Boeing In Crisis: Pays Embraer $150 Million For Failed Acquisition Deal

Summary:

• Boeing faces significant financial challenges, including a big debt load and a failed labor agreement, exacerbating its cash flow issues.
• Embraer will receive $150 million in compensation from Boeing, but this amount likely does not cover the full costs incurred from the failed joint venture.
• The failed Boeing-Embraer joint venture means both companies lost valuable time and resources, potentially benefiting Airbus in the competitive landscape.
• Despite current setbacks, I maintain a buy rating for both Boeing and Embraer, anticipating future production increases and improved competitive positions.

For Boeing (NYSE:BA), matters seem to continually become more challenging. The company is facing issues on its Starliner capsule and the Boeing 777X flight test program has been halted temporarily due to reported structural issues, and things didn’t end there for the US jet maker as it failed to reach an agreement with union members for higher wages and job security, resulting in strike of more than 30,000 Boeing employees potentially costing the company billions of dollars while it’s crumbling under a big debt load. If you thought that was the latest in terms of blows to Boeing after the company has been in crisis mode for the past six years, you were wrong. The most recent blow to the jet maker is that after arbitrage proceedings, Embraer will receive $150 million in compensation from Boeing over the cancelled combination of its commercial airplane departments. In this report, I will discuss what it means for Embraer as well as for Boeing.

Compensation For Embraer Is Low

Embraer and Boeing announced in December 2018 that the Embraer commercial airplane unit would become a joint venture with Boeing valued $2.5 billion, in which the US jet maker would get an 80% stake for $4.2 billion at a 85% premium. It was already quite clear that the company paid a significant premium for the 80% ownership in the joint venture. However, by 2020, Boeing abandoned the plan to acquire Embraer’s commercial aviation unit, arguing that the Brazilian aerospace and defense company did not adhere to its part of the deal. In what ways Embraer did not stick to the agreement is unknown, but it’s widely assumed that Boeing walked away from the deal due a combination of the pandemic and the grounding of the Boeing 737 MAX, which led to a significant cash drain for the company. By 2020, due to the pandemic, the value of the joint venture had fallen to $660 million and $1.22 billion after including the premium.

In case the deal would not be finalized, there was a breakup fee of $100 million. Embraer will receive $150 million, and that represents a 50% premium to the previously agreed compensation. It’s a very low figure. Embraer absorbed costs to carve out the commercial aviation business from the rest of Embraer and it also absorbed costs to reintegrate the unit after the deal was cancelled.

While Embraer has not provided a detailed overview of carve-out and reintegration costs, the $150 million is not a huge sum. In the quarter in which Embraer reintegrated its commercial aviation unit, it absorbed $17 million in arbitration and reintegration costs. Moreover, the month-long production stop have led to around $85 million to $103 million in lower revenues, putting just the costs for arbitration, reintegration and lost sales in Q1 2022 at $102 million to $120 million. Carving out the company might have at the very least been equally costly, putting the total costs at $204 million to $240 million in what I would call the best-case scenario. That means that the $150 million most likely does not cover the full extent of missed revenues and costs at Embraer. Currently, Embraer has a book value of around $3.88 per share, which at current stock prices means that the stock trades at around nine times book value. The $150 million compensation would add around $0.20 per share to the book value which multiplied by the price-to-book value would indicate a stock price of $36.81 or around $1.80 per share. That’s nice to have, and I don’t believe that we should be negative about Embraer receiving $150 million. It’s just a reality that it likely will not cover the costs that Embraer had, but those costs were already incurred and part of it is regained now. For Embraer, what remains somewhat more painful is that the strong sales funnel that would have developed in case the joint venture was launched has vanished and the company will need to adapt to that. Embraer airplanes are good airplanes, but the reality is that sales are not extremely fast and a tie-up between Boeing and Embraer would have helped secure more orders and potentially decrease costs due to combined purchasing power of materials and parts.

Boeing Gains Nothing At All

Boeing is the big loser in all of this. The company currently has $12.9 billion in cash and $4.8 billion in debt maturing in the coming year. Boeing’s annual report indicated that the company would have more than $17.5 billion in debt maturing through 2026 including more than $12.5 billion in 2025 and 2026. All of that was on the assumption that free cash flow would pick up significantly. The reality is that free cash flow remains negative and the $150 million payment to Embraer only adds to the company’s problems which includes a strike that could pressure free cash flow by billions of dollars.

Even if the cash would not be the issue, the reality is that the joint venture would have given Boeing a competing product against the Airbus A220 and an airplane to slot below the Boeing 737 MAX 7 or even in some campaigns replace the MAX 7 as the primary candidate. The Airbus A220 ended up with Airbus for free after Boeing battled Bombardier years ago and the company already saw itself in the position where it would be paying to have a competing product against Airbus, which basically scooped up the C Series for free. Hardly a good deal. More painful is the fact that Boeing at some point has to look at a next-generation airplane and the pool of skilled and cheaper engineers would have helped Boeing in developing a jet while also keeping control on costs without compromising quality. As we know now, that has been Boeing’s Achilles heel. Embraer is quite well versed with multidisciplinary design optimization or MDO and that would have benefited Boeing quite well. So, Boeing is losing $150 million on this failed deal while it already lost a valuable product line up and a skilled engineering pool.

Conclusion: Boeing Is The Big Loser

For the long term, I maintain my buy rating for Boeing and Embraer as I believe that Boeing will eventually get a labor agreement in place and increase production on its cash cow programs while Embraer can increase production and it could even aim to become a bigger competing force in the single aisle market. However, the fact is that neither Boeing nor Embraer really gained from the failure to launch the Boeing-Embraer joint venture. Both companies lost valuable time and resources to increase their competitive position and it might be Airbus that will be the laughing third.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BA, EADSF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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