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:: November 2002 Newsletter ::

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Dear Fellow Aluminum Tube Inhabitants,

Seen the new McDonald’s ad? They’ve got Donald Trump, praising the business acumen of an unseen pal, later revealed to be none other than Grimace, the long-forgotten McDonaldland character. “Together, Grimace, we could own this town,” Trump says to the innocent purple blob, who has apparently masterminded a new, cut-price sandwich. The ads started to appear around the time of Airbus’s easyJet victory, and it was a quick mental transition to imagine Trump’s place in the ad taken by Airbus’s John Leahy. Indeed, $1 cheeseburgers and $25 million A319s pack a powerfully competitive, if somewhat deflationary, wallop.

The easyJet win inevitably started a debate on whether or not the deal was a money loser. Airbus executives said it was a profitable, cash-positive deal. Pretty much everyone else (including some easyJet folks) regarded it as a cut-price, must-win fire sale. But from my standpoint, it really doesn’t matter. Airbus is an efficient builder of superb planes. I’ll give them the benefit of the doubt on this one, and call it cash neutral. What does matter is what this deal says about the next three years.

The jetliner market, by any metric, is imploding. This is no V-shaped recession. Airbus’s prediction of 300 deliveries in 2003 may well be right, but unless the airlines make a miraculous recovery, 2004 and 2005 will be grim indeed. And much of the volume will be termite-dry deals to predatory discount carriers, like that easyJet sale, or will involve heavy levels of risky manufacturer finance.

The rest of EADS seems like a subsidiary of Airbus. Hopes for the company’s defense sector growth have been dashed. Eurofighter and its Meteor armament have hit heavy turbulence. A400M has become the aviation equivalent of phone sex—lots of talk, no action. Germany’s old/new Schroeder Government takes an almost perverse pleasure in not spending on defense, maintaining an aggressively passive foreign policy. France is ramping up its defense budget (while basically telling the EU budget overseers to go to hell), but much of this goes to non-EADS suppliers (more Rafales, another carrier, etc). EADS has long-term hopes for access to the US defense market, but this will take time, and is unlikely to bear much fruit by the crucial 2003-2005 timeframe.

In short, Airbus’s profits are headed south, and the rest of EADS does not look set to take up the slack, at least for the next few years. They are basically in the same boat as Boeing—Airbus’s jetliner market share may be growing, but Boeing has a healthier defense side. What puts the European company in a different place, however, is its little A380 problem. EADS, like Boeing, can easily tread water through the current horrible market environment. But finding $1.5 billion or more per year to spend on A380 development? That’s an almost impossible task, even with one-third of the cost covered by European government loans, and even with EADS’s current low debt. Not surprisingly, EADS share price has dropped by about a third this year. Of course, this means little when only 30.8% is actually in public play (see www.finance.eads.net/efaq.html).

What will happen? Chances are that the current legal government support for Airbus will be supplanted by a torrent of direct support. Matter of fact, I think the A380 could suck up European government cash faster than McDonaldland’s Hamburglar sucks up hamburgers. Certainly, this is the way things seem to be headed in Europe. According to Teal Group proprietary research (well, okay, according to an October 17 Wall Street Journal article), the European Commission is increasingly sympathetic to EU-based corporations requesting subsidies. The Commission approved an impressive 93% of such cases between 1998 and 2000. Total EU state aid is hovering around $80 billion annually, which makes any A380 bailout look like chump change (although the lack of any bailout funds for Fairchild Dornier and Cargolifter implies that there are limits to this largesse).

It’s generally difficult to tell what equities markets are thinking. They aren’t monolithic organic beasts, but they do reflect a zeitgeist, a feeling about where things are headed. After the easyJet order, EADS’s stock price sent uncertain signals—down at first, then recovering, and rising. If I had to put a story to those numbers, I’d say investors at first reacted negatively, thinking the deal must be unprofitable. But within a few hours, perhaps, they thought about the ramifications. Airbus is growing its market share in bad times, and has established itself in the low-cost market. It is also spending heavily on new product development. If the company can pull off these ambitious achievements in bad times, what could possibly stop them? Investors, perhaps, felt that the money would be provided, somehow, and that EADS was a safe, if not necessarily profitable, bet.

Can the US challenge Europe over these coming subsidies? That’s the real question. The Bush Administration has fully embraced Big Government statism, spending heavily on agriculture, steel, and other industries (to say nothing of airlines). The EU, remarkably, has said little about this—both sides seem to be tolerating each other’s excesses. So, thanks to President Bush’s weirdly socialist impulses, if the time comes to fight a long-awaited trade war over Airbus and the A380, the American trade complaint arsenal will be quite bare. The US will have to either match Europe in industrial policy, or cede more of the field.

Onceuponatime, I made the prediction that the odds were against Airbus launching the A380, largely because government industrial support looked set to be a thing of the past. As Evelyn Waugh once said, “history has not followed what then seemed its natural course.” I’ll soon be proven definitively wrong. In three years, Airbus officials, including the smiling purple Grimace, will look on proudly as the first A380 rolls out. Any doubts about my A380 questions, or anyone else’s, will be laid to rest, largely thanks to government cash. But please, don’t confuse this Concorde-like outcome with real market capitalism.

What’s new? This supplement includes a new, relatively positive A380 update—after all, unless Boeing does something, the Airbus plane looks set to be alone on the market. We’ve also updated the EH 101, NH 90, Lynx, King Air, F-2, TBM 700, and others. Get in touch with any requests, and enjoy the leaves turning.

Yours, ‘Til Reality Intrudes,

Richard Aboulafia
(703) 385-1992 ext. 103 (office)
raboulafia@tealgroup.com
www.richardaboulafia.com

 

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