Richard Aboulafia: November 2017 Letter

Dear Fellow Seasonal Procrastinators,

It’s always like this for me at Christmas. I say I’ll buy gifts in advance, but then a few days before the great unwrapping, I run out and panic shop. The results are predictably hideous. In my defense, I’m Jewish, so this is all new to me. New for the last few decades, anyway.

I hope it isn’t the same for Boeing. Just four days before 12/25, the Wall Street Journal reported that Boeing was in talks to buy Embraer, “at a big premium to its market value.” Embraer stock jumped 25%. Given the timing, observers opined that this may be a reaction to the recent Airbus-Bombardier tie-up; perhaps Boeing really feels it needs a smaller jetliner after all. If so, this makes my ill-advised last-minute purchases seem paltry by comparison. Couldn’t Boeing, and I, have done this on Black Friday, like everyone else?

Boeing quickly confirmed that it was talking with Embraer about some kind of tie-up. The good news is that the WSJ might have been slightly off; there’s talk of a range of possibilities, from an alliance to a JV to a full acquisition. Here’s my view: Any kind of alliance or JV would be a very smart idea. Boeing buying Embraer would be akin to buying an aquarium stocked with piranhas. Mounted over a fire ant colony. Under a hive of Killer Bees.

First, the happy thoughts. Embraer is a great company, with some great products and great people. And there is no overlap with Boeing products whatsoever. An alliance makes lots of sense; I’ve been expecting one for over a decade, as have other analysts. Any JV would offer upside to Boeing’s current businesses. The E-175/190/195 family would be a terrific complement to Boeing’s large jetliners. The KC-390 military transport would be a fine product for Boeing to sell, particularly with the C-17 line shutdown last year.

The rest – business jets, small special mission jets, and Super Tucanos – may be of interest for Boeing too. Boeing’s global sales, marketing, and support presence, and of course its aggressive supply chain management methods, would be very useful to Embraer and these products.

There could also be new product developments. A JV could create new special mission variants of the KC-390, or more advanced ISR products using the EMB-135/145 RJ. The E-2 jetliners could incorporate common flight deck features with Boeing planes. It’s a bit far-fetched, but Embraer’s Gripen F co-production work could lead to a Boeing-Saab-Embraer Enhanced Gripen variant. The Gripen’s serious flaws – a high price tag and a small corporate parent – would be rectified with Boeing’s backing and first-rate cost-reduction work too.

On top of that, with the KC-390, E-2 jetliners, and Legacy 450/500 business jets out of the way, Embraer has a lot of experienced, relatively low-cost engineers, looking for something to do. And Embraer has no clear path for new product development. Tying up with Boeing as a Mid-Market/797 partner would be a smart path for both companies.

Now, a few reasons why Boeing might want to shop for remaindered Grisham novels and off-season apparel for Christmas instead. My objections fall in three categories: One is Brazil, second is Embraer’s markets, and finally there’s Embraer’s economics.

First, Brazil. Right after the news, President Michel Temer vowed to keep Embraer Brazilian (MBGA!). He left the door open to a foreign investment. But even if he did sign off on an acquisition, who knows what a future Brazilian government will think. They’ll still have a golden share. They could mandate jobs and program workshares, or just nationalize the whole thing altogether. Since Boeing is very much a US company, the usual Latin America Versus the Northern Giant dynamic would be a big risk. Lockheed Martin’s ownership of Argentina’s FMA (now FAdeA) provides all the cautionary tales needed.

Second, markets. Consider Embraer’s three core businesses: regional airlines, small and mid-cabin business jets, and the Brazilian military (along with other developing market militaries). Regional airlines (and small 100-seat jetliners) are a lower-margin business than any of Boeing’s jetliner products. Embraer builds great business jets, but it entered the market during a very tough decade and has had to discount heavily to capture any kind of market share. Plus, working for the Brazilian MoD is just like working for DoD; if, that is, DoD had its budget cut by 95% and occasionally issued bank checks post-dated by 12-24 months.

As for Embraer’s military export markets, suffice to say that selling Super Tucanos to the Dominican Republic is quite different than selling Super Hornets to Kuwait. You don’t get rich selling prop attack planes to Emerging Markets.

Finally, there’s the economics of being Embraer. Embraer is the only turbine aircraft company to successfully break into the market between 1960 (Learjet) and 2016 (Honda and Cirrus). It didn’t get that way by being a global aero-monster, and its DNA would not mesh well with Boeing, the quintessential global aero-monster. This is a very lean company. Given its home country and the markets it serves, it needs to be. It builds products that wouldn’t offer the kind of returns Boeing expects. If Boeing tries to grow Embraer’s margins, they’d likely find out the hard way that they can’t.

Last, a word of caution. I still have a Boeing Canada De Havilland Division notepad from the ‘80s. DHC was a disaster for Boeing. DHC’s Regional airlines had nothing in common with Boeing’s mainline customers. The economics of regional airliner production were a mystery to Boeing (and many others). And the peculiarities of Canadian aerospace were a mystery too. Ultimately, DHC was sold to Bombardier, which, as Canada’s national aerospace champion, will always be in a unique position, not readily fathomable to outsiders. All of this provides a cautionary tale for Boeing as (or if) it contemplates an Embraer acquisition.

Now if you’ll excuse me, I need to go out and shop. Stockings are calling. Maybe next year I’ll learn. Meantime, happy holidays, and all the best in 2018.

Yours, ‘Til We Enjoy Some Really Fun Europe/Canada Versus US/Brazil Trade Fights,

Richard Aboulafia