LONDON — Earlier today at the Farnborough Airshow, newly minted Embraer CEO Paulo Cesar de Souza e Silva fired a shot across rival Bombardier’s bow, calling into question an equity infusion received by Bombardier from the government of Quebec.
Said $1 billion equity infusion was finalized back in June, and is widely credited with saving the troubled Montreal-based manufacturer.
After the equity infusion was promised late last year, the then struggling CSeries hit an incredible hot streak, winning program-validating orders from Air Canada and Delta Air Lines for several dozen CSeries.
As a result, the CSeries has surged far ahead of the EJets-E2 in term of credible firm orders. And with the CS100 scheduled for its first revenue flight later this week and the CS300 coasting towards entry into service (EIS), Embraer finds itself in an unfamiliar position, that of the veritable underdog.
Thus it is no surprise that Cesar struck an aggressive tone against Bombardier at Farnborough this year, though few could have predicted just how far he went with his comments:
“I don’t believe Bombardier is able to raise equity in the public market. That’s why the government of Quebec helped out. We are very concerned about their subsidies. Immediately after the Delta and Air Canada orders, they are taking money from the Canadian tax payer in order to provide aircraft at below cost. It is a huge market disruption and we are disappointed at them… We are looking into it. There is a mechanism with WTO. We need the specifics on their transactions. The Brazilian government is worried about the situation. It’s still early to say what will be the next step. But Embraer will take measures.”
Case depends on whether state aid “directly” enabled discounting
In essence, Cesar has more or less declared war against Bombardier, with the World Trade Organization’s (WTO) rules and regulations as their battlefield.
While Cesar’s questioning of Bombardier so soon after the Canadian manufacturer’s resuscitation may seem like sour grapes, it is hard not to fault the perception that Bombardier was the beneficiary of unfair state aid.
The smoking gun, as it were for the Brazilian manufacturer is the $500 million cash charge that Bombardier had to take in the first quarter of 2016 due to aggressive discounting of the CSeries for orders won this year.
Our market intelligence indicates that both airlines paid less than $30 million per frame for their respective orders, well below Bombardier’s actual cost of producing the CSeries.
Now in and of itself, selling an aircraft below the cost of production does not violate WTO or any sort of competitive rules.
In fact early in a clean sheet aerospace program’s lifetime, every single airframe will be sold at a loss as Boeing is currently experiencing with the 787 and Airbus with the A350.
Even aggressive discounting to win market share, alternately dubbed undercutting or dumping depending on who you ask, is actually kosher under WTO rules, meaning that Boeing’s massive discount of 737-700s bound for United somehow did not break any sort of anti-competitive rule.
So in theory, Bombardier was well within its bounds to offer the kinds of discounts it did to Air Canada and Delta.
The question for Bombardier (and Embraer) is whether those discounts were only viable due to the promised equity infusion from the Canadian government.
Because the WTO does in fact regulate a company’s ability to utilize state aid in offering discounts, there may well be a case that Bombardier, which was on the brink of financial insolvency would not have been able to aggressively discount the CSeries without the assistance of the Quebec government.
WTO cases rarely have clean resolution
Embraer’s rhetoric appears dead serious, and with the EJets-E2 having failed to capture the public consciousness, the question is how they will proceed. A WTO case is almost assured, though many expect Bombardier to launch a competition case investigating Embraer’s own circumstances in Brazil.
As with the battle between Boeing and Airbus in the last decade, there is no clear answer as to which side is at fault.
Even though the promises of the Quebec government in backing the CSeries likely emboldened subsequent customers, no money technically changed hands until after the firm orders in question were place, which may or not be a viable defense.
There is simply no smoking gun. Instead, Embraer is likely to be frustrated by the same kind of uneven result that plagued both Boeing and Airbus in their WTO wars this last decade.