Boeing goes Brazilian?

Is Boeing set to buy Embraer? The two companies confirmed today that discussions are ongoing after the Wall Street Journal first broke the story.

Just as the duopoly looked like it might be crumbling Boeing hatches plans for Embraer https://t.co/R6jbsmc6Sm after Airbus moved on Bombardier https://t.co/0z5oEHxtgZ

— Robert Wall (@R_Wall) December 21, 2017

The motivation for such a deal looks somewhat obvious given the recent Bombardier CSeries/Airbus news but there are a number of ways in which the Boeing/Embraer play is different. And there are enough of them that it might prevent the deal from happening at all.

For starters, Boeing seems keen to pick up all of the Embraer portfolio, not just a small segment. Such a deal would give Boeing the ability to sell planes from 50 seats up through 400+, a wider range than Airbus will have with the CSeries acquisition. But there’s a lot more to Embraer than just the commercial jets. The company also is sitting on a relatively high share price valuation and spectacularly close ties to US government regulators these days. It is unlikely that any deal would face significant scrutiny from that angle.

The military side of the Embraer product line is significant and tightly tied to the Brazilian Air Force. The KC-390 military freighter, for example, was largely bankrolled by the Brazilian military, helping to cover the $5bn in development costs without leaving the company on the hook for those expenses. Also, it seems unlikely the government is going to give that away.

Read More: Airbus picks up CSeries

While Embraer is a publicly traded company the Brazilian government still owns a “golden share” in the operation. That allows Brazil’s president to veto any transaction deemed not in the government’s best interests. And while the government is reported as “surprised” by the announcement this afternoon the response from the president is less surprising. He indicated to Defense officials that Embraer would not be sold on his watch.

After rumors floated two months ago an Embraer acquisition, this is how Boeing CEO Muilenburg replied on the Q3 earnings call. https://t.co/QE9orhasI2 pic.twitter.com/E1i82JsZGF

— Steve Trimble (@TheDEWLine) December 21, 2017

That Boeing is now pursuing the merger comes as something of a surprise given that two months ago CEO Dennis Muilenberg suggested in an earnings call that efforts to “accelerate our core business, grow organically” would be the primary drive. Then again, admitting in an earnings call that secret merger discussions are ongoing usually doesn’t work so well either.

Beyond just the military implications of such a deal there is also a pride consideration for the Brazilians. Embraer is the country’s third largest exporter and generally seen as a bright spot in privatization of industry in an otherwise rocky few decades of economic instability for the nation. It is hard to underestimate the negative impact on a politician for allowing that to be “given away” to a foreign company, regardless of the purchase price paid. This thread on Twitter explains that angle well:

And…..2018 is a presidential election year in Brazil. How many candidates will run on the platform of "let's sell Embraer to the gringos!" Answer: Zero.

— Gabriel Elizondo (@elizondogabriel) December 21, 2017

Finally, there are questions about just what such a purchase would really deliver to Boeing. Even if only the commercial aircraft side was included the 70-120 seat market is one that Boeing historically scoffed at. The E195-E2 would compete with the CS100 in many ways (though shorter range) but still leaves a decent gap between that and the 737 MAX 8. The MAX 7 was supposed to fill that gap and maybe it still does, but Boeing also decided 18 months ago to make it larger, not smaller, further skewing the positioning of the product line in the market.

Of course, the ability to consolidate market share, lay off a few thousand folks in accounting and HR and marketing, squeeze suppliers further and then return those savings to investors is hard to ignore. And undoubtedly that’s what gets the investment community excited about these mergers. But that doesn’t always mean they’re a smart fit.