RichardAboulafia.com 

:: May 2016 Letter ::

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Dear Fellow Toronto Property Shoppers,

Crow. Humble pie. Ten years of Teal Group CSeries commentaries and reports. These are among the things that Bombardier management could have reasonably requested that I eat for lunch during my recent visit to Montreal. But CEO Alain Bellemare and company were exceedingly nice. The waiter brought a plate of tasty salmon. The conversation was friendly.

I went to make peace over the CSeries. The situation has changed with the Delta order, and I need to clarify my new outlook on the program. Also, I need to make nice with the Canadians, before the US November election. The Maple Leaf H-1B visa equivalent may be easier to get if Ottawa views me as friendly to their national jet. So I went. Here’s my report.

First, Bellemare (who I knew from his UTC days) acknowledged the obvious: that this whole thing could have gone the other way. Until Bellemare and a completely new team took over last year, all of those Teal reports I wrote and studies I led were correct. The CSeries was heading nowhere. Even when the new team took over, their success was far from preordained. By last September, when Bombardier pursued a somewhat desperate deal with Airbus, I thought the CSeries would fail. With the Delta order, it now seems that it might just thrive.

Let’s do a post mortem on the CSeries’ survival (according to The Google, Latin for post-survival is post superessendam). The first thing the new team recognized was that it was all about cash. While the previous team remained in blithe denial about both the financial realities of the company and the program, and about the need to get aggressive in pricing, the new team went all in. They focused on reinforcing the balance sheet, facing up to unpleasant realities (writing off $3.2 billion in development costs, cutting Global 5000/6000 production, etc.), and got what they could from whichever Canadian government agencies (particularly in Québec province) would invest money in BBD.

For years, old management denied the need to aggressively discount CSeries prices. As a result, few airlines were willing to sign for an unproven aircraft, particularly since Airbus and Boeing were willing to be aggressive themselves. So, the order book was a joke (two of the three biggest CSeries customers – Ilyushin Finance and Republic – were fictitious). New management recognized this and went back to Delta with an offer that should have been made years ago. Bellemare also hired many seasoned aviation professionals, thereby ending the previous management’s curious experiment with hiring random people (insurance agents, accordion salesmen, etc.) to run an aircraft company. Bellemare is quick to give his team most of the credit for restoring the CSeries’ hopes.

The team is confident, but also aware that they’re not out of the woods yet. There are still many risks, and most revolve around money. Anticipated cash burn, Bombardier’s financial position, and the CSeries production ramp-up plan don’t leave much margin for error. In fact, since I wrote a reconsideration of the CSeries in Aviation Week (tinyurl.com/zl9t69y) I’ve heard from many program critics who still believe this program will fail.

Predictably, Airbus’s John Leahy is also critical, saying he “heard” Bombardier sold the jets to Delta for $22 million each and will lose $7 million on each. “Probably by selling it faster they'll put the company out of business faster,” he told Aviation Week. His disparagement reflects an unpleasant reality: there’s very little margin in company resources to get to 90-120 CSeries deliveries per year in 2020, and the program won’t turn cash-positive until that point. Production costs for the ~300 jets planned for delivery over the next five years could be higher than expected. The Delta order helped drive a $500 million “onerous contract provision” planned for BBD’s second quarter results.

Additional Canadian government funding is one possible answer. While a requested $1 billion investment from Ottawa has not materialized, there is the implicit availability of backstop financing, which by itself may be useful. But then there’s also the risk of one or more trade complaints resulting from all this public assistance. With considerable government cash aiding the CSeries, its competitors are aggrieved. But the WTO has little history of getting countries to change their ways when it comes to aircraft support schemes (that Airbus-Boeing thing from 12 years ago is stuck somewhere in the appeals process today).

And what, realistically, can the aggrieved parties do? Boeing is angry, but the US (and Boeing) may be reluctant to annoy Canada’s government, which will soon buy ~65 fighters (perhaps from Boeing, and if not, from Lockheed Martin). Airbus is angry, but the EU, France, and Germany have been curiously quiet on the subject, and may be busy with other matters. Embraer is angry, but Brazil doesn’t technically have a government right now, so filing a trade complaint would be problematic.

There are other risks. I’ve just returned from EBACE in Geneva, where the large cabin OEMs seemed ready to throw themselves into Geneva’s eponymous lake. The big profit drivers at Bombardier, high end Globals and Challenger 650s, are threatened by this grim market. Will this year’s Global production rates – down by over 25% from last year – go even lower?

With all these risks, why has Teal Group raised its CSeries production forecast, and why do I think they’ll pull through? The CSeries has always been a good jet. But for the first time, this good jet is now in the hands of smart professionals who can sell it and bring it to market. The Delta deal is proof that they can do it.

I departed Montreal in a temporal conundrum. Over the past ten years, I said the CSeries was a value-destroying program heading towards possible failure. At the time, I was right. In the past 10 months, when I said it was doomed to failure, I was wrong. In the present, I feel right in saying that the CSeries has a pretty good chance at success. In the future, the past me may have been right all along. Or the present me may stay right.

Teal Aircraft Binder updates this month include the Regional Aircraft market overview, plus the 737/P-8, V-22, E-2, CH-53, Hawk, P-3, T-6/PC-9/PC-21, and ATR reports. Have a great month.

Yours, ‘Til President Sanders Gets A CS300 As Air Force One,
Richard Aboulafia
 

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