: Leases are more expensive than outright purchases for the simple reason that buying generally avoids finance charges. The Air Force and Boeing say they want to lease because the Pentagon doesn't have what could be as much as the $8 billion it would need upfront to buy the planes outright. I hadn't noticed any congressional reluctance to pony up, say, $70 billion when the Pentagon unexpectedly says it needs it, but let's pass on that issue.
For me, the problem is that critics like Senator John McCain (R-Ariz.) and some watchdog groups seem to oppose leasing on principle. Leasing itself should not be the focus. Leasing can make sense. Take telecommunications equipment and sensors, where technology improves at warp speed. Why get locked into obsolete technology by buying it? Lease it for three years or five years, then get more innovative stuff.
The real issue is not whether to lease but what to lease. By this standard, however, a plane you're going to keep for decades doesn't seem to be a prime candidate for a lease.
Special purpose entity: The lease will be financed through a special purpose entity (SPE). That conjures up images of Enron, which used SPEs to keep liabilities off its balance sheet. Despite the stench, the fact is that most commercial airplanes are leased, and the transactions are conducted through SPEs. Suspicion from some lawmakers and their aides is the price to be paid for bringing a very conventional private-sector practice to a Washington untutored in business matters.
Cost: Sure, a lease costs more, but maybe not that much more. According to the Air Force and Boeing, the tanker leases cost less if you assume commercial efficiencies in the lease -- because it has multiyear lease authority. Don't assume such efficiencies for a purchase, because there's no multiyear purchasing authority from Congress.
If you assume the same efficiencies for both and compare apples with apples, purchasing comes out cheaper. That's hardly a surprise. But it means leasing may not be so outlandishly more expensive. After all, interest rates are low. The estimated interest rate for the less risky pair of the three tranches of bonds needed to finance the deal is under 4%. The estimate is based on Office of Management & Budget assumptions that are far higher than current rates, so the cost may actually be lower.
One tranche is backed by the full faith and credit of the government, so it's essentially a Treasury rate. A second tranche is backed by the lease revenues and would carry a slightly higher coupon. If the Air Force terminates the lease, it would be required to make that year's payment plus the following year's, so as you get to the fifth year of the lease, remaining payments become government-guaranteed.
That reduction in risk means the premium above Treasuries shrinks. Since the government is running a deficit and would have to borrow money for an outright purchase, which apparently isn't included in the comparison of purchase and lease, the difference in cost could shrink further.
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Copyright 2003, by The McGraw-Hill Companies Inc. All rights reserved.
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