Shares in Embraer SA (ADR) (NYSE: ERJ), got a nice lift Thursday from the announcement that the Brazilian aircraft manufacturer was in discussions with Boeing Co (NYSE: BA) for a “possible combination.”
Embraer closed at $ 24.42, up 22.16%, after trading a huge volume of 16.91 shares.
As of writing today, ERJ has gained another 2.42% and is trading at $ 25.01.
Embraer SA (ADR) (NYSE: ERJ) In Boeing’s Crosshairs
Boeing has made deal overtures to Embraer in the past but regulatory issues and the Brazilian government’s right to an overriding veto (a so-called “golden share”) have brought these discussions to nought.
Attractive to Boeing has been Embraer’s presence in the market for smaller, regional haul jets, a sector in which Boeing is underrepresented given its focus on large aircraft suitable for long haul routes.
Boeing has perhaps been driven to make yet another attempt to forge a deal with Embraer after arch-rival Airbus SE (EPA: AIR) recently clinched an alliance with Bombardier, Inc. (TSE: BBD.A), a Canadian manufacturer of smaller jets.
Airbus paid just $1 to acquire a controlling stake in Bombardier’s struggling CSeries of jets which was developed over decades and cost $4.8 billion. In return, the deal breathed life into the marketing of the critically praised planes, and helped Bombardier’s defence in a trade dispute raised by Boeing – by having the jets assembled at Alabama, U.S., and thereby avoiding crippling import tariffs.
The revival of the CSeries likely sounded the alarms at Boeing, which now found itself staring at serious competition against its 737 MAX line of aircraft. Likewise at Embraer, which is hoping to launch its new E190-E2 jet next year, and could do without a born-again rival in the CSeries.
According to media speculation, this deal perhaps was instrumental in driving Boeing and Embraer into each other’s arms, with the resulting favourable impact on the price of Embraer’s shares.
Embraer SA (ADR) (NYSE: ERJ): Could the Share Bounty Disappear
Boeing-Embraer is not a done deal yet, because the old bogey of approval from the Brazilian government has not gone away. For Brazil, Embraer is a showpiece of its industrial development, and the government will be unwilling to sign off control on the plane maker, though it may be amenable to other commercial arrangements that would protect it from new found competition, and realize product optimization or cost savings. Embraer is the world’s third largest maker of commercial aircraft.
It might also be attracted by the likelihood of a large premium that Boeing may pay over and above Embraer’s current market cap of $3.7 billion, provided it received simultaneous guarantees regarding the future of its employees and brand. Of course, Embraer would also benefit immensely from Boeing’s marketing muscle.
Brazilian President Michel Temer too has reportedly negatived a sale of Embraer, though he may support partnerships or an injection of capital into the Brazilian company. A senior official clarified today that the Brazilian government has layed no role so far in the deal talks between Embraer and Boeing, saying “the golden share can only be used during official decision-making, which is not now the case.” However, Embraer shares have not shown any weakness due to this news.
If the deal falls through, Embraer shares may correct back to the levels they have being languishing at after the company’s recent Q3 earnings report.
Embraer SA (ADR) (NYSE: ERJ) May Welcome a Capital Injection
Embraer has been facing difficult business conditions in its executive jet and defence units, primarily because of an oversupply of business jets and an economic slowdown in the country. Revenues at the company’s Commercial Aviation segment decreased 8.7%, the Executive Jets segment witnessed a decline of 27.3%, and the same at the Defense & Security segment plunged 43.3% year over year.
In its forecast for 2018, which it called a “transition year,” the company warned that its profits would take a hit due to a sizable decline in deliveries out of its commercial aircraft division, as well as low margins on the new E190-E2 planes launching in that year.
Embraer expects to earn $5.3 billion – $6 billion of revenue and an operating profit of $265 million – $360 million next year, down from projected revenue of $5.7 billion – $6.1 billion and an operating profit of at least $450 million in 2017.
On the marketing front, the company must improve its order inflow for the new E2 line so that it lines up annual delivery of at least 100 commercial jets in the coming years. Here, a tie-up with Boeing would be a boon.
Embraer SA (ADR) (NYSE: ERJ) Investors Should Hold
It’s a no-brainer that Boeing and Embraer would have anticipated the regulatory hurdles, hence they probably have a deal in mind that they are confident would pass muster the scrutiny of the Brazilian government.
The airplane industry battle lines are about to be redrawn, and investors should stay invested to reap the benefits of consolidation.
Images: Embraer website