What happened

Shares of Embraer (NYSE:ERJ) fell more than 12% on Monday morning after Boeing (NYSE:BA) walked away from a $4 billion deal to acquire a majority stake in Embraer's commercial aviation unit. Embraer has vowed to pursue damages against Boeing, but the termination is a major blow to the Brazilian company at a difficult time for aerospace manufacturers.

Boeing shares are under pressure, too. For now, shareholders should be glad Boeing walked away, but the long-term strategic rationale behind the deal was solid and Boeing will suffer from not having Embraer in-house.

So what

Boeing and Embraer in 2017 announced plans to combine their commercial units, with Embraer seeking a deeper-pocketed partner with a global sales force to help it sell its E2 small jet line and Boeing eager to fill a hole in its product lineup via the E2 jet. But a lot has changed since that deal was announced.

Shares of Boeing and Embraer have plunged in 2020 due to the COVID-19 pandemic, with demand for air travel all but evaporating and airlines scrambling to cut costs. That is likely to mean fewer new plane sales for the foreseeable future, a blow to both Boeing and Embraer.

Embraer's E195-E2 on the runway.

Image source: Embraer.

Had Boeing proceeded with the original deal and paid $4.2 billion for an 80% stake in Embraer's commercial unit, it would have paid more than four times Embraer's current total market capitalization. Boeing instead announced on Saturday that the two sides were unable to meet all the conditions needed to finalize the deal by an April 24 deadline, and that it had exercised its right to terminate the agreement.

"It is deeply disappointing. But we have reached a point where continued negotiation within the framework of the MTA [master transaction agreement] is not going to resolve the outstanding issues," Boeing exec Marc Allen said in a statement.

Embraer responded that it "believes strongly that Boeing has wrongfully terminated the MTA, that it has manufactured false claims as a pretext to seek to avoid its commitments to close the transaction and pay Embraer the $4.2 billion purchase price."

The company said it "will pursue all remedies against Boeing for the damages incurred," setting up what's bound to be a long, drawn-out arbitration process.

Now what

It's understandable that Boeing, which is facing significant difficulties on its own, didn't want to commit to the deal in this environment. But the termination leaves Embraer in a difficult spot. The company's shares had been down 70% year to date even with the deal still pending, and they are now under further pressure as Embraer is forced to figure out how to go it alone.

The E2 is an attractive aircraft, and airlines are likely to be more interested in smaller jets than large ones until traffic returns. But Embraer will have to market it on its own against the A220, a better-established aircraft backed by Airbus' global sales force.

It is hard to make deals work in volatile markets, but both companies are weaker in the long term because Boeing walked away.