The saga surrounding the Boeing Brazil debacle will lead to lots of stories. Some will reflect sympathy for Embraer. Some will rationalize the Boeing view of this. All will be fair if you can understand where the writer is coming from. But in the end, this is a story of Traição (Portuguese for betrayal).
Let us start with a view of the deal from Boeing
The attraction for this deal consisted of not the E2 program so much as what is behind that program. At the core of the attraction as the Embraer talent pool – the skilled people that developed 14 programs over 14 years, largely on budget and on schedule. This is a team that was not satisfied with their landing gear supplier, so they brought the work in-house. The same for their wings.
What Boeing wanted more than anything was that talent pool. It comes at a lower cost than Boeing’s current people. It would provide a fresh talent injection and (let’s be clear) create internal competition for future program development.
Chief among Boeing’s future program development challenges would be the NMA and FSA. When Boeing Brazil was established, the Brazilian team could focus on FSA as this is clearly a narrow-body space they understand very well. The E2 is evidence of that. This would allow Boeing USA to focus on NMA.
But a few things went wrong for Boeing. First was the MAX debacle. With each new revelation, it became clear the MAX is the most poorly executed program in Boeing’s 100-year history. Boeing’s people must focus on the MAX and fix it, because it is the company’s bread and butter program, and generates the majority of cash flow and profitability. But just as they fix one thing, another seems to pops up. Unfortunately, this aircraft had flaws that were responsible for the deaths of 346 people in two crashes. And Boeing, after 13 months and counting since the MAX was grounded, still hasn’t got it fixed.
At the same time Boeing’s other programs have also come undone. The KC-46 is a shambles. The 787 suffers from customer complaints about quality. The 777X is delayed and now may end up being Boeing’s A380. And, of course, these issues have taken resources from NMA, effectively canceling the program and handing market share that Boeing once owned, with the 757 and 767, to Airbus. But worse still, even as the MAX failure should have accelerated the work on FSA, Boeing has now cut off its access to the engineering lifeline Boeing Brazil might have provided.
As recently as January 27th, the Brazilian antitrust regulator approved the Boeing Brazil deal. That’s the same day, a press release came out from Boeing and Embraer welcoming this approval. Here we are, some 90 days later staring at what looks like a stunning betrayal.
Does the deal breakup make sense from Boeing’s point of view? Yes, but only because the company is amidst across the board self-inflicted damage that is now compounded by the pandemic. Anyone can understand the latter because we are all suffering through it. But the former? Not so much. Can Boeing make the case it simply cannot afford the deal right now? Of course, that makes sense. But instead, Boeing said claims that Embraer did not satisfy conditions under the agreement. “It is deeply disappointing. But we have reached a point where continued negotiation within the framework of the [merger transaction agreement] is not going to resolve the outstanding issues,” said Marc Allen, president of the Embraer Partnership and Group Operations, in a Boeing news release.
It’s all about people
All companies tout their employees as their greatest resource. Amid the pandemic, you can see how many companies really believe this and act accordingly – actually, very few. One can understand and sympathize with people getting laid off by the thousands across the commercial aviation supply chain.
It will be increasingly important to see how Boeing and Embraer’s culture deal with the aftermath of the broken deal. Boeing has a poor record of labor relations and we expect this to continue, despite the potential federal aid to keep people employed. It is not clear to us how Embraer is going to respond. But we do know that Embraer is highly focused on its talent pool.
Now from the view from Embraer
The people at Embraer really are its primary resource. Embraer, being far from the traditional aerospace centers figured out a way to solve its skill challenge. It grows its own, with the company supported higher education facilities right next to their plant in San Jose dos Campos.
Whereas Boeing, for example, built its supply chain into an eco-system, Embraer went for vertical integration of its own making. (Boeing has run late on every program since the 777 that came to the market in 1995)
In keeping with how Embraer works, the company embraced its role in what was to be Boeing Brazil. Whereas Boeing had to undertake relatively little corporate structural work, Embraer had to tear itself apart. Embraer’s commercial unit had to be surgically extracted from the overall business. This includes IT. Cutting a company apart is complex and trying. For example, even though Bombardier sold off two programs, both of those programs still depend on Bombardier’s IT systems. Much to the annoyance of all concerned. It is simply a very messy thing to undo.
The extraction of Embraer Commercial came with more effort as well. Sales and marketing were held up. As was delivery of aircraft to customers. In the case of sales and marketing, that delay gave its E2 competitor a virtual monopoly. In terms of deliveries, several E-175s were ready to go to customers in January and February. Those customers have now backed away because of the pandemic. A double hit compounded by the breakup.
The timing on the breakup of the deal is awful for Embraer. It was committed to the deal and went through the hurdles to get ready. It exposed its business to risks that now can be seen as very expensive. Indeed, we understand that Embraer has incurred some $100m in separation costs to cut out the commercial side from the rest of the company. For Boeing that cost is the equivalent of two MAXs or less than one 787.
In short, Embraer spent a lot on getting ready for the deal to close. Embraer has seen its valuation decline sharply like all other aerospace companies. The time it has taken to get the deal closed has seen the deal price of $4.2Bn go deep underwater. In Embraer’s words: “We believe Boeing has engaged in a systematic pattern of delay and repeated violations of the MTA, because of its unwillingness to complete the transaction in light of its own financial condition and 737 MAX and other business and reputational problems.” The deal was announced in July 2018, and nearly two years later, it could not get closed.
The deal is clearly now off and it is now time for the lawyers. Boeing, despite being the party to cancel the deal, has refused to pay the contractually specified “break-up” fee. The longer Boeing can delay this process in arbitration, the more time it has to try to fix its internal challenges.
Embraer is not without options. Within 24 hours of the Boeing news of the deal breakup, Brazilian politicians were talking about China as an alternative partner. Unlike Boeing, China has the funds and interest to acquire aerospace assets. Especially if they are distressed.
Were China to do a deal with Embraer, it would gain several things – access to experienced engineers, a team that has certified several aircraft, access to a world-class support network, relationships with airlines worldwide, and instant market credibility. We expect to hear howls of protest from the United States and the European Union were China and Brazil to start talking openly. If Embraer tied up with China, Airbus would see a smaller market for its A220. And Boeing would be frozen out of the sub-150 seat market. That hurts Airbus, but it hurts Boeing even more. Traição always comes at a high price.