AEROSPACE Mergers and acquisitions

Boeing and Embraer jilted at the altar?​

Professor KEITH HAYWARD FRAeS assesses what happens next after Boeing terminated a $4.2bn deal to acquire Embraer’s commercial aircraft division.

Embraer

Two years ago, Boeing offered Embraer $4.2bn for an 80% share of its regional jet business. Boeing has now walked away from the preliminary agreement citing ‘unacceptable delays’ in concluding the deal. For its part, Embraer has accused Boeing of ‘manufacturing false claims’ as a pretext for breaking off negotiations. The Brazilians believe that Boeing’s own problems with the MAX8 and Covid-19-related issues and the need to cover a $19bn plus hole in its finances, are the real reasons for the collapse. The deal was also facing political opposition within Brazil and potential anti-trust action from the EU.

Filling personnel and product gaps

For Boeing, the main attraction of the deal with Embraer was perhaps the people employed in one of the world’s most productive and skilled aerospace workforces. They are also in the main young or at least younger than the aging members of Boeing’s US team. The aging of a generation of engineers and other skilled personnel has been a long-term concern of the US aerospace industry. Gaining access to a Brazilian source of new blood would have been a quick shortcut to supplementing the domestic cadre of incomers to the workforce, many of whom will prefer employment in the ‘technology’ start-ups – or are Chinese either going home or increasingly suspect as a thin end of an industrial espionage wedge.

More positively, the Embraer product line offered Boeing a quick way of filling an emerging gap at the bottom end of its product range. Well designed and currently in the midst of upgrading and modernisation, Embraer’s E-Jet range had acquired a solid market and a good reputation among its customer base. Its main competitor was Bombardier, now part of Airbus in a sort of junior league Boeing-Airbus duopoly. The absorption of the Bombardier C-Series into the Airbus range as the A220 would have increased the pressure on Embraer to match the mightier resources of the European consortium. Future developments in Brazil were handicapped to some extent by a shortage of capital which, of course, Boeing might have brought to the deal. However, with analysts beginning to think that in the future airlines will be downsizing their fleets, Embraer’s products would have filled a gap in the Boeing family.

Boeing has tried this before; remember the de Havilland Canada link in the 1980s? This failed because Boeing could not readily cope with the different market and customer base requirements of aeroplanes below 130 seats. Well, times are a-changing and Toulouse clearly believed even before Covid-19 that slots in the 90-120 seat category were worth nurturing. It also had the bonus of trimming some of the competition to the smaller Airbuses.

Embraer has lost some $100m in preparatory costs and is seeking legal redress. Is China waiting in the wings perhaps? A tie up with Embraer could be a way of short-cutting the acquisition of some of the ‘softer’ skills that the Chinese lack in terms of marketing, product support and the like that Comac is struggling with to launch the C219 as a global player. Not that Embraer’s harder skills would not be useful either, especially its experience in satisfying US and European regulations. A bid by the Chinese would be a ‘fox in the hen coop’ moment for both Boeing and Airbus, although the latter would feel the heat earlier as the A220 met increased competition.

Longer-term trends

Boeing

Would this accelerate the long anticipated break up of the Boeing-Airbus duopoly? Even only a month or so into a global aviation lockdown, the impact on future air travel, the survival of a bunch of airline and leasing customers and on the security hitherto afforded by a mountainous backlog of orders is now looking grievous. Boeing’s problems predate when Covid-19 struck. Airbus has had to cope with the A380 shutdown and continuing problems with the A400M programme. Now both have cut production, furloughed workers and are talking of redundancies. A two-year recovery phase may be optimistic.

Many things in the aerospace business move fast, especially technology (although not as fast as consumer electronics). Other stuff, especially the structural aspects of world aerospace, move at a somewhat slower pace. The current BoeingAirbus duopoly was over a quarter of a century in the building. 2020 saw the 50th anniversary of the creation of Airbus Industrie, the corporate forerunner of the present-day Airbus – a government-dependent consortium, laughed at by its American competitors as a loss-making political enterprise. Well, with the launch of the A320 in the 1980s, things began to change and smiles disappeared from West Coast faces. The increasingly bitter transatlantic dispute over government subsidies also dates from around this time and has continued to colour the context of the last series of product launches. Recent WTO rulings may well have limited future ‘subsidy’ behaviour on both sides of the pond but this will not take the politics out of civil aerospace.

China in the wings

Which brings us back to China. Economists talk about the high barriers to entry in the commercial aerospace business; to move up the steep climb to a world-class capability, state-funded R&D or product financing is pretty well essential (or access to a well-funded closed defence market). China has both and, pandemic notwithstanding, one of the largest and fastest-growing airliner markets. This gives Comac the kind of structural advantages that other challengers such as Japan have lacked (I have not forgotten the Russians, but their civil aerospace industry is still in a mess).

State aid, and domestic carriers dragooned into ‘buying Chinese’ will keep Comac in business whatever happens elsewhere. There is the promise of more and a future wide-body (perhaps in collaboration with the Russians) is sitting in the wings. Now, whether the market has in fact turned its face permanently from high-capacity aircraft in favour of smaller, ultra-long-haul aeroplanes including narrowbodies remains to be seen. However, narrowing the range of a ‘family’ could play into the hands of a new entrant by limiting the ability to offer a trade-off to customers across a range of products. A narrower focus in developing new products may also help.

Innovation is the key to keeping ahead

More subtly, the longer-term affects on profitability and a negative market response to the virus could erode the classic advantages of an established player still investing heavily in R&D and innovative future products. The history of civil aerospace has seen companies holding off for too long before refurbishing their product cycle: Douglas in the face of jet airliners in the 1950s and arguably Boeing downplaying the impact of the ‘fly-by-wire’ A320 in the 1980s. Airbus and Boeing, faced the Chinese with some confidence – even collaborating with them, recognised that the key to survival was to be faster into the next generation than the likes of Comac. If the downturn extends well beyond the mid-20s, it may be harder to launch new projects and to incorporate improvements that push the product cycle trajectory further out for new entrants. There are of course still other factors driving the need to innovate – carbon neutrality before mid century will not go away and may become even more imperative as people remember the clean skies of lockdown. But investing in the immediate aftermath of Covid on top of pre-existing conditions might prove tricky

The prevalence of some form of state aid for civil aerospace will not go away either if the political will stays strong behind a domestic producer. WTO rules might be extended or the WTO itself is stymied by the very country that benefits most from limits on direct funding for civil aerospace. Forcing China into a trading corner may only encourage further investment and perhaps obstacles to selling equipment to Chinese airlines. Of course, not everybody shares the same worldview about China; which brings us back to the prospect of a Comac-Embraer tie-up. My guess is that the Boeing-Airbus duopoly will be hard to shift but things have got just that little bit harder for both.

Well, the Chinese did see a curse in ‘may you live in interesting times’.