A deal made in Heaven?
It was the knight in shining armour who saved the flailing damsel in distress.
Three weeks ago I explained why the US Commerce Department had threatened the Canadian aerospace group Bombardier Inc. (TSE:BBD) with swingeing tariffs of up to 300 percent that could torpedo its new generation of airliners. The order from top US airline Delta (NYSE:DAL) for at least 75 (and possibly up to 125) new Bombardier Series C jets – competitors to the Airbus A320 Neo and the Boeing 737 Max – was put in doubt. And with that, so was the future of Bombardier itself.
This had repercussions in Britain, home to Bombardier’s important production facility in Northern Ireland where it is one of the province’s largest private employers. Bombardier acquired the Belfast production unit in 1989 when it bought Shorts Brothers, then the oldest aircraft maker in the world.
Bombardier’s crime was to have stepped on the toes of the global airframe manufacturer duopoly that is Europe’s Airbus (FRA:AIR) and America’s Boeing (NYSE:BA). Also, as I explained, Washington thinks that Bombardier has been far too cosy with its Chinese counterparts who are planning to take on the global duopoly with their own aircraft manufacturer in due course.
Then, seemingly out of a clear blue sky, a deal was announced on 16 October between Airbus and Bombardier. By the terms of this deal Airbus will take a 50.1 percent stake in a subsidiary company that owns the Series C airliner and in return will provide production facilities within the USA at its own existing plant in Mobile, Alabama. Bombardier and Investissement Québec (a Canadian state agency) will retain the remaining 49.8 percent.
This way, Bombardier’s jets will be built within the USA and will therefore not be subject to any future tariffs that the Trump administration might dream up (NAFTA renegotiation or not – so long as more than 50 percent of its components are sourced from the US). Remarkably for a deal of this kind, not a cent changed hands – it was a cashless swap of technology in exchange for production rights and sales and marketing heft.
Airbus’s Mobile, Alabama plant is already used to manufacture the A320 range of commercial airliners – much to the chagrin of Boeing which has now been overtaken by the European giant in its own domestic market. I reported back in the July edition of the Master Investor magazine that Airbus has been planning to expand production in Mobile for some time.
Back in the UK, UNITE, Britain’s largest trade union, welcomed the new partnership and said the manufacture of wings for the C Series would remain in Belfast where 1,000 people out of total staff of over 4,000 are employed on the programme. “We have received assurances that this will mean that employment associated with the manufacture of C-Series wings will remain in Belfast,” said Davy Thompson, regional officer of Unite[i].
And yet, on 26 October the Daily Telegraph reported that Bombardier would be making 280 redundancies in Belfast[ii]. Supposedly, the redundancies will be amongst support staff rather than front-line engineers.
Whatever the strategic efficacy of the deal, Bombardier is still a company under severe financial pressure. Delays and cost overruns on the C Series resulted in the Province of Montreal taking a $1.5 billion stake in the business. Bombardier also recently lost out when Germany’s industrial giant Siemens AG (FRA:SIE) turned down the chance to merge their train rolling stock construction businesses with Bombardier, instead preferring to tie up with France’s Alstom SA (EPA:ALO).
Most commentators viewed the deal as a major coup for Airbus which takes control of the newest commercial airliner programme without having to pay a cent upfront. The agreement also strikes a blow against its US arch-rival Boeing, which has relentlessly pursued both Airbus and Bombardier through the US and international courts in recent years.
By taking the 108-160 seater C Series into its portfolio, Airbus will enhance its already dominant hold over the booming single-aisle airliner market, which analysts expect to account for more than 70 percent of commercial airliner orders over the next 20 years. Boeing may now be under pressure to ditch plans for a new twin-aisle aircraft in order to focus on responding to Airbus’s now extended single-aisle dominance. Its biggest seller in this segment is the 150 seater Boeing 737 Max 8.
Airbus effectively acquires an aircraft with a proven market, the developmental costs (reportedly $5 billion) and risks having already been absorbed. The company apparently thinks that the potential market for the C Series could be in the order of 6,000 units.
Whatever the strategic efficacy of the deal, Bombardier is still a company under severe financial pressure.
Boeing’s reaction was sanguine. Phil Musser, Boeing’s Head of Communications tweeted: “If Airbus and Bombardier think this will get them around the rules – think again…” We may be sure that Boeing will do its best to undermine the deal. Trade lawyers speculate that the deal may remain subject to litigation for years to come. It was revealed that Bombardier and Airbus had been in discussions since August – months before the punitive US tariffs were mooted.
Airbus is already facing increased regulatory scrutiny in the US. On Tuesday, (31 October) it admitted breaching US arms export regulations as a result of previously undeclared payments to middlemen. Similar breaches were revealed in the UK last year, resulting in an investigation that is still underway by the Serious Fraud Office.
Thus far, the tit-for-tat court cases about government subsidies brought by Boeing and Airbus against each other have been kept in check by the World Trade Organisation (WTO). The fear is, however, that if the Trump administration decides to renounce the WTO as a means of dispute resolution and resorts to unilateral anti-dumping and anti-subsidy duties, the dispute between the two duopolists could have serious consequences for US-EU trade.
According to some analysts, the deal is not entirely without cost to Airbus as it will have to scrap the Airbus 319 Neo jet which made its maiden flight in March. Regular passengers on EasyJet PLC (LON:EZJ) will no doubt be familiar with the A319, no sales of which have been booked for about four years. The unique selling point of the C Series is its remarkable fuel efficiency.
Moreover, the strategic re-emphasis on single aisle airliners makes the Airbus 380 Superjumbo look more exposed. This was a grand projet gone wrong – the aircraft is just too big to be economic and has had disappointing sales. The only major orders thus far have come from airlines like Emirates (private) and Qantas (ASX:QAN) which operate super-long-haul flights. In modern aviation it seems that small is beautiful.
In my July magazine article I explained that Britain still plays a key role in the production of Airbus’s airlines despite BAE Systems (BA.) having sold its 20 percent stake in Airbus for a song back in 2006. Airbus manufactures the wings at Broughton, Flintshire for the Airbus A320 and A321 short-haul workhorses, the A330 long-haul airliner and the new super fuel-efficient A350 as well as the A380 Superjumbo. That amounts to about 60 pairs of wings per month sustaining approximately 13,000 jobs.
There have been rumours circulating – no more than that – that Airbus could decide, in view of Brexit, to relocate all wing manufacture to its growing production hub in Alabama. One possible source of reassurance is that, in the event of a Hard Brexit, under WTO rules, aerospace components are exempt from tariffs (as I have mentioned before – a fact corroborated by insiders). Also, the cost of building a wing production facility would be formidable. And American labour rates would be much higher.
The closure of the Bombardier factory in Belfast would have been politically calamitous for Prime Minister May, especially as she relies on the support of ten Democratic Ulster Unionists to sustain her Government in the House of Commons. Fortunately, that seems to have been averted – for now at least. BAE Systems (BA.) announced 2,000 job losses on 10 October due to poor sales of the Eurofighter Typhoon jet. Any further major job losses in the aerospace sector could be politically disastrous for Mrs May’s fragile Government.
The Chinese are coming
The Chinese do not have their own commercial airliner manufacturers. Yet they can still claim to own the skies.
This week, it was reported by FlightGlobal that Chinese banks and lessors will control an estimated $261 billion of commercial aircraft leases by 2022 when they will control 35 percent of the global aircraft leasing market. That would be a seven-fold rise in 14 years.
It seems that the Chinese, flush with cash, regard the aircraft leasing sector as offering viable returns for a reasonable level of risk in a near zero interest rate world. To such an extent that Chinese money is depressing leasing rates – which is good news for airlines.
Meanwhile, IATA, the aviation trade body, forecast last week that China will overtake the US as the world’s largest aviation market by 2022. China already has more passenger and cargo airlines than any other country[iii].
Electric and self-flying aeroplanes
According to Aviation Week NASA is preparing to test a redesigned lithium-ion battery module for its first electric propulsion prototype, the X-57 Maxwell, in anticipation of a maiden flight in early 2018. But in the commercial airline sector it is Boeing that is planning an electric future. Also, EasyJet is forging ahead given its alliance with US designer Wright Electric (private).
On 05 October, Boeing announced that it would acquire Aurora Flight Sciences for an undisclosed sum. Boeing has set up Horizon X, a venture capital arm designed to invest in disruptive innovation. One of its first investments was in Zunum Aero, a start-up based in Kirkland, Washington that aims to develop the world’s first commercial hybrid electric-powered passenger aircraft. Zunum unveiled details of its planned 10-12 seater electric-powered aircraft which it aims to launch commercially by 2022.
Greg Hyslop, Boeing’s chief technology officer, told the Financial Times that Aurora’s expertise in self-flying planes would add value for Boeing. However, it would be some time he said before fully autonomous aircraft would be used in commercial flight. The nearer term gains would be in making aircraft smarter, safer and more efficient.
Zunum, whose investors include low-cost airline JetBlue (NASDAQ:JBLU) as well as Boeing, revealed cost estimates for its hybrid-powered aeroplane. The company, which aims to scale up to a 50-100 seater hybrid aircraft by 2030, is targeting a direct cost per available seat mile — a measure of efficiency used by airlines — of $0.08. Ashish Kumar, co-founder and CEO of Zunum, said the company’s engineers had taken a lesson from the car industry by combining electric propulsion with generators (operated by conventional engines) that would give the aircraft a range of up to 700 miles.
Some insiders are sceptical, however, about claims that hybrid aircraft will be cheaper to operate since they will still have gas turbines burning kerosene. The problem remains that the weight of batteries severely limits the range of electrically powered aircraft. I recently cast a sceptical light on the future of electric cars. Electric aircraft are an even greater challenge, though small short-range electric aircraft are likely to be with us soon.
On 02 November the Financial Times reported that Bombardier had signed a letter of intent with a European customer for up to 61 of its C Series regional jets in a deal that could be worth $4.8 billion.
On the same day Bombardier reported revenue of $3.8 billion in Q3 2017 – up by three percent from the same quarter last year. But net losses increased to $117 million (from $94 million) a year earlier. The group announced that it expected full-year 2017 EBIT to be at least $630 million. It claims to have made “solid progress” in its two-year turnaround plan. The company’s shares jumped by more than five percent and have now regained previous losses incurred this year.
I have heroically managed to write an article last Friday for aviation enthusiasts (like me) while mentioning the word “Brexit” only once. In my view, the proposed “trade deal” with Europe should be restricted to just three chapters – aerospace, automotive and finance. For these are the overwhelming economic interests that Britain must continue to safeguard. A no-deal on agriculture would be economically inconsequential – even if we might have to forego Prosecco and Camembert for some time.
In the same spirit, I’m long EasyJet and short RyanAir (LON:RYA). The latter’s Q3 2017 net income figure seems remarkable given recent reverses. I’d love to get a forensic accountant to trawl through their accounts. In the meantime: Sláinte!
[iii] See: List of airlines of China on Wikipedia at: https://en.wikipedia.org/wiki/List_of_airlines_of_China