Is Embraer Better Off Without Boeing?

News:

Over the weekend, Boeing terminated its agreement with Embraer to acquire the E2 series of commercial jets. Embraer has protested this termination, but this transaction appears now to be like Humpty Dumpty and is unlikely to be put together again.

The proposed deal had several potential advantages for each side. Embraer would have obtained the marketing clout of Boeing and the opportunity for the E2 family to be considered in multiple-aircraft deals with Boeing. Boeing would have obtained the excellence in engineering at Embraer, who has introduced 14 new models in 14 years, with a track record for being on-time and on-budget. But in the end, the impact on the aviation market from the coronavirus resulted in market valuation that made the original proposed transaction mispriced.

Analysis:

Today, the market capitalization of Embraer’s entire enterprise, including commercial, business jets, and defense, has dropped to $1.3 billion. Boeing’s acquisition of 80% of the commercial business for $4 billion was no longer justifiable, particularly with Boeing seeking financial relief from the United States government. Without a renegotiated value, the transaction would be unfeasible. The second problem is that separation costs have been estimated at $1.2 billion, an enormous cost for both parties to absorb. Clearly, the numbers no longer work.

What does this do to Embraer, particularly marketing for the E190-E2 and E195-E2 against Airbus? This will make the job tougher, as they have a more sophisticated competitor than Bombardier that also has deeper pockets. But the situation certainly is not impossible. Their recent transaction with KLM indicates that Embraer can still successfully sell to world-class customers.

The E2 Jets are strong performers in their class, and economically competitive with the A220 albeit having slightly lower range. With uncertainty over the Boeing transaction now eliminated, potential customers now know that they will be dealing with the Embraer team on sales campaigns.

Insight:

A key question that will be asked is whether Embraer has the critical mass to survive in the commercial aircraft business, competing against Airbus and to a lesser degree Boeing. We believe the answer is yes, despite the difference in size between the companies. Embraer has the dominant position in the regional aircraft market with the E175, which the E175-E2 should take over when scope clauses change. Their position in the business jet market has been solid and growing, with the Phenom 300 the best-selling light jet. Their military C-390 Millenium appears to be a solid aircraft that will be successful in military markets and their existing marketing agreement with Boeing appears intact.

Embraer has solid engineering, and its products have been popular enough to provide the scale economics necessary for success. Nonetheless, the break-up of the Boeing deal and the impossibility of a deal with Airbus leave only COMAC as a potential but unlikely option for future cooperation.

Embraer, with strong engineering and a track record for success, has everything that the Chinese would seek in a future partner. While we do not expect Embraer to jump into any deal with China, the break-up of the Boeing transaction brings that possibility into play in the future, and that could become the worst outcome of all for Boeing over the long-term if the fast-growing BRICS countries were to cooperate in aviation.

Embraer also announced today that arbitration proceedings are underway with respect to the termination of the Master Transaction Agreement executed with Boeing. Our understanding is that while Boeing terminated the agreement, they are unwilling to pay the associated “break-up” fee that was previously agreed upon.

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