Insight: Friday 10 April 2020: The Other Side – Part 5: Bailouts and Equity Ownership

News:

The government bailouts for airlines and aerospace manufacturers in the United States will come with some strings, including the potential for some equity ownership by the government in exchange for their financial support. This seems like a reasonable proposal, given that aerospace firms and airlines have spent nearly $100 billion between them in buying back shares of their stock to raise share prices. That, of course, also has the side effect of increasing executive compensation but is very risky if the value of the stock drops.

With the COVID-19 crisis bursting the overvaluation bubble in the financial markets, it is quite clear that the result of these share repurchases went up in smoke – poof – the value has disappeared overnight with absolutely nothing to show for it. There is a moral hazard in giving money away to folks who have shown the ability to squander it with no strings attached.

Boeing itself essentially burned $43 billion. Yet they complain about companies like TransDigm, who acquire companies with proprietary products that are essential to aircraft production and charge high prices, yielding high margins and returns. What would the state of Boeing be today if they had instead, acquired TransDigm to solve their cost issues? It would certainly be better than the nothing they have today. Or what if Boeing spent the money to build a new middle-market airplane that could compete with the A321neo. Their current offering, the MAX10, falls well short and is being outsold 5:1. Something tangible is what they should have been focusing on, rather than lining their own pockets.

Similarly, airlines who bought back their own stock could have invested in new aircraft and provided the impetus for Boeing and Airbus to further innovate. Instead, their investment is also now up in smoke, while a couple of US carriers have among the world’s oldest fleets of aircraft. We certainly can’t say they are “green” airlines.

Lobbyists for Airlines 4 America and Boeing are fighting government shareholding as a part of the bailout program, and Boeing has gone as far as saying they will not accept government bailout money should shares be a part of that process.

Analysis:

The government should not, typically, be an investor in companies but rather support the free market. But these are unusual circumstances, and taking shares, which are bound to rise from the current levels is a way for the government to be repaid. Today, shares are low priced because revenues have rapidly dropped to nearly zero and costs have continued. Once the crisis is over, that will no longer be the case and the government could sell those shares to recoup their losses.

Taking shares in Boeing today may not be such a bargain. The MAX remains grounded, and the potential exists for further delays should international regulators press a couple of identified issues with the airplane. The 787 has quality issues, the 777X is delayed by problems and looks to be introduced just as the market for large airplanes has virtually disappeared, and the KC-46 tanker continues to fail to meet its mission requirements.

Boeing today is a failing company that has squandered its cash reserves, drawn down its credit line, and may be headed towards a Chapter 11 restructuring if things can’t quickly turn around. Not accepting a government bailout may mean losing key staff (the best can always find other work, and will continue to do so) and taking a risk on survival facing two crises, either of which going the wrong way could bring down the company and wipe out current shareholder equity. Were I in David Calhoun’s shoes, I might rethink the process. Too big to fail doesn’t mean too big to restructure under Chapter 11.

The airlines also don’t want the government to take an equity interest in exchange for aid. Most have been through Chapter 11 once and could do it again. But the very shareholders they spent billions on would find themselves completely wiped out. The airline PR machine is concerned about having the government as a “backseat partner for the industry” and “the dangers of having the airline sharing ownership with Washington outweigh any possible return on investment.”

Airlines are afraid of an activist government as a major shareholder dictating requirements, rather than the free market. But this is already a heavily regulated industry, and taxpayers deserve a return on their investment.

Insight:

Boeing and the airlines do have an alternative to accepting government money, and that’s to not take government aid and likely go through Chapter 11 restructuring. But is that the right thing to do and does it fulfill management and the Board’s fiduciary responsibility to shareholders? Management would rather refuse government equity and open their shareholders to the risk of being wiped out, through a Chapter 11 restructuring, rather than accept partial government ownership that would be temporary.

While we are not in favor of the auto industry type of bailout by the Obama administration, in which government-dictated corporate actions, a shareholding by the Treasury Department, who would wait for shares to rise again and then sell portions of its equity on the market to earn a return, seems like the fairest way to bail out companies that threw away their financial cushions recklessly.

Investment rather than financial engineering builds value. Repurchasing shares does not create value other than paper that can quickly become worthless. Both groups had management teams that cared more for their stock price (and management stock options) than the future of their organizations. They now may reap what they have sown.

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