RichardAboulafia.com 

:: April 2002 Newsletter ::

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Dear Fellow Laptop Haulers,

Funny thing about our usually lovable industry. While cuddly on the outside, it’s really a monstrous, cash-sucking beast. If you are an investor, for $100 million you can dig yourself a hole. For $500 million you can dig yourself a considerably larger hole. To do anything of consequence in the aerospace world takes billions. This capital-intensiveness scares most would-be backers away from new programs and companies. Fun and scary fact: Since 1960, only one all-new company, Embraer, has been created and succeeded in delivering more than one jet per month. The odds are really stacked against the little guy.

This is why the current horrors at Fairchild Dornier really shouldn’t be all that shocking. I didn’t see it coming, but that’s probably because I was too embarrassed about being wrong when I predicted the new entity would never find the backing to start the whole process. Of course, FD isn’t an all-new company. The two names are among the proudest in aviation. But their purpose in life as a new entity was to create a new family of large regional jets, the 528/728/928. This is a tremendously ambitious undertaking. So ambitious that it made all of their previous programs look like small fry. So ambitious, in fact, that it might just prove unattainable.

From the start, this was a high-cost venture. FD bet that passenger comfort would sell the plane, which is never a good bet in this industry (on a list of all their concerns, airlines generally rank passenger comfort about 115th, just after keeping toner in the Xerox machines). That 3-2 fuselage is comfy, but it costs more to fly through the air than the narrower ones. It also made the 50-seat version, the 528, a non-starter (it would have resembled a winged beer can). The death of the 428JET meant that FD abandoned the entire 40/60-seat market to the other guys. And given negligible progress between airline labor and management on scope clauses, the action in the RJ market looked set to stay in that 40/60-seat zone for years to come.

Nothing else about the company was skinflint, either. FD decided to keep a lot of manufacturing work in Germany, never known as a country with low manufacturing costs. It quickly acquired lots of talent, presumably at considerable expense. Guys with good names—Harrington, Eccleston, Stangarone, Stiley, just to name a few—gave the outfit a lot of respect. “Who cares if this industry is going to hell in a handbasket?” you could almost hear yourself think, “Fairchild Dornier is hiring like mad.” No one else in recent times, except perhaps LockMart’s JSF unit, has had so much confidence.

Anyway, FD is now sucking $50 million per month, and new aircraft program costs typically increase quickly in the certification and first production phases (which are theoretically imminent). What’s strange is that FD’s main investors, Clayton, Dubilier & Rice and Allianz Capital Partners, are not known for their shallow pockets. Perhaps the most horrible thing about Allianz and CDR’s move is that it implies hopelessness. It implies that they greatly underestimated the cost of developing the new jets, and greatly overestimated the likelihood of finding a buyer. Indeed, it implies that they’ve been searching unsuccessfully for a strategic investor for quite some time, and while they have the cash to continue funding FD on their own, they simply do not want to throw good money after bad.

So, am I writing an epitaph here? I wish I knew. It doesn’t look good. Some of those good people are being axed (another sign of despair). 328JET wing production is being halted in San Antonio (declining 328JET revenues, partly due to a capricious Chinese decision to deny Hainan Airlines an import license, have been another source of trouble). On the positive side, the new jets would be attractive products (Lufthansa has emphasized its commitment to acquiring them), and this bankruptcy process would lower the cost of acquiring FD. Yet if Allianz and CDR won’t fund FD without a strategic partner, then who will be the White Knight?

For a time, Boeing was mentioned as the likely rescuer. After all, when passengers start to flee DC-9s and 737s for large RJ service, Boeing would lose business if they didn’t have a large RJ product (the doomed 717 notwithstanding). But Boeing got burned by that whole De Havilland Canada thing in the 1980s, and seems to have concluded that pricing in this sector is going to remain wretched. Also, Bombardier has been considered a possible savior. After all, the 928 could be stretched into a fine replacement for the company’s shelved BRJ-X proposal, and Bombardier has a history of acquiring troubled aircraft companies at fire sale prices (DHC, Learjet, Shorts). But the CRJ-700/900 would need to die, and Bombardier has always had a low-cost RJ market position. Of course, both of these current non-suitors, and others, might change their minds as the price drops (again, bankruptcy does that to prices).

I guess I’d better wait for more information, with an eye on a May update of the FD reports. “But I just updated these reports!” I call out in my whiny voice. No one listens. And when I think about it, I guess I should count my blessings.

And speaking of counted blessings, the big beneficiaries of FD’s troubles (and the BAE RJX’s death) are Embraer and Bombardier. The latter company has had its low-cost derivative RJ philosophy heartily endorsed. They may even get Lufthansa back as a client. As for the Brazilians, they would have the only new large RJ family in the business. Ironically, though, their customer base revolves around Crossair/Swiss, which is certainly weaker than Lufthansa.

As for this supplement, it updates a batch of European fighters, including Eurofighter, Gripen, and Mirage 2000. It also updates the 737, Challenger/Global Express, V-22, T-45, EA-6B, Bell 206 family, EC 135, and the hapless Let 410/610. And in May, in addition to the FD reports, I’ll update the Business Jet overview, the A300/310, C-130, Hawk, P-3, and many others. Stay tuned. And thanks for reading.

Yours, Rooting For The Underdog,

Richard Aboulafia
 

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