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Forging a Giant -- Will Boeing Be Blocked?
by Jim Surowiecki (Surowiecki)

NEW YORK, NEW YORK (July 2, 1997) - The global economy, BOEING CO. (NYSE: BA) is discovering, can be a very complicated place. While it can be relied upon to generate enormous profits -- especially for companies, like Boeing, that prosper as the world becomes more and more interconnected -- it can also offer previously unknown problems.

Take, as a prime example, the trouble Boeing is facing from the European Union (EU). Even as the company cleared one hurdle in its attempt to consummate its proposed $14 billion purchase of McDONNELL DOUGLAS (NYSE: MD) by gaining approval of the deal from the Federal Trade Commission yesterday, it now faces an even higher one: getting similar approval from the EU.

Boeing is already the world's largest seller of commercial aircraft, and last year it won almost 80% of new jet orders. McDonnell Douglas was once among Boeing's fiercest competitors, but in recent years it has seen its share of the commercial market shrink even as its commanding presence in the military and aerospace markets has come under serious attack.

For McDonnell Douglas the merger has obvious advantages. For Boeing, the deal offers the possibility of establishing dominance in the defense industry as well as the commercial market. The new Boeing-MD colossus would have $48 billion in sales in 1998, would own more than 65% of the current jet airliner market, and its products would account for more than 80% of jets flying today. It would face only one real competitor in the commercial airliner business: Airbus Industrie, the conglomerate that is jointly owned -- and subsidized -- by companies from Germany, France, Britain, and Spain.

As expected, the Federal Trade Commission gave unconditional approval to the merger on Tuesday. The FTC decided that the acquisition would not "substantially lessen" competition in either the commercial or defense industries. The disappearance of McDonnell Douglas from the market for commercial aircraft would not have much near-term effect, as in 1996 it won just 4% of new jet orders. Although some commercial airlines told the FTC that the presence of Douglas Aircraft helped restrain Boeing's prices, when the agency talked to possible buyers of the unit about its viability as a competitor to Boeing and Airbus, no one expressed any real interest. Indeed, four of the five commissioners issued a statement saying that there was nothing Douglas could do that would change its "grim prospect[s]."

At the same time, the Department of Defense told the FTC that there are no significant military jet contracts coming up in the next five years for which Boeing and McDonnell Douglas would be expected to compete. That was apparently evidence enough for the commission.

Boeing itself has become so dominant in the U.S. market that further acquisitions are deemed to have little impact on its competitive standing. In addition, the FTC appears to be using its now-familiar distinction between global and domestic markets in evaluating the deal. While the merger between STAPLES (Nasdaq: STPLS) and OFFICE DEPOT (NYSE:) was blocked because of the potential impact on American consumer prices, other deals -- including the RAYTHEON (NYSE: RTN) acquisitionof HUGHES ELECTRONICS' (NYSE: GMH) defense operations -- have been approved as substantial competition would still exist in the world market, even if the relative number of American players shrunk.

Yet this news is not all good for Boeing. Indeed, the very global context that has made the FTC more likely to approve the merger may wind up being a crucial obstacle to the McDonnell Douglas acquisition. Over the past two weeks, the European Competition Commission, a division of the European Union administrative authority, has been scrutinizing the merger, and all indications are that it is unhappy with what it sees.

In mid-June, commission head Karel Van Miert publicly warned Boeing and McDonnell Douglas that they should have no doubts about the commission's willingness to block the deal if its concerns were not answered. And Dow Jones reported today that sources within the EU suggest that the commission is leaning against approval.

The commission's major concern is the sole-supplier deals that Boeing has signed in recent months with AMERICAN AIRLINES (NYSE: AMR), DELTA AIRLINES (NYSE: DAL), and CONTINENTAL (NYSE: CAI). Under the terms of the deals, the airlines committed themselves to buying planes only from Boeing for the next twenty years. In exchange, they received favorable pricing. Boeing has orders from the three carriers for 244 planes, worth $16.9 billion, while the carriers also have purchase options for another 1,300 jets.

While the sole-supplier accords, which the EU has described as the clearest sign that Boeing is attempting to use its clout to seal off competition, are the commission's main worry, it has also pointed to the beneficial effects on Boeing R&D of McDonnell Douglas' military work, as well some ill-defined impact in the area of "patents and licensing" because of McDonnell Douglas' experience in the defense industry.

On the one hand, much of this seems somewhat obvious. Clearly, Boeing believes that the acquisition of McDonnell Douglas will make it a stronger company, that it will improve its competitive posture, and that it will have a beneficial effect on various aspects of the way it does business. If it didn't think these things, it wouldn't be spending $14 billion to acquire McDonnell Douglas. On the other hand, the EU's concerns about the antitrust implications of the deal also seem very real.

One of the interesting aspects of the EU commission's investigation of the deal is that its concerns seem to center more around the deal's impact on Airbus than the deal's impact on consumers. In part, that stems from the fact that the consumers of Boeing's products are, for the most part, large corporations, and that the consequences for individuals are therefore indirect. It also stems from the EU's desire to ensure that Airbus remains a player in the global market.

In response to the commission's concerns, Boeing filed proposed remedies with the EU Monday night, beating the midnight deadline. Although the actual details of the proposals were not released, Boeing told Reuters that the remedies addressed all three areas about which the commission had raised questions: sole-supplier accords; dominance of commercial customer base; and R&D spill-over effects.

One option that Boeing has apparently considered, according to the Wall Street Journal, is dropping the exclusive supplier deals in order to win EU approval. In exchange for the go-ahead, Boeing would free the commercial carriers from the exclusivity requirement, holding on to the current 244 firm orders but allowing Airbus to compete for new orders. For the carriers, this would be a very sweet deal, since they would reap the benefits of favorable pricing without the costs of long-term exclusivity. And if it would gain the merger EU approval, it would probably be in Boeing's interest, as well.

The commission is required by EU law to investigate all mergers involving companies with global revenues above $6.6 billion and European revenues of $280 million. A law passed in 1990 allows the commission to block mergers completely if antitrust concerns are not met. Were the EU to block the deal, Boeing and McDonnell Douglas could conceivably merge anyway, since they are chartered in the U.S., but if they did, their contracts would have no legal standing in European courts, and the EU Commission would be authorized to fine them up to 10% of their revenue, which would come to almost $5 billion a year. In addition, it's not clear that Boeing jets would be allowed access to European markets. For the first time in recent memory, then, the fate of a merger between two American companies depends upon what a European commission decides.

The special antitrust committee is scheduled to make its recommendation by Friday, July 4, while the commission as a whole will make a final decision on July 23. Investors, buoyed by the FTC's approval, appear to be betting that the deal will go ahead. And it does seem hard to imagine that a deal of this magnitude would be blocked. The rules of the global economy, though, are still in the process of being shaped, and at this point there are still no guarantees.

Now, tell us what you think.

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McDonnell Douglas Message Board


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