THE LATEST ITERATION OF EMBRAER’S E-JETS: THE E190-E2. ENTRY INTO SERVICE IN THE FIRST HALF OF 2018. PIC/SHUKOR YUSOF
Aviation

Boeing-Embraer tie-up: É melhor esperar sentado*

There is a steakhouse in downtown Seattle appropriately named The Grill from Ipanema and it serves caipirinhas to complement the exotic Brazilian dishes and the mesa de frios.

Apparently Brazilian fare is quite popular in that part of Washington state and our friends in Seattle (to paraphrase John Leahy) certainly seem to have acquired an appetite for Brazilian products, notably its airplanes.

On Dec. 21, 2017 The Wall Street Journal reported that Boeing was keen to buy Embraer, the Brazilian aerospace company and the world’s third biggest aircraft maker, for USD3.7 billion. Both companies confirmed the WSJ article.

Why is Boeing interested in Embraer?

Few people out here in Asia know Embraer (or have even heard of the company) but the São Paulo-based company is a top class aircraft manufacturer, particularly in regional planes (typically those with 70 to 120 seats). See our previous review of the company here.

Boeing’s sudden zest for Embraer clearly was sparked by Airbus’ acquisition of Bombardier’s CSeries aircraft programme, announced in October. The CSeries planes (CS100 and CS300) have gained considerable attention and praise for its efficiency and versatility. And yes, it is a cute little aircraft.

Go regional in 2018

Airlines in North America and Europe have embraced Embraer’s hardworking E-jets but demand for the Brazilian planes in Southeast Asia can be best described as lukewarm. It is actually quite poor. But then, ironically, the deployment of regional aircraft isn’t such a popular concept amongst Southeast Asian carriers who mostly opt for either Airbus or Boeing narrowbodies.

That is likely to change in 2018.

Some airlines have already had informal talks with Bombardier since its CSeries was adopted by Airbus, signaling a changing mindset. Embraer, too, is also making progress – in Northeast Asia – with Fuji Dream Airlines (Japan) and Korea Express Air (South Korea) both flying its planes.

But the regional market is extremely tough in Southeast Asia where many carriers would rather an A320 or a B737 instead of a CS100 or an E2 jet. However, with overcapacity and intense pricing competition, there’s every reason to believe an airline can make money using regional aircraft.

Amidst intense competition, right-sizing is critical. That means aircraft offering fewer seats could extract higher yields. Granted a bigger plane can generate higher overall profit but the number of seats sold at very low fares will cut the unit revenue. It’s all about yields: an aircraft with a high load factor do not necessarily equate to profitability.

Over-capacity is an issue in the industry and will continue to be in 2018. Imagine deploying a plane with the “right” capacity – this would ensure seat and revenue management are maximized leading to better yields. Of course this concept isn’t applicable to all airlines, but for several carriers (particularly in Southeast Asia), this could transform their cashflow.

Can the takeover succeed?

Unlikely. Brazil’s president Michel Temer has already voiced his disapproval. The Brazilian government has a golden share in Embraer and can use it to veto any attempts of a takeover.

Temer had planned to tour Southeast Asia in the week of Jan. 8, with planned state visits to Indonesia, East Timor, Singapore and Vietnam but has cancelled the trip following minor surgery late December. He was keen to, among others, peddle Embraer’s products (including its business jets, such as the Legacy 450 shown below), especially in Indonesia and Vietnam, two countries that are geographically perfect for regional planes (if the airlines there could only see the value).

Embraer Legacy 450
EMBRAER LEGACY 450. JACKIE CHAN HAS ONE… PIC/SHUKOR YUSOF

The market for planes in the 70-120 seat segment is small – perhaps 7% at most – but this is bound to rise significantly in the next decade (mostly in Asia) where demand for air travel is growing at a phenomenal pace.

If Boeing succeeds in the takeover, it would – just as Bombardier did by seceding its CSeries programme to Airbus – give the new E2 jets a further outreach (particularly in Asia, where Embraer is weak) and a solid marketing and branding supporting power. But that’s a big if

Even if a deal were to take place, Boeing likely won’t have full control of the Brazilian company. And Embraer isn’t as desperate as Bombardier was, when it gave 50.01% of the CS programme to Airbus for almost nothing.

Our view is that Brasilia will have a hard time telling Embraer’s management to spurn Boeing’s offer. That said, Boeing needs Embraer more than Embraer needs Boeing, following Airbus’ coup with the CSeries.

All things considered, the E2 programme will benefit under Boeing’s wings and with Brazil’s national debt (78% of GDP in 2016) growing rapidly, flogging Embraer to the Americans would bring in much needed greenbacks – not a bad deal given that the workers at São Jose dos Campos are paid in Brazilian real (BRL). But that’s only part of the issue here.

At the end of it, there probably will be no deal or at most, a mini-deal, where both will just upgrade their existing partnerships.

* It’ll take a while, if it ever gets done

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