Can This Fighter Jet Contract Save Airbus Defense?

By Markets Fool.com


Lockheed Martin's F-35. Soon to become the most advanced, fifth-generation fighter jet in Korea's air force. Photo: Lockheed Martin

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Korea wants to build a fighter jet.

No, not the fighter jet you see up above, the F-35 Lightning II stealth fighter. That one they're buying from Lockheed Martin . But rather than continue buying fighter jets from abroad, what Korea really wants to do is build one of its own -- or even better, 120 of its own.

And two teams of companies want to help them do that.

Introducing the contestants
Last year, Korea announced an $8 billion program to build its own homegrown fighter jet, a warplane that will replace its aging fleet of F-4 Phantoms and F-5 Tigers (built by predecessors to Boeing and Northrop Grumman , respectively).

Two local companies, Korean Air and Korea Aerospace Industries, are vying for the contract. Each has brought in a foreign partner, specializing in fighter jets, to help with the technology. KAI is teaming with longtime partner Lockheed Martin. Last week, Korean Air announced it will be joining with Europe's Airbus to field a bid.

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No winner will be named before July of this year, but things already don't look great for the Korean Air-Airbus team. Experts warn that the Eurofighter Typhoon, which Airbus helped build, differs too much from the swept-wing design that Korea favors.


Eurofighter's Typhoon shows its soft underbelly. Photo: Wikimedia Commons

Meanwhile, the KAI-Lockheed team already has a track record building fighter jets for Korea, having built the T-50 Golden Eagle -- Korea's first supersonic aircraft -- back in 2002.


Korean F-4s fade into the background. Photo: Wikimedia Commons

But while Airbus seems to have little chance of winning the new fighter competition -- it could have quite a lot to lose.

Newsflash: Fighter jets are expensive
According to media reports, developing Korea's new fighter jet could easily cost the winning team between $10 billion and $30 billion. That seems like an awful lot of money for Airbus to want to invest, just to win a contract worth only $8 billion.

What's more, raising the cash to develop a new fighter jet won't be easy. Airbus partner Korean Air is basically broke. S&P Capital IQ data shows Korean Air having $13.7 billion more debt than cash on its balance sheet, and $235 million in losses racked up over the past four quarters reported on its income statement.

Airbus itself is a little better off, showing a net cash balance, and positive earnings of $2.5 billion. The company's cash-flow statement, however, suggests those earnings may not be worth much more than the paper they're printed on -- because actual free cash flow at Airbus last year was a mere $15.5 million.

In short, Airbus brings little financial strength to the alliance with Korean Air. But by tying up with them on this project, Airbus could easily be dragged down by Korean Air.

So, why is Airbus doing this at all?

Necessity makes strange bedfellows ... in Korea
Simply put, Airbus doesn't have choice. Much like what we've seen at Boeing, while Airbus'civilian business is booming, its defense business is withering on the vine.

Eurofighter (in which Airbus owns a sizable stake) just lost a 60-plane, $9.8 billion contract to sell the United Arab Emirates its Typhoon fourth-generation fighter jet. And with no other big projects to replace that lost sale, Typhoon production is now expected to shut down by 2020.


Source:Eurofighter

Airbus' combined Defense and Space businesses make up more than 21% of the company's revenue stream, but they already produce only 10% of Airbus' operating profit. (By way of comparison, Boeing's three defense, space, and security divisions together make up 34% of that company's revenue stream -- but made up 42% of Boeing's profits last year.)

And with defense sales dwindling, new orders received at Airbus D&S in 2014 were just 7% of all orders taken in by the company as a whole last year. So, already small and under-profitable today, Airbus' defense business is only getting more so.

Things are so bad at Airbus Defense that the company has even made noises about doing the unthinkable -- tying up with Boeing to build new fighter jets. Asked about the possibility late last year, Airbus Executive Vice President for Military Aircraft Domingo Urena Raso reportedly replied, "Why not?"

What all this means for investors
Priced at just 20 times earnings, and expected by many analysts to grow these earnings at 18% annually over the next five years, Airbus shares look like a decent bargain -- on the surface. But the health of Airbus' civilian airplanes business is masking some deep problems in Airbus' defense business.

Now, maybe that defense business calls into question the analysts' optimistic earnings estimates. Maybe it simply prevents the company as a whole from growing as fast as it might sans-defense. Either way, the fact that Airbus is even considering teaming up to build fighter jets with Boeing, its arch rival in civilian airliners, tells you just how desperate Airbus must be to salvage its dying defense business. Viewed in this context, Airbus' willingness to invest tens of billions of dollars in an effort to build less than $10 billion worth of fighter jets for Korea doesn't seem out of character at all. Clearly Airbus is out of options and must throw a Hail Mary -- hoping to catch a break in Korea.

They'd better pray hard, though. Because if this one fails, Airbus could soon be out of the defense business altogether.


In addition to helping build Eurofighter's Typhoons, Airbus also builds a handful of military transports and refueling aircraft -- and this PZL-130 Orlik training turboprop. For now. Photo: Airbus

The article Can This Fighter Jet Contract Save Airbus Defense? originally appeared on Fool.com.

Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 299 out of more than 75,000 rated members.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.