Premium 2018.25 – Boeing and Embraer isn’t a done deal as yet |

Reflecting on the recently announced Memorandum of Understanding between Boeing and Embraer, there are a number of factors yet to be resolved before the deal can be completed. Let’s examine several potential risks that could yet derail this deal. Remember, a provision of the MOU is that it is non-binding, meaning that either party can change their mind and back out. Prior to final arrangements, which will take several months to complete. Political Risk in Brazil While it is unlikely that Boeing will back out, there is a significant political risk in Brazil. Since this transaction is not scheduled to be completed until November, which is after the next election. Embraer is a Brazilian gem and perhaps Brazil’s best known international company. It is a world-class manufacturer offering high technology products to a global market. Many in Brazil do not want this Brazilian company to be absorbed into Boeing, and this will be a political issue in the next election. The current President is not seeking re-election, and anti-transaction sentiment exists on both sides of the aisle - the question is whether it will be strong enough to stop the transaction. The jury remains out. Political Risk Elsewhere This transaction will need the approval of ten different countries, one of which is China. China and the US are in the midst of a trade war, and aircraft represent the highest balance of trade item for the United States. Embraer has a facility in China that will require Chinese approval for this deal. Were we in the shoes of the Chinese, we would utilize that approval as a “Trump card” in negotiations with the United States on trade. The threat of unraveling the deal by not approving Embraer to be controlled by an American entity is an excellent negotiation chip. Shareholder Lawsuit The first shareholder lawsuit has already been filed objecting to the transaction as a violation of a Brazilian statute that established Embraer and prohibits more than 35% foreign ownership in Embraer. If the courts view the suit has merit, this is another risk to the transaction. Supply Chain Risks Our assessment of the reaction of the supply chain to this news is overwhelmingly negative. Current Embraer suppliers are not looking forward to Boeing’s Partnering for Success process. Integration of the Embraer supply chain and re-negotiation of supply agreements will be required and this will not be an easy task. International Trade and Protectionism Airbus has now taken over the CSeries, renamed it the A220, and will be building those aircraft in Alabama as a domestic US player. Boeing will be importing aircraft from Brazil. Suddenly, the US-based company is the importer, and the French-based supplier is domestic. The world has turned completely on its side, but Donald Trump will be happy with Airbus creating jobs in the United States. Could Boeing be forced to develop an assembly line in the US to remain competitive? Could Airbus make a WTO complaint against the Boeing-Embraer combination supported by the US? The previous ITC case casts a long shadow of unintended consequences. Partnership Risk With the acquisition of Embraer and its E175 and E175-E2 regional models, Boeing has become a competitor to one of its key international partners, Mitsubishi. The partnership with Japan is very important to the 787 program, which has substantial Japanese content. What impact will moving from a partner to a competitor have on the existing relationship? Will Mitsubishi be willing to participate in new programs now that Boeing is a direct competitor? And how, exactly, will Boeing fare being in the regional aircraft business? Market Risk The E175-E2 does not currently meet US scope clause requirements and cannot be used in the United States by regionals. It is unlikely that pilot union contracts will grant any scope clause relief until 2024 at the earliest, requiring Boeing-Embraer to continue production of the existing E175 model to serve the regional market. While a hybrid assembly line is in place at Embraer, it cannot be as efficient as a single line manufacturing only the new E2 models. Implementation Risk Boeing and Embraer are culturally very different and have very different organizational structures that are almost diametrically opposed in engineering. Boeing’s program by program structure is different than Embraer’s functional focus in which an engineering specialist may work on multiple programs, including business jets, commercial and military programs. How will Embraer’s engineering resources be allocated to programs, and can business jets and military aircraft, the remaining segments, be viable as a stand-alone entity? The Bottom Line The benefits from this deal are substantial, but so are the risks. We believe that it is premature to consider this a “done deal” until after the next Brazilian elections. While there is a need for Embraer to join forces with Boeing to more effectively compete with Airbus' A220, we believe a marketing alliance could be just as effective for both parties, with arms-length arrangements for outsourced engineering and services. Boeing and Embraer need to remember that you don’t need to own the ballpark to play the game and that Boeing marketing the E190-E2 and E195-E2 and bundling them with Boeing Services might be a better way to move forward while mitigating numerous risks.

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