Boeing and Embraer expect to close their deal-making over commercial and defense aircraft joint ventures by the end of the year, they said Feb. 26, after Embraer shareholders approved the proposals.
Two-thirds of Embraer’s shareholders voted in an extraordinary meeting at Embraer’s headquarters in Brazil, with nearly 99% of voters backing Boeing’s 80% takeover of Embraer’s commercial business, as well as a 49-51% JV to market Embraer’s KC-390. Embraer’s board already approved the deals, and critically, Brazil’s president announced last month he would not block it.
"Our shareholders have recognized the benefits of partnering with Boeing in commercial aviation and the promotion of the multi-mission airlift KC-390, as well as understanding the opportunities that exist in the executive aviation and defense business," said Nelson Salgado, Embraer executive vice president of finance and investor relations.
"Approval by Embraer's shareholders is an important step forward as we make progress on bringing together our two great aerospace companies,” said Dennis Muilenburg, Boeing chairman, CEO and president. “This strategic global partnership will build on Boeing's and Embraer's long history of collaboration, benefit our customers and accelerate our future growth.”
The companies did not comment on the third of Embraer voters who did not vote in the general meeting. There have been several lawsuits filed in Brazil in efforts to stop the commercial deal, at least, but many of them have been dismissed at procedural points.
In December, the companies finalized terms of their deals, which were announced last summer but rumored all year. As part, Boeing will pay Embraer $4.2 billion for the commercial JV.
Financial analysts have hailed the deals as signature savvy acquisitions by Boeing, but they continue to fret it will leave Embraer’s, Brazilian marquee airplane maker, with a weaker financial profile for the near future.
“If the transaction is completed as proposed, Embraer's business will be narrowed to its executive jet and defense units, which have lower margins and higher volatility than the commercial aviation division,” said S&P Global Ratings.
Moody’s Investors Service concured. In February report they warn that Embraer's so-called corporate family rating could be downgraded if its liquidity and leverage are worse than previously expected as a consequence of a weaker business model or less conservative financial policies.
In turn, both rating agencies have marked Embraer’s current debt for a potential negative downgrade.
“An upgrade on Embraer's CFR is unlikely in the medium term. Over a longer-term horizon, the rating could be upgraded if the company is able to improve margins in the executive aviation business and the KC-390 JV is successful in leveraging the new aircraft sales,” Moody’s said.
Still, both credit raters note the sales are not all bad for Embraer. For starters, Embraer’s commercial prospects are likely to brighten under Boeing’s prowess, and thus boosting returns for Embraer from its 20% stake. Embraer Further is likely to pocket about $3.1 billion net from the commercial sale. And, the military joint venture could generate “synergies” of about $50 million per year for Embraer, including equipment procurement, according to the analysts.
But what is left of Embraer may be more challenged as a standalone business. “Although the transaction will bolster Embraer's leverage metrics and generate an annual dividend stream from the JV, we view potential downside impact to Embraer's credit quality in more than one notch because the spin-off will considerably weaken the company's business risk profile,” S&P says. “This is mainly due to a smaller scale and rise in client concentration at its defense division, in addition to higher earnings volatility and the need to improve profitability of its executive jet division.”
The commercial JV is expected to have assets of $3.5 billion against liabilities of just $1.4 billion, with an equity value of $2.1 billion, according to Jefferies analyst Sheila Kahyaoglu.
She and other analysts have noted how the deal is certainly more positive for Boeing but will take time to prov out for Embraer. “The transaction complements Boeing’s narrowbody portfolio and allows for opportunity to cross-sell to its customer base (more than 25 customer overlap),” she said. “From a strategic standpoint it provides an opportunity to offer 70-200 seat jets to the market, a more diverse offering than the Airbus/Bombardier partnership that starts at 110 seats.”
But at the same time, the newfound dependence on bizjets for Embraer come as the outlook remains weaker. “Looking to 2019, Embraer’s revenue estimate of $5.3-5.7 billion is disappointing since it includes 85-95 commercial aircraft (no surprise) but only 90-110 bizjets – down from prior 2018 target of 105-125 planes despite the likely catch up from 2018's slip,” said Cowen and Co. analyst Cai von Rumohr.
At a Jan. 16 investor briefing, Embraer executives tried to sway analysts that the deal still made sense. According to von Rumohr, they argued the combination of the planned $1.6 billion commercial dividend to shareholders, $1 billion in net cash at new Embraer, and the option to sell Embraer’s remaining 20% interest in the commercial venture were worth around $20 a share. In a way, it suggests investors are getting the bizjet and defense businesses "for free" even though it could have substantial value.
That may be so, but investors will want to see more. “We agree with their math but are skeptical whether investors will pay a large premium over current market until visibility is in better focus,” von Rumohr said.