Saunders Aircraft

March 24, 1973 The Financial Post

Manitoba may be stuck with $8.65 million lame goose

By Donald Rumball

WINNIPEG – Manitoba Development Corp. is in the hot seat once again.

This time it is watching an $8.65 million investment in Saunders Aircraft Corp. and wondering if it will ever see the money again.

It is unlikely, in any event, that the MDC will recover all of its investment in Saunders. But if, as seems possible, the company fails to sell more than a handful of planes, the entire company may have to be written off.

The prospect comes at a time when the Manitoba NDP government is in the throes of deciding how to tie up the loose ends of the MDC’s disastrous involvement in the Churchill Forest Industries Ltd. Complex at The Pas. This may result in a write-off of as large as $50 million. [MDC’s predecessor, the Manitoba Development Fund, was, of course, deeply into The Pas project well before the NDP government came into power.]

If Saunders Aircraft should emerge as the MDC’s second major failure, it could turn the whole question of the government’s involvement in private industry into the dominant theme of this year’s election. Sidney Spivak, leader of the Conservative opposition, has advocated the abolition of MDC and the battle could represent a threat to Premier Edward Schreyer whose government currently stands a strong chance of being re-elected.

The MDC involvement started in October, 1970, with a loan of $750,000 which was almost completely swallowed by a long list of creditors. Since then, MDC loaned Saunders another $1.5 million and has pumped in $6.4 million of equity money. (Private investors have sunk $1.2 million into the project and own less than 20% of the equity.)

A bird’s eye view of Saunders now shows that in the 2½ years since MDC decided to back it, it has:

Built two planes and almost finished a third. Four more are at various stages of completion (the planes sell for less than $500,000 each).
Sold and delivered three planes – all to the same customer, a new airline in Columbia. (Two of these were built prior to the MDC’s involvement.)
Allowed internal delays and those at the Ministry of Transport to stall for two years a program to get a U.S. certificate of airworthiness.

In the next three-four years, if it is to survive, Saunders must increase the production rate from roughly five in the last 2½ years to five this year, 10 next year and maybe 40-50 a couple of years later. And sell them.

With so small an output to date, it is clear that a very large chunk of MDC’s $9 million must be considered as development costs – and there is still more to come.

Reg Kersey, president of Saunders Aircraft, says: “We expect the break- even point at which development costs will have been completely recovered to be the 91^st plane. We expect to bring the unit cost of our planes below the selling price by the time we’ve completed number nine – so we start recovering development costs with the tenth plane.”

A study performed for Saunders and MDC has estimated that the world market in which the plane is competing amounts to about 650 aircraft over a five-six year period, of which about 40% will be sold in the U.S.

Kersey elaborates:

“We’re planning on a market penetration of something in the order of 25% in the U.S. and 15% in the rest of the world – we expect to sell a total of 104-105 planes.”

That’s cutting the recovery of development costs a little fine.

So the company has five years to make and sell more than 100 planes.

What hope does Saunders have of achieving this objective?

Two-phase strategy

The marketing strategy comprises two phases. The ST-27 in Phase I is a conversion of the DeHavilland Heron – the 20-year old airframe (which is still in excellent shape) is patched up and stretched to become a 20-24 seater and the old piston engines are replaced with new turbo-props. This plane has had since 1970 a certificate of airworthiness valid throughout the world except the U.S. Although a much longer production run was originally intended, the company has decided to limit production to 10 ST-27s, partly because of the limited supply of Heron airframes, and partly because the U>S> certification program for the ST-27 has been abandoned.

The Phase 2 aircraft, the ST-27B, is identical except that it is built from scratch. The company has started preparing the production run for this plane and has so far completed 90% of the production planning and 10% of the tooling, according to Kersey.

Kersey says: “Production should start on the ST-27B in August of this year and the first plane should roll off tile line before the end of the year. The projected production rate after that is one plane every five-six weeks – probably a little nearer six than five.” If all goes according to plan on the marketing side, this will necessitate a substantial speeding up of the production rate in the next couple of years.

Can the company expand its production capacity to turn out perhaps 40-50 planes in 1977?

One of the major problems in setting up the operation in Manitoba has been the difficulty in finding skilled sheet metalworkers.

Problems: skills, sales

Saunders Aircraft has set up a training school for sheet metalworkers and expects to turn out 250 qualified men this year. But it takes a long time for the men to gain sufficient experience to be able to produce work efficiently that satisfies the exacting standards of the Ministry of Transport.

It may be a long, long time before enough skilled labor can be developed to meet the production projections.

The outlook for sales is gloomier still.

Negotiations are under way with a number of potential customers but the company has not been able to add to its solitary success. Not even a single Canadian buyer has yet been found.

One startling indication of the marketing drive is the absence of the Saunders plane in “Buyers’ Guide” contained in the December, 1972, issue of Canadian Aviation. This magazine publishes the guide annually, based on replies to a questionnaire sent out to all aircraft manufacturers. The ST-27 was excluded because the company did not reply to the questionnaire.

Kerrey claims, with justification, that the sales effort has been hamstrung because the company has not been able to offer firm and reasonably quick delivery dates. Now that the company has a viable production line and has access to the financial resources of a quasi-government body, there should be no further impediment to selling the plane other than the plane itself.

The original ST-27 was designed to compete with the DeHavilland Twin Otter. Designed as a bush plane, the Twin Otter has cashed in on the growth of the commuter-line operations and has been extremely successful. The ST- 27, however, is about the same price and slightly bigger and faster. It has enough edge on “cost per seat-mile” to beat out the Twin Otter and, in fact, the Colombian airline chose the ST-27 over the Twin Otter.

The ST-27B, however, does not appear to have that edge. It is still a 20-24 seater (compared with the 19-seat Twin Otter) but it costs about $200,000 more The commuter-line operators deal in hairsbreadth margins and this sort of differential is likely to be crucial.

It had originally been in- tended that the Phase 2 aircraft should be a 30-seater, identical in design to the ST-27. Chairman of MDC, Sydney Parsons, and Kelsey agree that a 30-seater version of the ST-27B would have been more marketable but claim that the higher design and certification costs of the bigger plane outweigh the market factor.

Saunders is still concentrating on selling the ST-27, so no one knows how the ST-27B will be received, but one thing is certain – even if the company does beef up its marketing effort considerably, it’s going to be an uphill struggle.

Saunders Aircraft has been the centre of controversy for some time. It became something of a political football during the last federal election campaign when the company lost about 12% of its staff. They decided the firm was not going to be kept by the MDC. The issue has been clouded by MDC’s tardiness in revealing information about the company it virtually owns and it is now clear that the information may not be too palatable.

The Saunders project has created employment for 300 people and has helped establish the abandoned air force base at Gimli as an industrial park (the departure of the armed forces threw about 1,000 people out of work). It has also resulted in the establishment of a training school for sheet metalworkers, expanding the supply of skilled labor in Manitoba.

But the way in which these highly desirable results have been achieved is open to question. The roots of the problem at Saunders seem to lie in the delays and policy changes that kept the project on the ground floor for an extended period. In this connection, it is interesting to note that only one man on the board has experience in the aircraft industry.

If there had been no government involvement, would the pressure of the profit incentive have kept the lid on expenditures?

Generous financing is absolutely essential for any project in the aircraft industry and Saunders Aircraft was unable to get enough money from private sources so it had to rely on government backing to survive. But it’s an interesting question whether using taxpayers’ money to buy equity holdings in private industry is the most efficient way of reconciling the often conflicting objectives of government and private enterprise.

How an entrepreneur lost his wings

You can always build a dream but can you make it fly?

By Donald Rumball

Dave Saunders had a dream – to build an aircraft.

An aeronautical engineer, he had the design, a marketing strategy and the firm conviction that his project would take off. So he formed Saunders Aircraft Corp. in Montreal in May, 1968.

But he had no money and developing an aircraft can swallow money in huge gobs. Undaunted, he embarked cheerfully on a fund-raising campaign, completely oblivious of the tensions and heartache that lay ahead of him.

The company’s story exemplifies the crunching conflict that is almost inevitable when a fired-up entrepreneur and his bottom- line-conscious backers try to pull a new venture through its birth and growing pangs.

But 1968 was a good year to be looking for backers. Money managers talked glibly of 20% yields on their money, and it seemed that all you needed to make money was more money. Even then, though, it was no cakewalk to raise such large sums of money for the notoriously risky aerospace industry. There were no detailed drawings – only the concept and a glowing description of the market waiting with open arms to be exploited. But Dave Saunders is a persuasive man.

Worked on Arrow

He was 34 years old at the time and his own best salesman. He had emigrated to Canada from Britain 11 years before to start work as an aircraft designer on the ill-fated Avro Arrow. Then he joined the Royal Canadian Air Force as a pilot, spent two years with Aircraft Industries of Canada and finally set up on his own as a design consultant.

Suave and convincing, he managed to raise $150,000 I the totally foreign atmosphere of the paneled offices of the money men.

Next he enlisted the help of the embryonic venture capital firm of Kauser, Lowenstein and Meade – in fact, raising capital for Saunders was something of a catalyst for the formation of the firm.

(Steve Kauser had first heard of Saunders’ venture when he was with All Canadian Venture Fund, then run by Tony Hampson. Hampson is now President of the Canada Development Corp., now settling plans to make KL&M its investing arm in Montreal.)

What does an entrepreneur do when he is trying to persuade people to put their’ money in his care? He appeals to their hopes for a real winner; venture capitalists deny strenuously that they are looking for another Xerox, but it doesn’t hurt to hang out the possibility.

But he must also explain the risks involved. It’s a tightrope act; his presentation must be neither so negative that the project is killed before it even starts, nor so optimistic that it merely lays the foundations for a credibility gap when things go wrong later (as they undoubtedly will). Only those present at the sales pitches know how well Saunders trod that tightrope. But he trod it well enough to come away with $735,000 from the Steinberg family trust and three institutions – Prudential Assurance Co. of England, All Canadian Venture Fund and Woodford Investments Ltd.

The understanding was that the money would be used to build the prototype and fly it before the end of May, 1969. At that point the shareholders would review the project to decide if it was worth pursuing. If it was, they would deliver the second-stage financing.

Saunders had told them that he expected the development and certification costs for his two-phase program to come to $5 million, miniscule compared to estimates by various studies on this type of airplane, which vary between $20 million and $100 million. The production of the first prototype, ST-27, saw Saunders in his element. He is a charming but demanding man who has a habit of getting his own way. In that first year, he inspired the men working on the plane to put in incredible hours, and built up a superb morale.

The plane flew two days before the deadline.

What’s more, he had done it on a tight budget. His expenses amounted to only $606,000.

(The ST-27 is really a stretched version of the de Havilland Heron, with two new turbo-prop engines replacing the old piston engines. Using the sturdy old airplane cuts the cost to a highly competitive level.)

So far so good. The next steps hinged on the rapid acquisition of a certificate of airworthiness and split-second timing in the two-phase marketing drive.

The certification of air-worthiness is a costly procedure and absolutely vital to the success of a plane.

The details are complicated but the essentials are that the U.S. is the acknowledged leader although the British are recognized throughout the rest of the world. However, whereas the British have only one category of certification (“transport category”) which is applied to all aircraft up to the VC-10, the U.S. Federal Aviation Administration (FAA) has a full-transport category ( Part 25) that is tougher than Britain’s and a lesser category (Part 23) for third-level operators that is considerably laxer than Part 25.

Simple plan

Saunders’ plan was simple:

Go after the British certificate of airworthiness – opening up all the world except the U.S. for sales.
Go for Part 23 registration in the U.S. within three months of receiving the British certificate.
Then build up a second prototype from scratch. It would be identical to the first in appearance but would be a 30-seater instead of a 20-24 seater. This plane would be registered under Part 25 in the U.S.

Flushed with the success of the first stage of the project, Saunders anticipated his forthcoming program with excitement. In June, 1969, he signed a contract with KL&M as financial consultants and figured he had solved all his financing problems. But events had overtaken him.

June, 1969, saw the bubble burst on Bay and St James streets. The euphoria of the previous year evaporated. The financial men were now gloom and doom personified as they watched their levered losses mounting.

KL&M was optimistic, however, and promised to arrange the necessary financing “within two weeks”. Its optimism can only be described as naïve because it finally took five months. It was not for lack of effort – it scoured the country but was unable to raise a penny.

As each month went by with no further financing in sight, the tension between Saunders and KL&M mounted rapidly. Saunders wanted to maintain the momentum he had worked up; he was dealing with a design group in Britain who were doing the detailed drawings for British certification and with the Canadian Ministry of Transport in preparation for the validation of British certification. On top of that, he was keeping the production of the second aircraft going and trying to notch up a few sales. He was president, sales manager, chief designer, and personnel manager. And, he remembers, “It was impossible, to keep a tight rein on the program.”

With his back to the wall, Saunders gave it everything he had but, perhaps understandably, began to lose objectivity about the plane.

In this battle situation, anyone who does not exhibit the same devotion to the cause is tainted with the suspicion of being a turn-coat; relations between the financier, who is worried at the rate at the rate at which money is being spent, and the entrepreneur, who is anxious to keep the momentum going, are bound to deteriorate.

KL&M tried all sorts of avenues to put their hands on some money. The Caisse de dépôts et placements of the Quebec Pension Plan was interested in putting up $750,000 but the deal fell through. There was even a small town near Montreal where a group of citizens pooled their money, offering the company some $350,000. But KL&M reluctantly turned it down because these people could not possibly have known the degree of risk they were undertaking — and would react accordingly if anything went wrong. The original shareholders resisted further involvement. One of the maxims of risk capital is that it always costs more and takes longer than anticipated.

Have limits

Saunders and KL&M found. to their cost that institutions are not always well: suited to this type of investment since they may have arbitrary limits to the amount they can put into risk ventures. If that limit has been reached, it’s just bad luck if the entrepreneur wants more.

By September, the company was in deep trouble. There was not enough money left to pay one week’s salary. The creditors had long lost all patience. In desperation Saunders sold the uncertified prototype aircraft. It was a bad deal but the company got $125,000 in .cash with an- other $75,000 to come in installments. The company eventually bought back the plane for about $400,000 but the sale had kept the project alive.

Finally, in November, KL&M put together the second-stage financing. It involved another $504,000 from some of the original shareholders (who had apparently changed their minds). An individual interested in a depreciation write-off added another $392,000 under a sale-and-lease-back arrangement.

The position was temporarily retrieved – but at what cost?

The five-month delay had allowed the certification program to stray off course and relations between Saunders, on the one hand, and the shareholders and KL&M, on the other, had deteriorated to a disastrous level.

Obsessed with the momentum of his program, Saunders saw himself as the man who had control of the ship. After a full year during: which the shareholders had let him have full rein, he could not tolerate their insistence that he change his priorities. He began to feel that they were deserting him. Convinced of the integrity of his objectives, he could not understand how anyone could question his judgment – especially when he was the one who had thought the whole thing up in the first place.

At the same .time, the shareholders and KL&M saw only a headstrong man with grandiose plans who spent their money recklessly and didn’t want to share the project with them. They weren’t familiar with the aircraft industry, so they couldn’t contradict him – but he wasn’t reacting in the way that financial men react when money is tight. They accused him of signing a long-term contract with the British designers, Aviation Traders, when the company had no money.

Second dollop

At about this time, Saunders felt that a conflict of interest existed for KL&M. He saw them as his agents to sort out the financial details – including shaking down the shareholders for more money when necessary. They, on the other hand, had persuaded most of the shareholders to come into Saunders Aircraft and saw’ themselves as the representatives of the shareholders’ interests – which, in calm times, of course, is identical to the interests of the company and its management.

Saunders went to Arnold Steinberg with a plan to terminate the contract with KL&M. It was a disastrous move because Steinberg turned Saunders down flat auld immediately told KL&M what had happened.

It was not long before the second dollop of money began to diminish and. the company was once again trying to pull rabbits out of the hat. KL&M thought optimistically it could raise another $250,000.

KL&M’s best efforts were in vain. All it could do was secure a guarantee of a bank loan for $110,000. The guarantee was provided by Steinberg, KL&M and a senior man in the company, Reg Kersey (now president). In return for the guarantee, these people received 400,000 shares. Saunders, who had not put up any money (his total investment in the firm was about $6,000) was enraged at the dilution of his share in the company. Much later (too late for his peace of mind) he was given enough shares to maintain his equity – at no cost to himself.

At about this time, the aircraft was given provisional British certification and a sale was made to Air North in Burlington, Ont. (provisional on getting U.S. certification, but this never happened). Nevertheless, the shareholders finally recognized that they had bitten off more than they could chew and decided to look to government bodies to rescue them. After some dickering between Manitoba and Quebec, they finally accepted a loan for $750,000 from the Manitoba Development Corp. in October, 1970.

The loan was enough to pay off the $600,000 odd owed to creditors by this time but it also meant that further financing would be forthcoming and the company could be run on a long-term basis for the first time.

The loan was conditional on Saunders Aircraft moving to Manitoba. The site chosen by the company was Gimli, 60 miles north of Winnipeg. The move meant that the company could also apply for a DREE grant. They applied for $1.3 million and just under $900,000 was approved – although the conditions attached to the grant have only recently been achieved so the grant has still not been paid.

The company has also applied for a PAIT grant but no decision has been made on that yet; everyone seems to be waiting to see if the company will be able to sell its planes.

No pleasure

For Dave Saunders, the move to Gimli was no pleasure. He is a city man who contemplated the small town with horror – he even suggested that it would be preferable for the president to remain in Montreal, where he could spearhead the marketing drive. He was putting his head on the block. The entry of the MDC onto the scene relieved financial pressure on the firm, but Dave Saunders’ role was still in question.

A week before the annual general meeting in February, Saunders called a meeting with KL&M to repair relations and they expressed solidarity and the wish that he continue as president. Seven weeks later, Steve Kauser informed Saunders that his services were no longer required. His replacement was an American, Bill Kelly, who had been recommended to KL&M by a director of McDonnell Douglas Corp. Kelly, who had no manufacturing experience, was not a success and was fired after six months – to be replaced in turn by Reg Kelsey, Saunders’ vice president of manufacturing and former vice-president of Canadian Aero Services Ltd.

Venture capitalists love to lean back in .their chairs, stare at the ceiling and pronounce upon “the entrepreneur.” As the man who runs their money, he is their greatest hope and often their greatest frustration. He is project-oriented rather than cost-conscious. He is usually wonderful as an inspirational force to get something going but cannot make the transition to manager of a going concern. He deeply resents interference with “his baby.” “Such a shame.” the venture capitalists conclude, “the entrepreneurs have to be replaced almost without exception.”

The financial statistics tell the story graphically:

In the first year, Saunders spent $745,000. It built one plane – and had more than $135,000 in fixed assets and inventory at the end of the year.
In the second year, the firm spent $1.75 million. It had not quite completed the second plane but had secured a certificate of airworthiness (the British one) and built up the fixed assets and inventory by another $210,000.
In the next 33 months, most of which was after the MDC had entered the scene, the firm spent $8.65 million. In that time, it completed the second plane, built another three and had four more in various stages of completion. It also started on the tooling up for the second-phase plane. It did nothing further on the certification front.

It is a story of diminishing returns. Reg Kersey has done a sound job and has set up the production line but the MDC must be wondering if it and the original shareholders didn’t fire “the entrepreneur” a little too early. But then, maybe they couldn’t take his tongue any longer.