Boeing’s decision to let the deadline pass for its purchase of 80 percent of Embraer’s commercial airplane business ranks among the most dramatic competitive shakeups in the aerospace industry since the onset of the Covid-19 crisis, but perhaps it shouldn’t have come as a surprise. In a way, the pandemic served to seal the fate of a deal that had become more of a distraction than it was worth to the board members and executives in Chicago already absorbed in the 737 Max drama and the structural upset it wrought.
Not only did the $4.2 billion purchase price look overly steep following Embraer’s precipitous decline in market value since the pandemic took hold, but the $1.6 billion that would have gone directly to Embraer shareholders would seem to conflict with the spirit of the restriction on dividends attached to any government support on its way to Boeing under the CARES Act.
While those considerations seem like obvious hindrances to any eventual conclusion to the deal, no one really knows what went on behind closed doors between the companies’ respective boards. For its part, Boeing blamed “unsatisfied conditions” of the master transaction agreement (MTA) on the part of Embraer for the repeated delays to the closing until the April 24 deadline arrived. Embraer said it believes Boeing purposely and systematically delayed the process because it had decided ahead of time it didn’t need or want to close the deal at a time of financial and reputational crisis at the U.S. aerospace giant.
What seems certain is that Boeing chose not to avail itself of a deadline extension the language in the MTA allowed. Whether or not it effectively scuttled the deal for the reasons Embraer outlined, it certainly can use the $4.2 billion that would have gone to the Brazilians, particularly now as it seeks to tap capital markets and probably government loans to maintain the level of liquidity it will need to execute on its plans to emerge from the Covid crisis relatively healthy.
For Embraer, the short-term situation appears dire. Although it has reported no order cancellations since the start of the year, sales activity had begun to dry up before the pandemic hit. The Brazilian company doesn’t control near the resources of Boeing or Airbus to weather a two- to three-year industry recovery from this crisis. It will, of course, also need cash desperately and to what extent and in what form the Brazilian federal government will help remains a big question.
Meanwhile, the competitive reasons Embraer fell into the arms of Boeing seemed apparent well before anyone but global health experts seriously considered the threat of a pandemic. While relatively stable over the past couple of years, regional jet sales haven’t shown much chance of returning to the boom times of the late 1990s and 2000s. Embraer, to its credit, stayed relevant by developing a next-generation E-Jet known as the E2, while Bombardier centered its efforts on a small five-abreast narrowbody that it managed to get to market without going bankrupt, but only barely and with significant help from the Canadian and Quebec provincial governments. Finding itself in a precarious financial position even with an airplane that by most accounts was technologically sound and highly regarded among airlines, Bombardier saw little choice but to give up control of the program to Airbus.
Analysts often assume the Bombardier-Airbus combination triggered the Embraer-Boeing talks because, the thinking goes, Embraer reached the conclusion that it couldn’t compete with the support network and pricing power Airbus brought to the C Series, since rebranded the A220. Nevertheless, Embraer Commercial Aircraft CEO John Slattery told AIN last September that the talks with Boeing actually started before Airbus announced its intention to take over the C Series. “Our transaction with Boeing was completely independent of that,” he insisted. “That being said, being pragmatic, it does add a sense of urgency to want to move on now with the transaction.”
Slattery’s admission of a newfound urgency brought about by the Airbus-Bombardier marriage meant that the A220 did, in fact, raise the stakes for Embraer. But it also suggests it wasn’t the main consideration. Perhaps the premium Boeing agreed to pay for Embraer, along with the $1.6 billion dividend payment to Embraer shareholders, sweetened the offer to the point that the Brazilian company could not refuse.
Both companies often promoted the “synergies” the deal would bring: the Embraer E-Jets would benefit from Boeing’s market reach and financial muscle while Boeing would gain access to what the Brazilians often touted as Embraer’s engineering expertise. Some, however, wondered how Boeing—one of the world’s most technologically advanced enterprises—could face a shortage of engineering expertise. It seemed more likely that Boeing coveted the access to cheap labor in Brazil, though neither company has explicitly said so.
Whatever the reasons for Boeing’s early interest in Embraer, the Brazilian company seems to have far more to lose than its U.S. counterpart from the collapse of the deal. Embraer spent untold man-hours in the so-called carve-out of the business, particularly as it related to IT systems and the moving of its business jet tooling and production out of Sao Jose dos Campos to Gavião Peixoto, where it manufactures the KC-390 military transport.
Meanwhile, the European Commission’s repeated pauses of its antitrust review of the Boeing-Embraer combination left the Brazilian company in the unenviable position of having to practice patience with the process while costs associated with preparations for the proposed merger mounted. In fact, Embraer suffered steep losses as it committed what Slattery called enormous resources to the effort. “There’s no doubt as this drags on there’s a cost associated with it,” he told AIN last November. “If you ask the customers, they don’t want this noise in the marketplace. They want clear visibility.”
Now, as if to add insult to injury, Boeing refuses to pay Embraer the $100 million termination penalty specified by the MTA in the event it exited the deal. Embraer has filed for arbitration and said it would pursue “all remedies” against Boeing for damages.
Despite the obvious costs associated with the collapse of the deal, Embraer put a brave face on its prospects for the future.
“Our history of over 50 years is lined with many victories but also some difficult moments,” it said in a statement. “All of them were overcome. And that’s exactly what we are going to do again: overcome these challenges with strength and determination.”