MIAMI — Earlier today, the Wall Street Journal confirmed widespread reports that Boeing had held takeover discussions with Brazilian aircraft manufacturer Embraer, contemplating a deal that would value Embraer at a substantial premium to its current $3.7 billion market valuation. The potential merger would give Boeing a product lineup stretching from roughly 80 (the Embraer E175-E2) to 400 (the Boeing 777-9X) seats and would allow the Chicago-based carrier to compete more effectively with the Airbus after the latter purchased Bombardier’s financially troubled CSeries program.
Brazilian government approval is the major sticking point
According to the WSJ’s report, the major sticking point with the merger surrounds approval from the Brazilian government, which holds so-called golden shares that allow it to have veto power over major corporate transactions. Given that Boeing dwarfs Embraer in revenue (it’s roughly 20 times larger) and production, the Brazilian government may be worried about Boeing consolidating or closing factories in Brazil proper. Boeing may have to make substantial concessions to the Brazilian government, including production rate guarantees and local commitments to factories in Brazil.
Like the Bombardier – Airbus deal, a Boeing takeover makes sense for both sides
For Embraer itself, while it is not facing the same kind of financial challenges as Bombardier, the premium from Boeing should be more than enough to convince shareholders. Moreover, Embraer has faced non-trivial sales challenges with its re-engined E-Jets E2 family. The family only has 233 firm orders with less than four months until its entry into service (EIS) with Wideroe in April 2018.
Before Embraer won 30 new commitments for the E190-E2 and E195-E2 at the Paris Air Show this summer, it had only sold 8 E-Jets since the summer of 2015. Meanwhile, the CSeries is already at 360 total orders and now has the might of the Airbus sales engine behind it.
Because the E-Jets are a touch smaller than the CSeries family (the E195-E2 seats roughly ten fewer passengers than the CS300) and because the 737 MAX 8 is 10-12 seats larger than the Airbus A320neo, they don’t fit as neatly into the Boeing product lineup as the CSeries family did with Airbus. There is roughly a 45 seat gap between the E195-E2 and the 737 MAX 8, whereas the gap between the CS300 and the A320neo is a more manageable 20.
But Boeing can still now go out into the market and pitch a unified product family which now becomes a competitive ante with Airbus doing the same in every narrowbody contest. Boeing will be paying several billion dollars for Embraer as an asset, but Embraer is a profitable and financially sustainable company. Moreover, the elevated combined sales pitch with Boeing and the lower supplier costs that Boeing can enable via its heft should push up gross margins and profitability further.
Boeing does not get the same kind of technical benefits as Airbus
While the CSeries is one of the most technically advanced products on the market today, the E-Jets E2 are a mere re-engining of a more mature platform. There also isn’t much potential to stretch the E195-E2 which means that unlike Airbus, Boeing likely can’t use the E2 family as the base for it’s future narrowbody offering alongside the middle of market (MoM) plane currently under development.
The news of this deal makes the CSeries tariff fight even weirder
The fact Boeing has its sights set on Embraer makes its continued efforts to slap a tariff on CSeries imports into the United States even more confusing. Embraer’s E-Jets are all produced in Sao Jose dos Campos, Brazil, which means that they would be imported into the US to fulfill orders with any American customers like regional carrier SkyWest, who accounts for nearly half of the E2’s order book with 100 firm orders for the E175-E2. If the CSeries is slapped with a tariff, then Boeing cannot credibly import the E2 family for American buyers, which kneecaps this deal in one of the most important markets for small mainline jets and the most important market for regional jets bar none.
Boeing still has to solve the Embraer E175-E2’s scope clause issue
Still, for the Embraer deal to truly pay off for Boeing, it must resolve the very real scope clause challenges faced by the Embraer sales team, as the US market is the most important to service the deal. The E175 is optimized to seat roughly 85 passengers, but based on most US scope clauses, mainline carriers like United can only outsource flying up to 76 seats. But even more worrisome is the fact that the E175 as currently constructed is too heavy for the weight limits in those scope clauses. Given the negotiating power of US airline pilots right now, scope clause relief for a larger regional jet is not a likely outcome. And the net result puts close to half the E2 order book at risk and necessitates a costly re-design to strip weight out of the E175-E2.