No More Free Money for Boeing

Warning: Today's column is going to wax a bit wonkish. If you're not exactly a detail-oriented Fool, you might want to skip right past the next few paragraphs, proceed to the takeaway about Boeing (NYSE: BA  ) , and move on to the rest of your day's reading material.

On Tuesday, the governments of Brazil, Britain, Canada, France, Germany, Spain, and the U.S. hammered out an agreement on the rules for export financing of aircraft. (Remember -- you were warned about potential dryness.) Why is this important? Well, take a stroll with me down memory lane, to January 2010, when we were discussing the advent of Bombardier's new CSeries 100-seat commercial jet up in Canada.

Without going into too much detail, Bombardier's new jet was coming to market at an advantageous time. Boeing and Airbus had just agreed to restrictions on the amount of export financing their home governments could provide to foreign airlines buying their planes. Because such financing generally came at below-market rates, it benefitted both the airlines (which paid less for their planes) and also the plane builders. The only losers in this game were the taxpayers, who picked up the tab for the subsidies.

(Actually, not everyone would agree that taxpayers were the only losers. Airlines domiciled in the same countries as the plane builders, such as United Continental (NYSE: UAL  ) , Delta (NYSE: DAL  ) , and AMR (NYSE: AMR  ) in the U.S., all say these subsidies hurt them by providing less expensive planes to foreign rivals such as Ryanair (Nasdaq: RYAAY  ) in Ireland. Then again, they could always buy their planes from Europe's Airbus ...)

The biggest winners
As I say, subsidies help plane makers. Of course, companies like General Electric (NYSE: GE  ) , which build jet engines, also benefit from any trend that tends to make it easier to ink plane-sales contracts. But the biggest beneficiaries of the export financing restrictions were new plane makers like Bombardier, Sukhoi in Russia, Mitsubishi Heavy in Japan, and SAIC in China. None of these guys were covered by the Boeing-Airbus detente, and so they were allowed to sell their planes even cheaper than the big boys.

As you can imagine, this is a pretty sticky issue. Boeing, Airbus, and their home governments have been haggling over a new deal for years; they finally concluded negotiations this week. Subject to final approval from the governments involved, premiums charged to airlines that receive export financing are set to nearly double. Your average investment-grade airline is going to have to pony up a minimum 8% premium to secure financing for its foreign airplane purchases going forward.

What's this mean for Boeing?
Essentially, the agreement hashed out in Paris is going to reduce the size of subsidies governments can give their airplane builders, to the detriment of Boeing and Airbus. Now, there's good news, too. Under the new regime, smaller builders like Bombardier and Embraer (NYSE: ERJ  ) in Brazil get their subsidies restricted as well. So out the cockpit window goes their built-in pricing advantage.

Further good news comes from the fact that Boeing and Airbus were able to twist arms and get part of their backlogged orders grandfathered into the old subsidy regime. Seeing as Boeing and Airbus have built up a seven-year backlog of planes -- while Bombardier, SAIC, et al, are only just beginning to market their jets -- this would appear to confer a pricing advantage on the incumbent airplane oligopoly. Up to 69 planes per builder can be sold to foreign buyers under the ultra-lax, pre-2007 subsidy system. Plus, any planes Boeing and Airbus manage to deliver from their backlog between now and the end of 2012, which were sold under more favorable subsidy rules, can be delivered at the lower prices.

Problem is, this last bit of "good news" is also bad news. Now, you may not be aware of this (it really hasn't gotten much press), but Boeing has run into a few hiccups in the production of its marquee 787 Dreamliner aircraft. Its latest snafu has some analysts saying deliveries of backlogged 787s could be delayed by another 12 months. And since the first planes were most recently slated for delivery in early 2011, that would push the actual delivery date off well into 2012. The very year in which the U.S. government begins waving "buh-bye" and ushering cheap financing for such planes out the door.

Foolish takeaway
In short, negotiations in Paris have handed Boeing an advantage over newer entrants to the plane-building game -- but it's an advantage with an expiration date. The faster Boeing gets its 787 production line up and running, the more profits it can reap. One more major delay in deliveries, and Boeing may lose much it stood to gain from this deal.

Embraer is a Motley Fool Stock Advisor pick, but Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.

Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On December 23, 2010, at 12:05 PM, FBEditorial wrote:

    The CSeries is a big an industry joke as the market is for the A380 (and notwithstanding the chaos on the 787).

    http://www.fleetbuzzeditorial.com/2010/12/16/over-to-you/

    Bombardier is stuck with a truly failed product. The 787s saving grace is its gamechanging featueres while Europe will die propping up disaster that is the A380.

    The Cseries has no such luck and will remain a failed product like it has been during its 6 long years while its been on sale with a pathetic 90 orders and no launch customer to deliver to (as Lufthansa refuses point blank to be the first).

  • Report this Comment On December 23, 2010, at 7:29 PM, baldheadeddork wrote:

    Pretty much what Fleetbuzz said. The C-Series was designed to be the best commuter jet ever. Unfortunately for Bombardier, that market disappeared three years ago when oil went over $100. No one in the airline business believes its going to be possible to make money on <150 seat aircraft over the next decade because of fuel prices. Sales for all commuter jets have fallen off a cliff, and orders for new planes like the C-Series have gone to the 737/A320 instead.

    About the 787...the delays aren't good but they aren't going to be a game changer in the long run, either. The key story on Airbus and Boeing is about financial strength and the development cycle.

    Boeing is going to have to pay a lot in penalties to early 787 customers, but it's going to be a minor cost when you look at the financial health of the company as a whole. Boeing is in pretty good shape. The development costs of the 787 and 747-8 are almost totally behind it, and it has a fat book of 737, 777, and 787 orders to fill the years ahead.

    Airbus is in a different situation. Because sales have vastly underperformed expectations there are still billions of unpaid development costs for the A380. That plane is probably never going to make money for Airbus. The A400M military transport has been a fiscal disaster, too. Airbus has years of A320 and A330 orders on its books. But the cost overruns on A380 and A400M development have left EADS strapped for cash when they're just entering the most expensive phase of development for the A350.

    Even if everything goes perfectly in the A350 development (it won't, but let's pretend) Airbus is going to be strapped for cash at least through 2015. If they run into the same level of problems with the A350 that they had with the A380 and A400M (and Boeing had with the 787), this could wipe out EADS profits for most of the decade.

    All of this is prelude to the real battle that will unfold beginning in a couple of years - the next generation of the 737 and A320. Airbus has committed to refitting the existing A320 design with new, high-efficiency engines from Pratt and Whitney, but it doesn't have a choice. Airlines want improved efficiency from narrow bodies by the end of the decade. Putting new engines on the A320 is the only thing Airbus can do before 2020 because they don't have the money.

    Boeing is in a much stronger position. Once the 747-8 and 787 are certified (and it will happen in 2011), their development plate is clean. They've got the rest of the decade to spend on an all-new narrowbody, or a heavily massaged 737 that also uses new geared turbofan engines.

    Either way, they are going to have the resources and time to come up with a plane that has clear advantages over the A320 "Neo". And if they can do that, it's game over. Project fuel prices out to 2020 and the smallest advantage in efficiency between two planes is going to have massive effects on operating costs. If one narrow body becomes dominant, the other company won't be able to survive.

  • Report this Comment On December 23, 2010, at 7:41 PM, TheDumbMoney wrote:

    Two comments:

    1) "...but it's an advantage with an expiration date." Not really true. Boeing is still selling 777s, and has a backlog of over 200 orders. I'm sure the 69 planes applies to that, or to the 737, though they're less costly/subsidized. No?

    2) @bald, I love your comment, except that the EU will never let Airbus go under. What this will amount to is a tax on French and German growth, and some WTO fights in my less-educated opinion. What do you think?

  • Report this Comment On December 23, 2010, at 10:51 PM, baldheadeddork wrote:

    I don't think EADS is going to go under. But if they aren't competitive in narrow bodies they're going to stagnate and probably fade over a decade or two. If the past is any guide they would eventually be bought by someone else, maybe a Russian or Asian company the way the world is going.

    Would the EU pump money into EADS if Boeing gets a clear lead? A couple of years ago I would have bet on it, but looking at the sovereign debt crises and the bill that's being handed to the EU countries who are in good shape, now I'm not so sure. How much water can Germany bail? I think if it got to that point they'd be much more interested in finding an eastern partner with lots of money to put in legally, or close to it.

    But remember, EADS money problems are only half of the picture. Even if money wasn't an issue, Boeing is going to have at least a 2-3 year head start on their next narrow body. Airbus is still claiming that the A350 will enter service in 2013, but if they only miss it by a year I'll be impressed.

    One important note about my little hypothesis: Building a 737 that is clearly better than the A320 Neo is not a sure thing, even with Boeing's advantages. Boeing has already said the composite construction used for the 787 would not scale down to a 737-class plane. They could investigate other composite construction methods, but after the birthing problems with the 787 I don't know how much appetite they have for reinventing the wheel one more time. And cost is a much more sensitive issue in this class.

    My SWAG says that Boeing will split between an update and a brand-new plane. New wing with a lot of composites, but still using aluminum in the fuselage and a lot of carry over from the 737NG.

    (Note on my earlier post: I neglected to mention the CFM engine entry in the A320neo and 737x. I'm sure Fleet Buzz editorial didn't. I've been a reader of his blog for a couple of years, it's a great resource.)

  • Report this Comment On January 13, 2011, at 11:21 PM, globalex wrote:

    Bombardier will succeed with the C series while Boeing and Airbus squander all their resources on their floundering failures of the 787 and A380. Airlines want efficiency and the C series delivers. Boeing will not re-engine so they are out. Airbus will re-engine, but the aircraft will get left behind. There is a new player and Bombardier is it. Get on board or get left standing at the gate.

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