Professional Statement: Airbus A340-500/600 Product Life Cycle and Nacelle Components Final Report

MB STRATEGY CONSULTING has unparalleled experience in aerospace, defense, and energy equipment finance, operations, engineering/technical, market research, strategic planning and strategic market development, new product development, and aftermarket services.

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  Williams FJ44 turbofan engine
  
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  Kawasaki M7A industrial gas turbine
  
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  Pilatus PC-12 single engine turboprop
  
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  Sino Swearingen SJ-30 corporate jet
  
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  Kawasaki GPB15X industrial gas turbine generator set
  
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  Kawasaki M7A gas turbine
  
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  Pratt & Whitney Canada ST30/40 industrial gas turbine
  
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  Pratt & Whitney Canada ST5 miniturbine
  
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  Pratt & Whitney Canada PW600 turbofan
  
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  P&W PW6000 turbofan engine
  
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  Engine Alliance GP7200 turbofan engine
  
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  GE/Honda Small Turbofan
  

Mark Bobbi’s consulting history is as follows:

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  Provide strategic market development of a new small low cost turboshaft engine for rotorcraft and industrial applications for the former Allison Division of GM
  
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  Development of a strategic alliance between two of the world’s largest diesel engine companies, Cummins Engine Co. and Niigata Engineering.
  
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  Provided advance warning of 1990/1991 airline industry “crash”
  
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  Assisted a First Bank of New York financial institution in a $700 million aerospace private placement/leveraged buyout
  
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  Accurate predictions of rapid, high volume growth of regional jets and new generation entry level jets
  
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  Assisted GE Capital in taking aerospace component unit of ALCOA private
  
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  Guided Chromalloy’s entry into the RR Trent maintenance market
  
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  Assisted world leading aircraft company in development of a new super mid-sized bizjet
  
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  Developed the aerospace market entry strategy for Honda Motor Company
  
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  As one of four principal owners, developed small gas turbine (non microturbine) market entry strategy for a new firm, Candent Technologies. The company won US Army SBIR Phase I and II contracts in 2003/2004 for a 770 shp aviation turboshaft engine
  
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  Provided strategic business planning guidance to operating units of Pratt & Whitney and Pratt & Whitney Canada
  
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  Developed detailed competitive assessment and financial models of the BIG 3 aircraft engine and Big 6 industrial gas turbine firms including Solar, GE, Alsthom, and Siemens/Westinghouse
  
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  Developed a comprehensive market and business development strategy for Pratt & Whitney’s industrial turbine operation including recommending launch of FT4000 in 1996/1997. Resulted in launch of the new P&WC ST30/40 in 1998. The engine has won orders from Bombardier and the Swedish Navy for locomotive and fast patrol craft propulsion.
  
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  Developed a comprehensive market and business development strategy for a Kawasaki Gas Turbine Americas including helping close the first commercial order for the world’s most advanced gas turbine low emission combustion system
  
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  Helped negotiate a joint marketing agreement between Kawasaki and Cummins for industrial gas turbines
  
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  As State certified expert witness, helped a CA company win $78 million jury award against GE
  
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  In 1985, lead market research effort that resulted in formal launch of the Williams FJ44 turbofan engine. Two years later, Cessna selected the engine for its CJ1. The engine was also selected to power the SJ-30 and Premier I jets of Ed Swearingen and Raytheon Aircraft respectively
  
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  In the mid-1980s, led market research effort that resulted in Kawasaki launch of the 5-7 MW class M7A industrial gas turbine
  
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  In the mid-1980s, was integral member of market research team that defined the specification for what would become the Pilatus PC-12.
  

Over the past 20+ years, MB Strategy has accurately predicted the long-term competitive landscape in aerospace and defense to include:

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  GE victory in the “Great Engine War”.
  
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  GE ascendance to the number one position in large commercial jet engines.
  
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  RR ascendance to the number two position in aircraft jet propulsion behind GE and ahead of P&W
  
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  Lockheed and P&W victories in the ATF competition (F-22 Raptor)
  
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  Boeing/Sikorsky victory (and subsequent cancellation of) in the LHX competition (RAH-66 Comanche).
  
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  Massive growth in regional jets.
  
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  Record growth in sales and delivery of business jet aircraft including new high-speed aircraft, and new generation entry-level jets.
  
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  Congressional salvation of the Bell/Boeing V-22 and eventual production.
  
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  Procurement of a many more than 120 C-17s.
  
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  Rapid incorporation of aero engine technology in all classes of industrial gas 1`1turbines.
  
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  Massive growth in sales of base load combined cycle and simple cycle peaking gas turbines and subsequent market “bust”
  

1. 
   Executive Summary – In December 2008, MB Strategy was asked to provide an update of our 2007 report. We fulfilled this requirement with an interim update in January, subsequent to our utilizing industry sources. Six weeks on, we provide our final report concerning A340-500/600 aircraft (Trent 500 nacelle) and in particular the market and “industry” awareness of the Replacement of acoustic exhaust ducts within a specified limited life. This update provides the following in detail:
   
   1. 
      Update of market position/ orders and A340-500/600 aircraft production expectations
      
   2. 
      Documentation in the aerospace industry regarding life limited components and need for full replacement by spares.
      
   3. 
      Any other comments and information based on the document disclosures provided.
      

4. 
   Overall Aircraft and Nacelle Forecast Outlook. There has been no change in the production or sales outlook for the A340-500/600 from that August 2007 report. Forecasting firms and investment banking analytical organizations that we know of have the A340-500/600 ending its series production life over the next two years at a total program of 130-135 not including six aircraft for Virgin which will not likely be finished. The year end 2008 Airbus order total is 139 including “white tails.” (Airbus confirmed 1 A340 net orders in 2008.) Among those forecasting 130-135 are Teal Group (Washington, DC-based aerospace/defense consultant), Janes DS Forecast (operating unit of Janes Information Group), Banc America Merrill Lynch Securities, and the Airline Monitor. Only Forecast International has been the outlier, until summer of 2008 forecasting 170 aircraft with production continuing through at least 2018. The number of aircraft on the backlog at the end of 2008 was 24 of which six are for Virgin Atlantic and we know with near certainty that these will not be taken by the customer. In all likelihood, those six orders will be converted to A330; A350 or A380 aircraft as Airbus retain the deposit from the 2004 order from Virgin Atlantic.
   

1. 
   2008 Orders. Airbus net 1 order for A340-500/600 made up of six new and five cancelled orders; 2 Kingfisher and 3 Air Canada. The comparable Boeing aircraft, the B777 accrued 54 orders. In 2007, Airbus recorded 11 orders for the A340-500/600 while Boeing booked orders for 83 B777s. B777 and A340-500/600 are direct competitors
   

2. 
   Real Backlog. The real backlog is dropping dramatically even from the Airbus claimed 24 aircraft. Eithad (3 Dash 600s), Iberia (5 Dash 600s), Lufthansa (3 Dash 600s), Arik (1 Dash 500), and Kingfisher (3 whitetails), 3 Unnamed Customers. Jordan’s aircraft has been classified as delivered by Airbus.
   

3. 
   Available Second Hand Aircraft. Twenty months since our first report, a secondary market for 7/7 Dash 500/600s has appeared; all of these available this year from original customers.
   

4. 
   Series Production. Production is likely to be completed 2010 as expected 20 months ago.
   

5. 
   Nacelle Forecast - The 2007 Magellan forecast of 721 new nacelles through 2016, when combined with the actual delivered figure (through 2006) of 434 units) is greatly exaggerated as it is based on a Forecast International forecast that is 2 to 3 years old. The total of delivered and forecast new nacelle deliveries is 1,155 which works out to at least 275 aircraft, more than double what all other reliable sources say will be built over the life of the program Among those sources predicting half the number Magellan was were Merrill Lynch, Teal Group, Airline Monitor, and Janes DS Forecast. The FI forecast had to be dated March or April 2004. (Attached you will find Forecast International’s 2005 forecast of commercial jets). The reason we know Magellan was using an old forecast was that its internal nacelle forecast (Also attached), began with 2007 and noted Forecast International’ estimates are provided through 2013 only. As Forecast International forecasts for ten years, the first year of that forecast had to be from March 2004. Forecast International’s 2005 forecast projected 163 from 2007 to 2014 and we believe Magellan’s more than doubling annual production forecast in 2010 and 2011 was a direct result of that out of date forecast. Through 2006, Magellan had delivered 434 assemblies for roughly 100 aircraft. To add 721 as Magellan forecast, another 180 aircraft would have to be ordered bringing the overall total A340-500/600 order book to 275-280.
   

5. 
   Component Life and Spares Forecast. With respect to the life of the nacelle component, we can find no technical information that states specifically there is a 40,000 hour life. The original 1999 beta21 test did not project a finite life and only since the March 2007 report did Magellan attempt to estimate a 40,000 life from estimates and the original beta coupon test.
   

1. 
   Sources Report NO ISSUES. In our interim report, we included feedback from at last a half dozen reliable sources with direct contact at A340-500/600 customer airlines and their engineering organizations (Singapore Airlines, P&W Commercial Engines, P&W Composites, and Goodrich Aerostructures). Their contacts reported NO ISSUES with the A340-500/600 exhaust nozzle/duct. For the final report, we took an the extra time to expand our sources to include other A340 operations Virgin, Lufthansa and Emirates. Once again our sources were unanimous in that there were no reported technical issues on the nacelle as a whole or on any nacelle component. Indeed, Virgin and Singapore should be coming upon Magellan’s projected 33,333-37,393 hours within the year. Throughout Magellan documents, the company states they will sell significant numbers of replacement spares due to the “hot life limit.” True enough, if there in fact is a “hard time limit” on this assembly, full replacement would be required. However, there should be manufacturer notices or other technical information available to the customer well in advance of a potential 40,000 hour life issue. Additionally, using Magellan’s own forecast, some 100 nacelle exhaust systems will need to be replaced within 20 months meaning orders would have to be made now due to the very long lead time for Beta21 sheet from the single patented source, Timet¹. Had there really been a life issue of such an importance, that issue or problem would have been communicated to the customer airlines and regulatory authorities. Each would have undertaken actions to determine the true nature of the problem, if one existed, and to recommend a solution. Indeed, such a problem may have been considered ‘safety of flight’ by regulatory authorities who would have forced the airline to remove, replace, and/or repair said item. The regulatory agency would have issued an Airworthiness Directive (AD), which is published on the agencies’ web sites and in various airline and aircraft industry publications. No such regulatory action has been taken with respect to the A340-500/600 nacelle and there is no evidence from the operating airlines themselves that any such problem exists, our sources state emphatically. (Singapore, Virgin, Emirates, P&W Commercial Engines, P&W Composites, Goodrich Aerostructures, Barnes Aerospace). Two responses are shown here:
   

“I contacted my buddy at my previous

2. 
   THERE IS NO FINITE LIFE. We can find nothing in Magellan documents that states specifically that the ultimate life of the component is 37,000 or 40,000 hours. Those figures are only estimates based on the coupon test and an 2004 independent report². Even Magellan, in a variety of memorandum, admits that those two figures are ESTIMATES. What Magellan never discusses is that in REAL AIRLINE SERVICE, the component may last far longer than 40,000 hours as both of the references tests do not replicate typical life cycle temperature and stress patters of the installed component. Such real life tests require a significant investment in hardware; for both sea level and altitude testing in a test cell. In some cases, testing is actually done on a complete propulsion system on a representative aircraft or aircraft “test bed.”³ Small to medium sized companies such as Magellan do not have the resources to conduct such testing. As such, the validity of the Magellan coupon test and prior literature on the same material can not be used to project component life and spares or repair parts consumption. My view is actually the same as that of Mr. Richard Neill that he knows of no ultimate life limit and because of this, there is no valid way to project new replacement spares. More importantly, Mr. Neill goes
   

Our own forecast for spares/repair sales is in the 100-130 range, well below what Magellan number 190 has predicted, and is predicated on eventual delivery of no more than 135 aircraft (versus 275-280 called for in Magellan’s forecast), and a limited replacement spare and repair market dominated by airline repair shops or authorized nacelle repair firms including the nacelle prime contractor, Aircelle. Any Magellan suggestion that it could capture repair business runs counter to industry practice (airframe structure and nacelle producers such as Aircelle, Goodrich, GKN Aerostructures, and Vought) where forecasts generally excludes repairs unless there is certainty of the company producing the forecast actually winning that repair work. Magellan had no such certainty. In short, for Magellan’s forecast to come true Airbus would have to sell far more aircraft, as many as 180 more and as we now know, those orders are not coming or are unlikely to come in the years ahead.

3. 
   Magellan Spares and Repair “Language”. After having reviewed the documents numerous times, it also became clear to me that Magellan was using the terms Spares and Repairs interchangeably in discussions of future aftermarket sales potential. It should be noted that airlines traditionally repair nacelle/thrust reverser items rather than replace them. There is a very rational economic rationale for such repairs; nacelles, thrust reversers, and exhaust systems are very expensive items to acquire as complete spares. Lufthansa developed a repair on the A340-200/300 CFM56-5 nacelle exhaust duct in the late 1990s and reported that out on the Lufthansa Technik website October 10, 2000.⁴ Most importantly, the Magellan documents, particularly the Rich Neil memo of March 29, 2007 (See Attachment 1) in the first paragraph, states: “This analysis shows that the likely spares requirement was in excess of 800 units over the period 2007 to 2021. So to achieve a volume of only 190 units was an extremely safe number to use in the EAC analysis.”
   

Later, in the same memo Magellan claims;

6. 
   Spares. Our original forecast 20 months ago had 100-300 spare/repairs. After further detailed analysis, our forecast has been reduced to 100-130 for a variety of reasons which are detailed in the body of the report. This forecast is lower than the Magellan 190. More importantly, it is highly likely that a significant majority of nacelle components would be repaired by the customer or independent shop⁵. However, there is no such repair being discussed by those customers coming soon to the 40,000 hours (Virgin, Singapore, Lufthansa). Magellan produces contradictory statements with respect to the sale of spares or repairs, acknowledging that parts can be repaired by customers but Magellan consciously chose to ignore than probability when producing its internal sales forecast for the Trent 500 system; spares OR repairs. Again, this runs counter to industry practice.
   

7. 
   Technical Documentation. None of the documents specifically state there is a 40,000 hour life or that there is a firm life limit. The original 1999 test did not ascertain such a life nor guarantee one. Also, the 2005 report, while suggesting such a life, did not specifically state one. Only in the March 2007 report did Magellan attempt (Dr. Thamburaj) to predict life on the very limited coupon test. And even Dr. Thamburaj wasn’t thinking about replacement when he offered his life assessment and thoughts on future aftermarket sales. He specifically mentioned the likelihood of repairs, again consistent with industry practice.
   

2. 
   Sales/Production Outlook – The A340-500/600 was introduced in 2001 with great expectations that the four-engined wide body would secure well in excess of 400 orders over its life. However, since introduction, the aircraft has not performed as expected with range, reliability, and speed issues that put it at a distinct disadvantage versus directly completive Boeing 777 products. We will not go into detail on the performance problems of the A340-500/600 but will simply say that its fuel burn and engine maintenance burden are far higher than competing aircraft and these in part have resulted in poor sales. Indeed, in what was a very bad year for commercial aircraft orders in general, Boeing booked 54 B777s while Airbus took just 1 A340 when considering shifting existing A340 customers to other buyers like Nigeria Arik.
   

Merrill Lynch’s August 27, 2007 Commercial Orders report⁶ had just 8 RR powered A340-500/600s remaining and 43 Trent 500 engines (32 on wing plus 11 spares). The backlog was 19 as of Jan. 1, 2009 with 15-18 reportedly delivered in 2008. However, a look at that backlog shows the end is near.

3. 
   Operator Utilization – A340-500/600 are used in very long range operations. The total fleet averages 4200-4500 hours per year on 500-550 cycles.⁹ There are one or two carriers who fly very long stage lengths; Singapore for one fly 14 hour stages so some will quote 5,000 hours as the “typical” annual utilization for the A340-500/600. This is just not the case for the fleet as a whole. Engine on wing time is averaging 20,000 hours even with somewhat troubled introduction of the Trent 500. More importantly, the existence of “white tails” and future availability of aircraft from existing customers such as Thai will increase the number of aircraft not generating significant annual flight hours, further diluting the fleet average. Moreover, the worldwide traffic downturn has led many airlines to reduce capacity. Among those are Singapore who in February 2009, announced it was reducing capacity 11% by parking 17 aircraft by April 2009. We believe A340-500/600 may be among those that are “parked” further reducing utilization and the prospects for “spares” sales on nacelle components.
   

4. 
   Aircraft Service Life – We specifically reference the R. Neill memo of 3/29/2007 in which he states that the “history” of the industry points toward Airbus continuing to update the aircraft, implying it would remain in production for some time to come. Mr. Neill states: