The planned merger of Embraer’s commercial aircraft business with Boeing appears increasingly tenuous on the day the agreement is set to terminate.
Political squabbling, a cash-strapped buyer and an aircraft market that has all but collapsed in the wake of the global pandemic are some reasons analysts suspect Boeing may back away from the deal.
Signed in January 2019, the agreement has an initial termination date of 24 April 2020.
“The speculation is, Boeing could terminate,” says Bank of America Merrill Lynch managing director of aerospace and defence Ronald Epstein. Alternatively, Boeing and Embraer might delay the closing, he adds.
The pending merger, worth $4.2 billion, has gained approval from most required regulatory bodies except the European Commission, which had earlier expected to give its blessing by the second quarter of this year
But on 22 April, European antitrust authorities again delayed a decision, to 7 August. The European regulator last year voiced concern about removing Embraer as the third-largest global player in the commercial aircraft industry.
Brazil’s Embraer says it remains in discussion with Boeing about extending the deadline for closing the transaction.
“The finalisation of the transaction requires the approval of the European Commission and the fulfillment of other conditions,” Embraer says in a statement on 22 April. “There are no guarantees regarding the extension of the initial limit date, the finalisation of the transaction nor the period in which the transaction will be finalised.”
Boeing would not comment about the deal.
The proposed tie up calls for the US aerospace giant to buy 80% of Embraer’s commercial aircraft division for $4.2 billion. Embraer would retain its business aircraft unit unaltered. Initially, the parties expected the merger to close by the end of 2019.
The coronavirus pandemic has further complicated the deal. Some passenger carriers are flying 5-10% of pre-coronavirus scheduled flights, with some reporting single-digit load-factors. Airlines have grounded thousands of jets and are hemorrhaging cash and searching for opportunities to cut costs. That has raised doubt about airframers’ ability to sell new aircraft, and also sucked equity out of the sector.
“With the current market cap for all of Embraer at $1.3 billion, why should Boeing pay over $4 billion for 80% of its commercial aircraft unit,” Ernest Arvai, president of Air Insight Group, asks. “The transaction just doesn’t make sense anymore.”
Bank of America’s Epstein disagrees about the price. He views $4.2 billion as fair regardless of stock performance, noting Raytheon and United Technologies did not renegotiate their recent merger due to stock prices.
”I think Boeing got a good price… and I don’t think they need to renegotiate now,” he says.
But Epstein doubts Boeing is in position to outlay $4.2 billion. He estimated Boeing had about $30 billion in liquidity at the end of March, possibly enough only for 8-10 months of operations.
“Using $4.2 billion in liquidity today just probably isn’t in the cards,” he says.
Arvai estimates the chances of the merger not succeeding at 60%.
“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,” he writes in a 23 April note.
In February, the Office of the US Trade Representative raised tariffs on large European aircraft to 15%, up from a 10% levy implemented last October, in an ongoing spat over government subsidies to the regions’ biggest aircraft manufacturers. At the centre of the ruling were EU subsidies for Airbus, which the World Trade Organization (WTO) heavily criticised as being “WTO-inconsistent”, and causing adverse effects to the USA.
Boeing may receive financial aid from the US government to help it manage through the coronavirus crisis, but has signalled reluctance to a deal that would requiring it offer equity rights to the US government. The government aid package passed by Congress in March, called the CARES Act, stipulates that companies receiving financial assistance – in the form of grants and low-interest loans - must give the US government ownership warrants worth 10% of the loans.
Numerous US airlines have taken advantage of the deal, but Boeing remains on the sidelines. Financial support for the Chicago-based manufacturer could come with additional strings, such as a prohibition against using funds to close the Embraer deal, Arvai speculates.
“The optics of them getting a bailout and sending the money to Brazil are not good,” he says.
Challenges aside, analysts still think a tie up makes sense.
Embraer would help Chicago-based Boeing compete against Airbus, particularly in the single-aisle aircraft market, they say.
“Engineering-wise, everything [Boeing] have touched in the last few years has turned out to be a disaster. Embraer has launched 14 new aircraft in the last 14 years, all of them on time and on budget. Boeing can learn from that,” Arvai says.
Embraer would bring Boeing a low-cost engineering workforce, Epstein adds.
The deal would help the companies counter Airbus’ A220 programme, which the European airframer acquired from Bombardier in 2018. Gaining access to Boeing’s massive supply chain and sales reach could help Embraer keep costs low and land new deals, analysts have said.
“Clearly Embraer needs Boeing for their sales support, and being able to do deals where there are more than one aircraft involved. It’s not easy for Embraer to sell their planes, especially with uncertainty of whether the merger will actually happen,” Arvai adds.
If the deal does not close, Boeing and Embraer will survive, Epstein suspects.
”It’s not going to be easy for them,” he adds of Embraer. “It’s not going to be easy for any of these companies. But I think they will survive. I think they will flourish.”