As we examine the situation in April 2020 AirInsight believes the Boeing-Embraer deal has a 60% chance of not moving forward.  There are multiple factors involved in our assessment.

First, the EU decision on regulatory approval is due on June 23rd, but that date was prior to the Coronavirus crisis, which has further delayed the approval.  Should the EU not approve, which is possible since their motivations appear political and in retaliation for tariffs on European aircraft implemented by the Trump administration, the deal would falter.

Logically, if the Airbus acquisition of the A220 program (nee Bombardier CSeries) which competes with the A319neo, the potential competition between the E-195 and 737MAX7 appears to be even less competitive based on seating capacities.  Nonetheless, the world of politics is not always logical.  The EU would logically be looking at a way to save face and approve the transaction in the absence of political pressure.

With the COVID-19 crisis likely resulting in a delay to the European decision beyond June 23, the uncertainty in the market will continue, which benefits neither Boeing nor Embraer.

Second, should the deal, which was signed on January 24, 2019 lapse beyond October 24th, it can be dissolved by either party.  While it is unlikely that the European decision will take until then, it is not likely that the parties would close the deal immediately given cash flow issues at Boeing.  Yesterday both parties indicated that they want to extend the time period to complete the deal, which implies a new time frame of  March 2021.

Third, Boeing is looking for a rescue package from the US government but does not want to provide warrants for future equity.  The Trump administration has shown unusual backbone and analytical capabilities in completing its deal with airlines in a much more sophisticated manner than the industry and Wall Street expected.  We believe similar pressures may be applied to Boeing.

Fourth, with the current market cap for all of Embraer at $1.3 billion, why should Boeing pay over $4 billion for 80% of Embraer’s commercial aircraft unit?  We believe that the U.S. government could restrict the proceeds of a Boeing bailout from being utilized for the transaction – as it could be construed that taxpayer money would be sent to Brazil to complete a transaction that has an outrageous premium over current market values.  Financially, the transaction simply doesn’t make sense anymore. Our understanding of the situation is that the renegotiation process is already underway, with the extension to the time frame for very logical reasons.

Boeing, given its cash flow issues from the MAX and coronavirus, is likely in no hurry to complete the deal.  Embraer, on the other hand, wants the deal completed as soon as possible, as airlines have held off ordering E2 jets, potentially waiting for multiple aircraft deals and better discounts once the aircraft transition to Boeing.  With the EJets that the E2 could replace being very young, there is a scant add-on or replacement market for Embraer to sell into.  As a result, sales were tepid prior to coronavirus and may decline further as new aircraft demand falls.  While the E2 should be an ideal addition to airline fleets as they seek smaller and efficient aircraft to replace older models in their fleets, it is essential for Embraer to get the Boeing deal resolved, one way or the other, so it can conclude campaigns with potential customers.

Our reading of the tea leaves suggests that the deal will collapse, given that the separation costs of $1.2 billion are roughly the same as the value of the entire Embraer enterprise. 

It is still in the interest of both parties to continue.  Embraer needs the marketing clout of Boeing to compete with the A220.  Boeing needs Embraer’s engineering expertise for the next generation 737 replacement and NMA aircraft, as Embraer has been able to deliver 14 new models in the last 14 years on-time and on-budget, something Boeing hasn’t been able to achieve in quite some time.  

The Bottom Line

The problem we see is that the numbers no longer work, and a renegotiation may not provide the right incentives for both parties to move forward, especially in an era where government bailouts cloud the financial situation. We see this transaction as having a 40% chance of moving forward and a 60% chance of falling apart, despite the parties pushing back the time frame.  What’s needed today is resolution rather than further uncertainty and a longer time frame.  But deals aren’t going to be easy in what is looking like a new financial environment once we emerge from COVID-19.

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