If you want to make headlines, then announcing a 150-plane contract is a darn good way to do it. It's a nice round number. It's big. Everything about it sounds important -- but the most important thing of all is that Boeing (NYSE:BA) not do this deal.
The news at 10 (billion)
The news broke late last night: UAL (NASDAQ:UAUA) subsidiary United Airlines wants to spiff up its air fleet with a batch of shiny new rides. And seeing as there are only two manufacturers with the savvy to build the kinds of aircraft United needs, this will turn into a winner-take-all financial cage match between the two contenders, Boeing and Airbus. Up to 150 planes to be bought. An order of at least $10 billion for the winner. Make your best offer or suffer the consequences.
United's game...
The advantages of the deal for United are clear. While rival airlines like AMR's (NYSE:AMR) American, Delta (NYSE:DAL) and Continental (NYSE:CAL) were busy ordering planes during the strong market that prevailed in recent years, United sat out the buying spree. Now, with the recession in full swing, customers canceling orders, and investors nervous, United strikes while the iron a-glowin' -- hoping to win the very best prices Boeing and Airbus can offer.
It will do this in two ways. First, Boeing and Airbus will be played one-against-the-other, asked to offer their best prices (natch). But the second prong of the deal is the one where the plane-makers will really need to hang their hats: debt-laden, unprofitable, and cash-burning United will demand favorable credit terms from its would-be suppliers, as well as the right to wiggle out of its orders should it need (read "any time it wants") to.
... and why Boeing should refuse to play
Let me put this plainly: This is a bad deal. Boeing shouldn't bite. Why not? Well, mainly because it doesn't need to. Although Boeing certainly has "issues" with its order book, the company's still sitting pretty on some $350 billion in backlogged work. While another $10 billion would be nice, Boeing doesn't need it.
What's more, after the beating Boeing's profits took last year, and the critical status this have left its cash reserves in, Boeing would be crazy to cut profit margins any further, or grant loose financing terms just to land a sale it doesn't, strictly speaking, need.
Crazy like a fox
Boeing should respond in kind -- by being crazy like a fox. Let's take a look at a few other numbers to see how Boeing can come out of this game a winner, no matter what. Last year, a series of crippling labor disputes helped dunk the operating profit margin at Boeing's commercial division to less than 4.2%. Airbus, in contrast, emerged from a multiyear funk to earn a 6.4% margin on its planes. As things now stand, Boeing can ill-afford to sacrifice profits to win new business. It must earn reasonable profits on its sales, and cannot afford to accede to United's terms.
Interestingly though, if you draw back a bit in how you view Boeing and Airbus, the situation reverses itself. Boeing's uber-profitable defense business helps to balance out the weak commercial side of things, whereas EADS (Airbus's parent company) depends primarily on its commercial sales to counterbalance an anemic defense unit.
What all this means is that right here, right now, EADS relies very heavily on its commercial sales to shore up the company's overall health. Boeing, in contrast, might actually do better by limiting commercial sales while business, and profit margins, are weak. Thus, EADS is the more "motivated seller" by far. To my mind, this also means that Boeing can use its own weakness, and its opponent's commercial momentum, to its advantage.
Commercial judo
How? By putting up just enough of a fight for United's business to send EADS/Airbus tumbling into a deep, dark hole.
Once upon a time, a little company by the name of Garmin (NASDAQ:GRMN) faced a mirror image of the dilemma now facing Boeing. Dependant on a product with few suppliers (maps), Garmin was at risk of being squeezed out of its own market for GPS devices when Nokia (NYSE:NOK) bought its key supplier, and its archrival GPS-maker, TomTom, bid for the only other game in town (Tele Atlas).
Garmin countered by bidding for Tele Atlas in its own right, forcing TomTom to overpay to win the auction. Garmin didn't "win" the auction. But today, Garmin's netting more than 19% on its sales, while poor, luckless TomTom is booking losses.
Foolish takeaway
If Boeing's managers are smart, they'll learn from Garmin's lesson. Sometimes, a battle just isn't worth winning. Sometimes, the best deal is the one you walk away from.
What's worse than losing a sale? Losing a labor dispute. Read all about it in:
