RichardAboulafia.com 

:: January 2015 Letter ::

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Dear Fellow Paused Program Mourners,

Forecasting an aircraft death is sad work. Each zeroed production line tells a tragic story of jobs lost, lives changed, and, of course, dead aircraft. Worse, there can be a contagion effect; killing one program can lead to deaths elsewhere (and benefits for competitors). Case in point: this month’s Learjet 85 death. It has a much greater meaning.

First, Bombardier’s statement about the late Learjet was as egregious as I’ve seen in this business. They blamed a weak market, just as the market is picking up. For an industry whose health depends on customer confidence, calling the market “weak” is just bad corporate citizenship. The company also called its Lear 85 move a “pause” (“Kids, the vet had to pause the family dog.”). But you don’t fire 1,000 people and write off $1.4 billion for a “pause.” The 85 is clearly dead.

To an extent, you could blame the corpse. Composite business aircraft have a troubled past – the Starship, Hawker 4000, and Premier One were all disasters. Predictably, the 85 was suffering from serious delays and cost overruns. Also, the 85 was rather close in price and capabilities to BBD’s Challenger 300/350, making it somewhat disposable. Yet healthy companies don’t kill programs that are this far along in development. Ergo, BBD is not a healthy company.

BBD’s financials tell a more compelling explanation for the 85’s “pause.” Thanks to the cost of developing the CSeries jetliners, BBD’s total liquidity has dropped from $4.8 billion in 4Q 2013 to $3.3 billion in 3Q 2014. BBD Aerospace free cash flow has been burning at -$1.2 billion per year. These losses had been partly offset by BBD Transportation, but that unit has turned negative too, burning away $370 million in 3Q2014.

BBD says it has $2.4 billion in cash and cash-equivalent assets, and that this is enough to bring the CSeries to market. Unfortunately, in 2013, BBD issued $2 billion of unsecured senior notes with $750 million due in January 2016. There is another $900 million of debt due in 2016. BBD will need go to capital markets in 2016 or possibly sooner. Debt will be very expensive, and equity markets unforgiving.

With the CSeries still burning through cash, the Lear 85 simply needed to die. It may have been a deeply troubled program, but even if it weren’t, it would probably be killed anyway. The company needs to save money everywhere it can. Also this month, BBD sold its Military Aviation Training business to CAE.

BBD’s Business Aircraft illustrates this need to cut everything other than CSeries. Unlike Commercial Aircraft, BBD Business Aircraft has a great product line, and until 2013 it enjoyed the number one market position. Yet it heavily depends on new product development money to remain competitive. It needed a fast response to Gulfstream’s ultra-high-end G650, but the cash wasn’t there for a fast response. The Global 7000/8000 development schedule generously gives Gulfstream five years alone on the market (if, that is, nothing goes wrong with 7000/8000 funding or the program).

BBD’s slow response to the G650 allowed Gulfstream to grab the top business aircraft market spot from BBD in 2013 (and in 2014). Now, the Lear 85 disaster shows that BBD Business Aircraft’s problem is getting worse (see my June 2005 letter for a letter predicting a negative impact on this unit from the CSeries launch…I got it right, although it wasn’t exactly a tough call). BBD will likely never reclaim its number one business aircraft market position.

The BBD Business Aircraft story raises another issue. When we lower or zero product forecasts, competitors often benefit. In addition to Gulfstream and its 650, there are also these winners:

Embraer business jets. Killing the Lear 85 is a big plus for Embraer’s Legacy 450/500, which is just arriving (they don’t see the market as weak). The 85’s demise helps Cessna’s Latitude/Sovereign too.

Embraer commercial jets. BBD’s neglect of the CRJ family has been a huge plus for Embraer too, as the E-Jet/E2 series has taken BBD’s position as top regional jet player.

ATR turboprops. BBD’s Dash 8Q turboprop, starved for sales and development resources, has been barely surviving. Its rival, ATR, took 160 orders and 120 options in 2014.

Embraer, Gulfstream, and ATR are BBD’s biggest competitors, and the biggest beneficiaries of BBD’s quixotic CSeries gamble. And this BBD product line carnage leads us back to the CSeries itself. Given its problems (two years late so far, well over $1 billion in cost overruns) we wonder whether BBD’s grim financials imply that we need to zero Teal’s CSeries forecast. This is one of the bigger calls we might make in 2015.

What could save the CSeries if BBD’s cash problems threaten the new jetliner’s existence? There’s the possibility of massive amounts of Canadian federal and Quebec aid, which would be controversial and contentious.

The alternative is China. For years, I’d dismissed the possibility of Comac acquiring BBD Commercial Aircraft, because China simply doesn’t pay for other people’s IP (more in my July 2012 letter). Yet my friend Kevin Michaels, one of the smartest guys in this industry, points out that if things get desperate, BBD could be compelled to sell Commercial Aircraft at a very low price. Comac is the only entity that could absorb the risk and expense of running this unit. While they might not want the CSeries, they’d learn lots about Western jetliner certification.

If they sold Commercial Aircraft at a very heavy discount, BBD would take a huge and painful write-off, but after that they’d be able to focus on businesses with respectable 10% profit margins. Kevin calls this the “Combardier” scenario. It’s one of the weirder possible wild cards in our industry.

Here’s to a year without too many weird wild cards, or too many zeroed forecasts. Teal Group’s January Aircraft Binder reports include the World Aircraft Overview, the World Fighter overview, plus updates of the Gripen, AW 101, S-92, ERJ 145, MiG-29, Superjet, E-6, and the C-212. Have a great month.

Yours, ‘Til ConcordeNeo Enters Service,
Richard Aboulafia
 

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  ~  Last updated on January 08, 2006