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Leeham News and Analysis
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Pontifications: Taking a knife to a gunfight
April 27, 2020, © Leeham News: There is a great line in the movie, The Untouchables. Sean Connery’s character tells an assassin that he’s bringing a knife to a gunfight.
By Scott Hamilton
That’s what came to mind when Embraer says it will seek remedies against Boeing following the latter’s terminating the joint venture agreement between the two companies.
In the movie, the assassin lured Connery into a trap. Connery was gunned down by a machine gun. But don’t expect Boeing to be lured into any trap by Embraer.
Boeing doesn’t pull a move like this without thinking through all the possibilities. It may muff the thought process, as will be noted below, but it does think through alternatives.
Embraer’s claims
Boeing said Embraer failed to meet all the terms and conditions of the Master Transaction Agreement. Therefore, it was terminated, the company said Saturday.
Embraer countered that it did. EMB claims Boeing terminated the MTA because it can no longer afford to pay the $4.2bn in cash and because of its own problems with the 737 MAX and reputational issues.
It was an unusually harshly worded press release.
Embraer didn’t say how much it plans to claim in its “remedies.”
Airfinance Journal reported that Embraer spent more than $100m carving the commercial unit out of the company. LNA understands the amount exceeds $121m.
But this cost is only a fraction of what Embraer is likely to claim.
Lost business opportunities, reputational damage and other claims are likely.
Officials said in the past that orders for the E2 were slow in part because customers were waiting for the Boeing deal to close. Absent any information for outsiders, it’s impossible to estimate a price tag for these lost sales.
But hypothetically, only 50 orders at an average of $25m each would come to $1.25bn in revenue. Just how much of this would be actual profit is the key and the likely subject of part of any claim. LNA believes the profit margins to be 10% or less.
In the nearly 1 ½ years since the JV was announced, it might not be too hard to claim at least 50 orders were put on hold awaiting the consummation.
Look at the stock prices of Boeing and Embraer today. Friday’s close for Boeing was $128.98 and $5.82 for Embraer (on the US exchange). Market caps Friday were $77.77bn and $1.086bn, respectively. It Boeing’s stock goes up now that it’s not obligated to pay out $4.2bn, this is likely to be noted in Brazil. If Embraer’s stock goes down, this, too, will likely figure into a damage claim.
The perception on the market is that Embraer is in a weaker position now, alone, facing Airbus’ A220. This, too, likely will be part of the claim.
Boeing’s position
Boeing remains mum about why it believes Embraer didn’t fulfill all its obligations under the agreement.
However, Boeing is well known for taking strong defensive legal positions. After the 737 MAX was grounded, its legal department wrote some lessors initially denying any compensation claims. Boeing claimed the grounding is an “excusable delay.” According one lessor, Boeing invited the company to sue it if it wanted to pursue a claim.
Similar action was taken when the 787 was grounded, LNA is told.
Boeing took an extremely aggressive legal position when it filed a complaint with the US Department of Commerce in 2016 alleging Bombardier sold the C Series to Delta Air Lines through price dumping. Among the assertions was that tiny Bombardier, a junk credit-rated company, would eventually destroy Boeing and with it the entire US aerospace industry. This novel theory was widely derided by objective observers.
Boeing won the case at Commerce, which was expected, but lost before another agency that had to determine whether Boeing had been “harmed” by the Delta deal.
It was a miscalculation by Boeing of major proportions.
Steve Trimble of Aviation Week, who has an astute sense of reality and a wicked sense of humor, aptly summed up how Boeing muffed its thought process that led to today’s predicament:
“The Boeing/Embraer JV is dead. All because Boeing brought an anti-dumping complaint against Bombardier over the Delta C Series order, which prompted Airbus to acquire the C Series program, which motivated Embraer and Boeing to team up.”
Knife to a Gun Fight
Embraer by revenue and market capitalization is but a fraction of the size of Boeing, even in the latter’s present circumstances.
But just as Bombardier took a knife to a gunfight, it ultimately prevailed.
Embraer officials are livid.
Expect a lawsuit to be filed in US courts. The Master Transaction Agreement provides for governing law to be New York. This doesn’t necessarily mean a lawsuit would be filed in New York, however. Boeing is headquartered in Chicago, so Illinois Federal Court is another potential venue.
Boeing’s move to file a lawsuit against Bombardier was completely asinine. Terminating the move with Embraer IMHO was a smart move. Sales were low and will probably go lower. Probably not worth the investment.
One could buy all of Embraer and more for the price Boeing agreed to pay for the commercial unit. So a good decision.
But a series of good short term decisions may add up to a colossal long term screw up
jacob/el – If this is a genuine business judgment, why the charade of claiming Embraer did not comply with T&Cs? Why not just say ‘Our “What-if?” considerations did not anticipate present circumstances, which for us make the JV as written unsustainable, so we’re pulling out and we’ll pay due compensation…’?
A very, very naive suggestion, I know, but it would do no further harm to the low esteem in which I fear Boeing’s reputation has come to be held by just observers.
@Pundit
The Master Transaction Agreement was a DEFINITIVE agreement, NOT a non-binding letter of intent. Boeing had and has a LEGAL OBLIGATION to complete the transaction with the agreed terms.
Boeing knew this and knows this now. They wanted out, but the MTA does not contemplate any party breaking the agreement without paying a break up fee. Boeing erroneously believes they can avoid that. Instead, they will lose their lawsuit with EMBRAER and be forced to pay hefty damages to the Brazilian company. Boeing has not exercised good judgement, or even good corporate business ethics in their dealings with EMBRAER.
NYCjo – TYVM; my imagination was limited to circumstances such as ‘the MTA does not contemplate any party breaking the agreement without paying a break up fee…’ If you are correct, I am not sure whether that option or a lost lawsuit might involve the greater loss of face.
Boeing has and continues to behave in a manner not befitting a company of its historical stature.
It is unethical and a bully. It’s behaviour has however been consistent over the years. In the manner in which it deals with;
– it’s employees
– it’s customers
– the state of Washington
It exhibits the very worst traits of the very worst companies.
Yet still hasn’t made the link with these ongoing behaviours to its present day predicament !
It might be that Boeing, in the Covid 19 scenario, no longer considers their small single aisle position, relative to Airbus (with the C-Series) to be so disadvantageous as to require the tie up with Embraer.
That implies they believe they can recover post Corona to a much more competitive position in the single aisle segment. I wonder what their plan to achieve this is, and just how realistic and achievable it is.
It will be interesting to see if this one works out for them or, if in the long run, this one also blows up in their face.
By way of applying “Thinking the Boeing way” one could come to the conclusion
that the JV project intentions did not go beyond maiming Embraer?
Who knows, maybe this was a second option, or first?
I wonder what will do GOL with MAX orders.
Come, come Uwe! That’s a very cynical thought, surely?
Nevertheless, I confess that — while always expecting that C Series (if not all Bombardier Commercial) would be eaten whole (and alive) by Boeing and Airbus — I had not thought through potential implications for Embraer if C Series (A220) remained in production…
Airlines have to ask themselves why companies and capital are shying away from commercial passenger aviation. Yet someone with computer code and a San Francisco office can probably raise $5 bill just like that , and can’t even offer a positive cash flow.
I was thinking who could rescue Embraer…maybe BAE…no they exited commercial aviation nearly 2 decades ago , just as Bombardier did last year. Maybe GKN who bought the remnants of Fokker, but they have new owners who might carve up that business.
The airlines have to wonder if their buying practices have created this monster which eats it’s young, relentlessly squeezing new entrants and existing players alike.
There has been a massive influx of capital towards aviation finance in the last decade despite it being an extremely complicated instrument requiring a lot of investment / expertise for a start.
The influx was reflected in massive lowering of debt/leasing costs for airlines in that period (above and beyond the relief that interest rates were bringing)
15 years ago there were 10-20 bidders on medium size aircraft financing RFPs, in 2019 we had over 100 in some cases
Airlines do not need to ask themselves anything, it’s the manufacturers who are in trouble
With low rates returning, why wouldn’t the demand for leasing return in a few years?
“The airlines have to wonder if their buying practices have created this monster which eats it’s young, relentlessly squeezing new entrants and existing players alike.” good point @Dukeofurl. Boeing last years harmed well airspace industry and market.
“Yet someone with computer code and a San Francisco office can probably raise $5 bill just like that , and can’t even offer a positive cash flow.”
The real metric in making money is in managing hype.
A tangible product is a damper anchored to reality.
Rather amused by the line “Boeing doesn’t pull a move like this without thinking through all the possibilities”…having failed miserably to think of the possibilities when they brought their lawsuit against Bombardier! They seem to be prone to be making mistakes at the moment
Unfortunately for Boeing s*** sticks, and some may believe that Boeing is in a much weaker financial position than it claims.
It also leaves Airbus in a much stronger position in the smaller end of the market.
Fully agree that the line “Boeing doesn’t pull a move like this without thinking through all the possibilities” is a bit optimistic. They failed miserably doing so with Bombardier. And probably a few other cases. Boeing hasn’t been the exemplar of strategic thinking in the last years….prioritizing shareholder value and stock buybacks. But then it is indeed a David versus Goliath struggle and Embraer may not have the enough life in itself left to wait on the outcome of a multi-year legal struggle.
I can’t think of a single thing Boeing has thought though in the last 15 years.
Remember the famous, we are moving to Charleston because of the Union?
Ooopps, NLRB says you can’t use that as a threat, but they did.
Now they have two factories that can make 787s, so now you will have to abandon Everett line leaving that under used and a whole campus cost in Charleston to support with vastly reduced mfg numbers. Good move.
Yep, that thar management really thinks things through.
More like the Gang that Could Not Shoot Straight.
P8, T-X, x-45 looks ok.
“The Boeing/Embraer JV is d…………..er and Boeing to team up.”
Defective thinking ( by corporate management/lawyers ).
I’d like to direct attention to one Sapir Whorf hypothesis:
https://en.wikipedia.org/wiki/Linguistic_relativity
This is not limited to Boeing but afaics culture ingrained.
Boeing miscalculates lots of things last years – Bombardier case, MAX return, 777x development, 787 development etc. and loses and loses. It is/was biggest airspace company with lots of political connections and always bold so tries to bully everyone around. Now it’s a colossus standing on legs made of clay. I think Embraer will have viable case against Boeing.
“But just as Bombardier took a knife to a gunfight, it ultimately prevailed.” Really??
Bombardier gave 50.01% to Airbus for $0.
BOMBARDIER took a knife to a gunfight and AIRBUS wins the fight, by observing, then bodyslams the entire small, narrow-body market, more like it….
Ultimately, Bombardier prevailed in the trade dispute when the ITC found no harm to Boeing and therefore no tariffs could be levied by the US. The deal with Airbus was a separate issue.
More like Boeing takes a balloon to a knife fight.
Pop.
Embraer is now free to compete against Boeing, without McBoeing management as a burden to deal with. They are free to build good, solid airplane designs, with good engineering talent. Without an 800 lb gorilla on their back
The problem is what airplane? They can’t compete with the A220.
All the new stuff is Over Scope for regional.
so only the old ones can sell in the US in a no need for any aircraft climate for years?
MHI will have their scope model out in 4 years.
RE: slow selling (50 units) of Embraer E2
Isn’t the aircraft’s weight at slightly over the scope clause for most USA airlines also a factor, and the fact that the chances for changing the scope clause did not materialize as hoped for, also a factor that impacted the success (or perhaps, failure) of the E2?
Or is that NOT a factor?
Just wondering…
It’s a big factor. Embraer should have built a lighter plane. Force Majeure – Boeing won’t pay a cent. The whole industry has taken a gut punch from airlines to OEMs. See other recent merger and acquisitions. Just like Airbus, Boeing and Bombardier, Embraer will get the help it needs from their Brazilian Government.
Just a little addendum here: The US Congress is looking to stop M & A at this time.
Reporting is that Boeing asked Embraer to make a larger investment in the commercial business before finalizing the deal. In part this may have been to limit their losses if the deal progressed, in part it may have been an impossible ask to scuttle the deal. Embraer felt they had made the investments called for in the master agreement. So now the courts will have to decide.
Boeing was in a no-win situation with the COVID crisis. If they paid $4.2 billion for a company valued at $1.1 billion, they would have been massively criticized and probably mapped themselves out of federal COVID aid. So they asked Embraer to adjust the deal to make it more palatable, but Embraer felt they needed to hold the original price.
Boeing also could have also extended the master agreement and kicked the can down the road to see how the market settles after COVID. The valuation may well rebound, and that would have been a better solution. But perhaps they saw the risk as too great, given all their other existing problems.
In any case it’s a bad business. I get what Boeing did but hope that Embraer will have some redress in the courts and do well in general. Reports are that Boeing will not pay the $100 million cancellation fee because the withdrawal did not hinge on approval of the deal.
RE: “Embraer is now free to compete against Boeing, without McBoeing management as a burden to deal with. They are free to build good, solid airplane designs, with good engineering talent. Without an 800 lb gorilla on their back”
Yeah, but the “geniuses” at McBoeing are probably crossing out “Bombardier”, “Canada” and “C-Series” on the paperwork they’ll file to address that “problem” by seeking to instigate a trade-war with Brazil as this reader comment was being written!
Hehehe 😉
@Scott
The diagram in https://leehamnews.com/2020/04/27/the-squeeze-on-embraer/ seems to be wrong. The vertical axis is labeled as “single class capacity” but the two class capacities seem to be plotted for the A22o 100/300.
For example the A220-300 should be at 160, basically same as the A319.
No?
It’s Embraer’s artwork. I just added the circles. But your point is taken. EMB shows the M100 with many fewer seats than the E175-E2. They have about the same.
The 175-E2 is 88-seats and the M100 is 76 seats, isn’t it? I believe that the reference is M100 against the 175E1 which both are 76 seats.
I believe that US will not let the Chinese to step in for Embraer. Therefore, Embraer will have to seek partners mainly from financial partners, like they did when the company was privatized. Embraer is good on shrinking and staying viable when things go bad, it is not the first time, and I believe they will survive. And Boeing might just created a new direct competitor in the future.
And the US can stop China from working with a company who is in Brazil how?
Sure they can. There are dozens of US export control itens on E-Jets.
We already have an existing instance of that tactic. How much is it hurting Huawei that the US banned the export of chips to them ? They certainly haven’t gone out of business, and they have increased revenue and net.
Ultimately the people to suffer will be the providers of the technology who are no longer allowed to sell to the world.
China will step in and buy Embraer. It will be another step in the destruction of American influence and the ascendancy of China in the new world order.
Maybe and maybe not.
Keep in mind the current lame China offerings are prestige projects and buying it from Brazil does not meet that PR goal.
It would give them outlet for the 929 support wise, but Embraer does not support large aircraft either and you still have to deal with the Brazlian government on the less viable regional area (which China purports to have covered but none is certified nor certifiable in the ARJ and 919).
During the last ten years we have seen BA stocks shoot to crazy levels just by being one of two players in the mainline jet biz. With EMB stock nearly worthless I can’t help wondering if some smart capitalists somewhere might see it as a chance, a company worth snatching up and recapitalizing. An EMB 737 replacement payed for by new capital and a Braz gov subsidy, supported by an existing network, could easily produce a couple of thousand orders worth 2000x$40mil=$80 bn over 20 yrs for a $10bn investment, but there is a good possibility the stock market, which is becoming more awash with capital every year, would value that company at $160bn.
Further to an earlier post EMB could seek a JV with a relatively healthy military OEM like Lockheed, Northrop or BAE to do a 737 competitor. Military spending is notoriously cyclic and the boom in BA shares, even when a shadow hung over the company, might encourage one or the other military supplier to look for an easy way into the civil market.
Martin – for ‘[a]n EMB 737 replacement paid for by new capital and a Braz gov subsidy’ to be truly profitable an awful lot of decisions need to be made correctly at the first time of asking, even were the OEM able then to come close to developing such for only ‘a $10 billion investment.’ But might it be that some defense OEMs are ‘healthy’ exactly because they do not build commercial airplanes…
The stock market has only been awash with money because investors and/or speculators think there’s money to be made; the ‘boom in BA shares’ was stimulated by the directors spending revenues to buy their own stock and to pay dividends. For sure, there will always be a temptation (right word) for bosses to ‘look for an easy way into the market.’ We all know how to make a small fortune from aerospace…
I’d say that if you want into the civil aerospace market the safest way is to take over an existing company. I didn’t mean it would be easy.
Wall street is awash with cash because of endless stimulation, how much Covid cash will end up there? It’s the new form of hyperinflation, smart investers will buy into anything which has a chance of moving ahead because they have to, nowhere else to park the cash.
NB demand is so big and the MAX is a reputationally damaged product, if that wasn’t enough older NGs are running into unexpected problems so a 737 competitor done well, on time and budget, which EMB have a history of doing, would work. Add that the USA is fighting to maintain influence in Latin America so anti trade measures would be a big mistake and yep, an EMB mainline NB might make a lot of sense, payed for by new investors.
I’ve often wondered this. If Boeing and Airbus have backlog for years, wouldn’t a Lockheed be able to build a plane in this segment with reasonable success? I suppose it wouldn’t have any large jet commonality but many airlines have Airbus barrow body and Boeing widebody or the opposite.
Zoomzoom – A Lockheed entry would have to get just about everything right first time and offer guaranteed performance and product support better than A or B can offer (and sufficient to then overcome considerations of current fleet commonality), while competing against both for the orders that lie just beyond the current backlog — a very big ‘ask,’ I fear.
Embraer has painted itself into a corner and sans a major government bailout, they are sunk.
It was a huge mistake to build non scope aircraft. They can supply into the market if it recovers with the old ones only.
MHI made the same mistake, but they have the bucks to change course.
Embraer should have gone within the new birds in scope with growth air frame as an out, or they should have done an A220 type.
I never saw any hint that the unions would let scope go. Why anyone bought into that I have not a clue.
Now if Brazil govt fund them an A220 type, then Boeing will come calling again.
I agree with you. Embraer was over conservative in their product line in order to replace E1. They will need to be bold in their strategy, like they were when they released the E-Jets in 1999. And with the BRL currency being so low, it is the right time to do so, if they find the right investors, which not necessarily should from aerospace business.
Max, “they need to be bold in their strategy” do you mean entering the A320/ B737 territory? I don’t see many gaps to fill. Maybe the A321 XLR, since it is currently unrivalled due to New Midsize Airplane setback. That would be a hella plot twist!
Boeing thinks about all the possiilities? Really? If they did perhaps Airbus would not have the A220 for 10 cents on the dollar, or 350 people would still be alove. Boeing has acted out of arrogance and entitlement again and again. This is probably going to cost them a HUGE amount of damages.
Both Airbus and Boeing rejected the initial Bombardier JV proposals.
It was only after that when Trudeau pushed Bombardier into Airbus because of its distributed production strategy did that initial JV eventuate.
Boeing may have had its eyes on Embraer as its preferred partner even back then because it had got the systems integrator production strategy to work well- Embraer only makes the upper front cockpit section of its E jets itself.
And Boeing most likely wanted to go that way for its FSA
First a tangential remark. My primary computer finally bit the dust and there is currently a shortage of computers and computer parts. Prices are going up overnight. The graphics card I bought on Saturday, returned on Sunday, now costs more on Monday. There are massive supply chain disruptions right now.
No one will come through this unscathed. 1/10th of the global economy evaporated and 1/10th of global savings we burned up too and there is no end in sight. Widebody demand just went off a cliff. Narrowbody demand is not far behind. Regional aircraft is flatline. I can’t figure out who would want an A220 right now although the volumes are so small, the cost of keeping the line open is pretty minimal but there is no money to invest in increasing production because there are no buyers. This might ultimately be good for the A220 as Airbus will have the breathing space to ramp up production when demand returns; but it will be five years for regional aircraft if its three years for mainline carriers. In the short term, the A220 will bleed cash.
I think the A330neo will be dead in a year-that weak order book looks much, much weaker; 747 is already dead. Rate cuts for almost every airframe left standing and everyone losing money. The only plane with a short-term future in this market is the A321 which will become the standard for cross-Atlantic travel. Boeing is better off keeping the 737 line closed and implement more improvements to the airplane when they restart.
Boeing needs to write thank-you notes to the European regulators as Boeing avoided a disaster. The larger the company, the more it bleeds right now.
I agree with you. But what if Embraer start doing a competitor for A321XLR? I guess the “thank-you” notes sender will be the opposite.
Buy refurbished leasing articles.
( all my laptops came that way. 2..3 years old higher end machines for pennies. replace hard disk with new.)
– Business reliability damage for Boeing might be significant. Taking strong legal positions, miss using politcal muscle, breaking promises. Boeing is dependent on it’s supply chain, banks and customers. Those get second thoughts being asked to invest.
– Don’t underestimate the E190-E2. The E-190 was by far the most popular E-Jet and has no competition in the 100 seat niche.
– I expect the Chinese to take a look. Embrear is a good company. The Chinese are smart enough to be carefull and look ahead 40 years. No take-over bid, but a life line. A win-win commercial JV expanding Embraer capabilities in Brasil. Plus a commitment for 300 E2’s.
1. Boeing will lose any civil case claiming it failed to meet its obligations under the Master Transaction Agreement with EMBRAER. Why? Because Boeing failed to meet its obligations under the agreement, despite stating EMBRAER failed to meet conditions
2. EMBRAER has capital options other than strategic investment from state-owned enterprises located in totalitarian nations with absurd industrial ‘ambitions’ and voracious corporate stripping appetites
Point #2 implies private investors assess risk and commercial opportunity to price the cost of capital. That is the basis of any CAPITALIST society, which both Brazil and U.S. embody. There are vast private pools of corporate risk capital available for EMBRAER to receive investment from. Pension funds, insurance companies, mutual funds, alternative investment funds, and public equity portfolio investors would all consider investing in EMBRAER.
The Brazilians do NOT need to sell capital in EMBRAER for absurd political reasons, there are private sources available, even in the midst of a global pandemic obliterating the tactical business cases for commercial aviation.
EMBRAER has an amazing track record developing and launching innovative and successful products in new markets like general aviation jets and military transport tanker projects. The E2 190 and 195 will soon see enormous interest from carriers seeking small, efficient, and proven aircraft as commercial aviation activity begins to recover at the end of the year and next.
Everyone needs to take a deep breath and allow EMBRAER to develop and execute its future strategic direction.
NYCjo, well said. I hope Embraer brace the opportunity that this situation has taken (covid+Boeing). I believe if it makes the right calls, and I do mean being bold and entering big and profitable markets, it will make most of the situation.