Boeing's 737 MAX Faces Extended Grounding Period

News Air Canada announced that it is suspending all 737MAX flights until July 1st, meaning that the aircraft will be out of service another three months, at least for one airline, while improvements to the software and MCAS system are made. This is the first airline to cancel MAX flights for a lengthy period, and provides an initial indication of how long the recertification of the aircraft could be. The last time an aircraft was grounded, the Boeing 787, it was for a similar period of just over three months until a revised battery fire containment system could be installed. But today, the environment has changed. Just as there was a non-uniform grounding, there could be a non-uniform return of the aircraft to service, as various regulatory agencies want their own testing and recertification processes, rather than rely on reciprocity. We fully expect different timing for different regulatory entities in this case, some of which may be longer than others. The era of the world relying on the FAA as a global safety authority appears to be over. Analysis With a likely three month grounding before the FAA and EASA independently approve Boeing’s proposed modifications (which have already been presented to the agencies in the wake of the Lion Air accident), the financial implications for Boeing will be substantial. We view a three month grounding as a likely minimum time frame, as regulators must complete rigorous testing of the new MCAS system in every failure mode, and must still determine that there were no other causes of the crashes. First, Boeing will need to compensate the airlines for the loss of use of their aircraft, which will be negotiated. That will likely include both the monthly rent (about $350,000 per aircraft per month) and profits (negotiated) as well as some element of inconvenience. This could occur either as a cash payment, or perhaps as a credit toward future deliveries, as the program is just ramping up, and most customer have signed on to take additional aircraft. We estimate at least a $500 million cost to Boeing in this category. Second, Boeing will need to continue to produce, and then retrofit, new airliners that it cannot deliver to customers to maintain its delivery schedule. There will likely be a lot of finished aircraft clogging the ramp in Renton, or perhaps ferried to other facilities for storage until customers can once again accept them. But with the final payments not coming in, Boeing will face negative cash flow for the program as it builds aircraft without additional progress or final delivery payments. This will likely cost Boeing $2 billion until deliveries can be resumed. Third, Boeing will need to absorb the cost of the fix, which will include the new software development and extensive testing, both in flight and on the ground, and the costs for regulatory agencies to approve the system upgrades. Unlike the FAA, EASA, which has indicated that it will perform its own testing and certification rather than traditional reciprocity with the FAA, charges for those services. We believe the cost to engineer and certify the fix could exceed $100 million. Fourth, Boeing may face liability in this case if a flawed system is determined to be a contributory or primary cause of the crashes. Damages resulting from 346 deaths in the two crashes could be substantial, and we fully expect additional civil lawsuits to be filed. These will need to be settled, likely at a significant cost. We have no estimate for this category Fifth, Boeing itself and its employees may face criminal liability should the French BEA determine that the system itself was designed with negligence. The reliance on a single sensor, in itself, may be enough for the French to reach such a determination and introduce criminal liability into the equation for Boeing officers and employees. Given that a major software fix was already underway and presented to regulatory agencies before the ET302 crash indicates that the initial system was indeed flawed, as otherwise a fix would not be needed. The question for lawyers may be what did Boeing know, when did they know it, and why did they not take more pro-active actions after the Lion Air crash. We don’t know what will happen here, but attorney fees won’t be inexpensive. Insight Three months appears to be an optimistic time frame for the MAX to be back in service. But even if it is out for only three months, the costs will be substantial, as much as $3 billion when all is said and done. Fortunately, with only about 350 airplanes in service, it could be much worse, since more than 5,000 of the type are on order. Had these accidents occurred later in the program, costs would have been staggering. Boeing certainly has the wherewithal and capacity to absorb a multi-billion financial hit. The question is what would it do to Boeing’s new product strategy, and could this result in a delay to the NMA/797. While we do not believe it would, the excess cash that Boeing has been using to repurchase stock and increase its stock price will likely not be available to continue that process in 2019.

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