30 October 2015, ©. Leeham Co: There has been dramatic news this week around Bombardier’s (BBD) CSeries program. I wrote a subscribers article about what to expect in terms of the cash flow problem that the BBD management has been wrestling with. The announcements yesterday and the following earnings call confirmed the financial modelling I did with our aircraft modelling tool.
Having watched experienced Wall Street analysts being hard pressed to understand what has happened with the CSeries, I thought I could use this week’s corner to explain the overall economical flow of an aircraft program like the CSeries (there will be details in a follow up subscriber article). I will also put it in context with how it affects a company like BBD and what one must think about when it comes to timing of such projects.
To give the timing aspect more colour, I will also compare with Embraer and their E-Jet E2 project and Boeing’s 787 program. The three programs are very different and they demonstrate in an illustrative way the challenges of making a new civil airliner and that one must adapt the project to the company’s position and its strength and weaknesses.
The dynamics of a new airliner project
An aircraft project has traditionally been divided into two phases, development and production. To understand the project from an economical perspective, this is too simple. We need to divide it into more phases. We take a project the size of the CSeries as example for the money flows involved.
Here a description of the typical phases of such a program:
During the Initial phase of the CSeries project (and any other as well), a business plan has been made how to take the program to profitability. Typically this can be at over 500 aircraft and when that many aircraft have been delivered, there shall be an overall positive program result. For the CSeries, the plan was to burn $3.5bn for development, then probably close to the same amount for production and the whole program should break even with what the customers pay somewhere around 400 to 500 aircraft (my guess, I don’t have the number).
The payment of Phases 1-5 is with excess company cash and any additional loans that are taken. Typically existing programs that are in Phase 6 shall contribute as well. When a program gets delayed, the expensive Phases two and three typically get extended, as it has for CSeries (and 787, A380, A350 and so on, so BBD has good company). Phase 4 will now finish with $6bn on the books in 2016 for the CSeries instead of $3.5bn in 2014 (includes CS300 development).
The problem for BBD was that CSeries was now (because of the delays) one of three big simultaneous development projects. Learjet 85 and Global 7000/8000 were also going through Phases 2-3 over the last several years. The company had increased their loan side from $4.5bn to $9bn to pay for this all and the three times larger Business jet side with their highly profitable Global 5000/6000 contributing something like $30m a copy. At 80 of these per year, the cash flow should have been ample.
Soft business aircraft market and too many cash drains
The problem for BBD was not only that the CSeries (and Learjet 85) cost more, they also slid into a time where the business jet market went soft and BBD needed to reduce the Global 5000/6000 production to 50 a year instead of 80. With parts not stopping coming as fast as customer progress payments, there was suddenly $1bn less cash from the Globals during 2015 than planned.
This was unexpected and coincided with the first CSeries customers not accepting their first aircraft at the end of 2015 (Malmö Aviation) but spring 2016 (Swiss), money from customers would take another 6 months. All-in-all, there were billions of cash missing and BBD management needed to act. They had too many programs stressing the company for cash at the same time and a weakness in those that should have been in their cash producing phase. The long-in-the-tooth CRJ keep the market going but was no cash producer, nor wasn’t the Q-400.
In all this it should be remembered nothing of this was caused by the CSeries being a worse aircraft than planned. If anything, it lives up to what has been promised and a tad more. The problem was that the aircraft’s software side took much longer to stabilize than planned and everything got badly timed in the process.
A project which had a better timing was Boeing’s 787. It more than doubled its development cost and production has clearly been more expensive than planned; yet the Boeing Company has taken it on the chin. Program accounting has helped present nice figures over the years but the real crunch cannot be masked by program accounting, missing cash flows. Yet there has been no cash crisis; why? Because the 737 and 777 have acted like BBD Globals, only much stronger and with much higher numbers.
These have been producing a lot of positive margin when it was needed and now when the 777 morphs into the 777X then the 737 MAX and 787 are asked to take over the show (the MAX is a rather modest change and will be cash positive quickly; the 787 shall produce cash from 2017 if things go to plan).
Embraer also presented their 3Q results this week. Here, one can see that the less challenging E-Jet E2 program is well supported by an E-Jet that is still selling well and being produced with ample margins. It supports both E2 and a build up of their business jet side. The company is only wrestling with the effects of Brazil’s currency, the Real, loosing half its value against the dollar. It makes production work in Brazil cheaper but creates problems with currency effects in many other corners. Overall the result is: “Steady as she goes.”
It is challenging to put a new civil airliner in the market. When one has reached certification, one is only half way through the economical marathon; there is about as much left in cash drain on the company before the project stops consuming company cash.
Before it has paid back all the money it consumed and generated an overall profit, there are many more years needed. In all, a project will be overall positive somewhere close to half its economical life. Only the clever, prudent and strong survive in this business.