The Saturday, Boeing (NYSE: BA) terminated a $ 4 billion deal that would give it control of the commercial aerospace operations of Embraer (NYSE: ERJ) after a deadline of Friday evening, the two parties passed without the final details being settled.
In a press release, Marc Allen, president of Boeing’s Embraer partnership unit, called the decision “deeply disappointing”, but said “we have reached a point where further negotiations … will not resolve the outstanding issues ”.
The termination, like the original agreement itself, is likely to be highly controversial, and the decision has advantages and disadvantages for Boeing.
Why Boeing shareholders should rejoice
The world has changed a lot since these two long-time partners decided to join forces. In 2017, Boeing had a multi-year order book, billions of cash on its balance sheet, and a roadmap for further expansion. Archival Airbus (OTC: EADSY) had acquired the C-Series small throw line from Bomber, and Boeing saw partnering with Brazil’s Embraer as a way to counter the threat of the C-Series and compete better in the small jet.
Boeing agreed to pay $ 4.2 billion for an 80% interest in the Embraer commercial jet, a rich but fair estimate at the time. However, in the midst of the COVID-19 pandemic, which evaporated travel demand and left airlines in a bad position to buy new planes, Embraer’s total market capitalization fell to around $ 1 billion. .
As a result, before the weekend, Boeing was on the verge of paying more than four times what investors currently think Embraer’s assets are worth. Even this Embraer assessment was probably inflated due to the current deal. Embraer’s shares are expected to drop on Monday after Boeing’s decision to depart.
Boeing is also getting a lot less money than it did two years ago. International regulators’ decision to ground the 737 MAX in March 2019 is expected to cost the aerospace giant more than $ 20 billion in additional spending, customer penalties and advanced payments to maintain the supply chain working.
The pandemic has only exacerbated Boeing’s cash flow problems, causing the airline to temporarily suspend operations and lower demand for new aircraft. Boeing suspended its dividend and asked the US government for $ 60 billion to support the commercial aerospace sector. Given the company’s scrutiny right now, asking for money in Washington and then sending billions of dollars overseas to Embraer is probably a no-brainer.
Buying Embraer, no matter what the cost, is probably a distraction that Boeing doesn’t need at the moment. Furthermore, buying Embraer at the agreed price would have been a huge burden on scarce cash resources.
Why Boeing shareholders should be disappointed
Nevertheless, the reason why Boeing wanted to buy Embraer was solid. The collapsed deal leaves a gaping hole in Boeing’s product offering.
Indeed, Boeing pushed the C-Series into the arms of Airbus by aggressively attacking Bombardier’s sales strategy, accusing the Canadian company of dumping the product in the United States at a price below cost. The C series, renamed Airbus A220, has aroused considerable interest from customers, in particular Delta Airlines and JetBlue Airways.
In recent years, Boeing has tried to convince airlines to choose smaller versions of its 737 instead of an aircraft the size of the A220, in part because it has no real alternative. Embraer’s next-generation E2 jets are said to have been installed under the 737, providing Boeing with an attractive offer for customers looking for an aircraft of this size.
Unfortunately for Boeing, the smaller jets seem to be big sellers in the years to come. Before the pandemic, global airlines were already moving away from big jets for smaller planes. This trend is expected to accelerate if demand for air traffic remains below pre-pandemic levels for an extended period.
The success of the A220 is due in part to the fact that airline customers were forced to wait and see what would happen to the Boeing / Embraer deal. Even combined, Boeing / Embraer faced a tough battle to sell the E2. Embraer is likely to find the challenge much more difficult on its own.
So how should an investor feel today?
Given all of the other issues that Boeing faces and the challenges of integrating massive cross-border transactions, even in the best of times, existing investors should be happy that this transaction has collapsed.
Ideally, both parties can now return to the table and find a compromise. However, that might be easier said than done. Talks leading to Boeing’s decision to end these negotiations appear to have been tense.
For its part, Embraer does not seem to be in the mood for compromise. The company released a statement saying the deal had been “improperly terminated” and pledging to “pursue all legal remedies” against Boeing.
“Embraer firmly believes that Boeing has wrongly terminated the [master transaction agreement], that it fabricated false allegations as a pretext to seek to avoid its commitments to conclude the transaction and to pay Embraer the purchase price of $ 4.2 billion, “the company said. “We believe Boeing has engaged in a systematic pattern of delays and repeated violations of the [master transaction agreement], due to his reluctance to close the deal given his own financial situation and the 737 MAX and other business and reputation issues. “
Which means that in the short term, Boeing still has one thing in mind. For potentially the rest of the decade, Boeing’s business fortunes will be largely driven by the success of the still-rooted 737 MAX.
Boeing focuses on survival. Survival is good, but investors should be aware: the price of survival could be lost decade in terms of commercial sales. My advice: avoid Boeing actions.