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June 21, 1990

BLEAK OUTLOOK FOR WOULD-BE LESSEES IN IMMEDIATE AFTERMATH OF ATLANTIC CRASH

By CBR Staff Writer

What went wrong at Atlantic Computers? According to Barry Graham, ex-worldwide marketing manager for the company in one of the shortest tenures in record, it was not Flexlease that caused Atlantic’s problems and eventual downfall. Graham defended this unconventional view at this week’s Xephon Technology Transfer seminar entitled Leasing After Atlantic. Wearing his independent consultant hat, and emphasising that he is no standard bearer for either Atlantic or Flexlease, Graham insists that the concept is neither inevitably flawed nor thoroughly discredited. A Flexlease is a five year contract with an option to change equipment for equal or greater value at three years. If the lessor and lessee cannot agree on an upgrade, then the remainder of the contract is honoured as a standard operating lease. Graham insists that the so-called walk option is a separate issue and not part of original Flexlease contracts.

First mistake

He says that Atlantic’s basic pricing policy was to work out the cost of an operating lease and subtract 10%. While that could be regarded as the company’s first mistake, it was not going to make enormous losses so long as residual value estimates were fairly accurate, and losses could be written into subsequent deals. Which they generally were. The real problems lay in Atlantic’s profligate behaviour combined with extended paper leases. These were costed at 15% below standard operating leases and included a five-year walk option. Not only were losses on these deals too big to write into subsequent contracts, but all costs were based on an 84-month profit expectation, and the five year walk option had to be recognised in company accounts. By the time Atlantic crashed, the majority of leases in the UK were seven-year contracts, even if a conversion process to operating leases had been set in motion. However, conversion depended on further investment from the already financially straitened British & Commonwealth, and that was not forthcoming. There has been speculation that AT&T wants to buy the remaining assets of Atlantic Computers from administrators Price Waterhouse (CI No 1,449). Despite the misgivings that sort of European foothold may occasion in ICL, DEC, IBM, and British Telecom, there are strong arguments that a company with the prestige of AT&T could restore a degree of user confidence in leasing, and possibly attract users away from the lock-in safety of IBM Credit Corp.

By Janice McGinn

If AT&T does acquire Atlantic, it seems unlikely that the Flexlease will be retained. But Graham believes that in the hands of a financially stable and reputable company such as AT&T or IBM, Flexlease would be an attractive proposition, especially in times of rapid technological change. However, in the short term, he believes that the leasing market is heading for lean times. Finance to lessors will decrease, and the actual cost of leasing will rise. There is likely to be less leasing, and more customers will flock to IBM. Lessors will emphasise the operating lease, reduce the size of their portfolios, and IBM is probably the one beneficiary since it can exploit customer fears to increase prices and achieve market domination. But in the longer term, there will be a cycle. More mergers and acquisitions will lead to stronger but fewer companies, and while the competition will decrease, IBM will continue to expand its market share. At the same time, customers will want more information and demand tighter terms and conditions in all types of leases. The second stage will see finance pouring back into leasing. To gauge bankers’ short term memory syndrome, Graham suggests that we only have to look at how the banks lost millions through Third World investment, but are now tripping over each other to get into the Eastern Bloc. He believes that Flexleases will reappear since they do reduce costs, and that will be enormously significant as portfolios become increasingly expensive to stock and maintain. For the same reason, residual values will become more significant – both to lessors and lessees. Graham also recko

ns that IBM is currently developing a Capacity Lease where the user pays $Xs-per-MIPS-per-year. One major drawback to the Capacity Lease is that only manufacturers can offer a lease based on a pay-by-need concept. The cycle will be complete when competition hits the remaining lessors, and initial lease costs rise as the pros and cons of lease versus purchase are reviewed. Graham is adamant that customers must achieve more control over variables such as interest rates for upgrades, get-out clauses, and sub-leasing. Users shouldn’t shy away from leasing, but he advocates that they compare purchase price and the cost of leasing. For example, in the case of buying or leasing a 3090, he reckons it’s more economical to take a short-term lease, whereas Summit would be a better buy. Graham says the one thing he learnt during his time at Atlantic is that the lessee cannot win. If the residual value of a machine is higher than anticipated – as has been the case recently – then the leasing company does not pass the benefit on to the lessee. If the value is lower, the lessee will pay for it in any lease change. It is at upgrade that a lessor makes profit since he has the residual value of the original machine, plus the revenue from re-leasing, plus interest charged on every deal.

Sub-lease

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If residuals are higher than expected, Graham says it may be appropriate for a user to sub-lease and draw up a new lease with the lessor. As a business activity, it is much more popular in the US, where, previously at least, it was fostered by the tax system. The diversity of European taxation has had the opposite effect, but as users increase the volume of their equipment, it is becoming more tax efficient. However, while it enables lessees to capitalise on residual values, subleasing requires the prior consent of the lessor. It also means that the lessee has become a lessor, and that can be fraught with difficulties. Neither does it release him from his original obligations to meet lease payments, but he is then dependent on his lessee to make regular payments and return the machine in good condition. Like many observers, Graham’s message to the user is simple. Be well-informed on terms and conditions. Understand residual values and exploit them. Negotiate upgrade terms before signing a lease.

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