Around midyear, Boeing (NYSE: BA) and Embraer (NYSE: ERJ) reached a preliminary deal for the U.S. aerospace giant to acquire an 80% stake in Embraer's commercial aviation business. The deal is strategically important for Boeing, which wants to be able to provide end-to-end solutions for airlines' fleets. It is even more vital for Embraer, which is struggling to stay relevant in an industry dominated by Boeing and Airbus.
However, the two aerospace companies got a scare last week, after a federal judge in Brazil issued an order temporarily blocking Embraer from signing any deal with Boeing. Fortunately, that ruling was reversed on appeal on Monday, removing this obstacle to finalizing an agreement.
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Negotiations have been ongoing
While it has been more than five months since Boeing and Embraer announced their plans for this strategic partnership, the two companies have continued to negotiate key terms of the agreement. Indeed, when the proposed deal was first announced, the amount of Embraer's debt that would be assumed by the new commercial aviation joint venture had not yet been settled.
Embraer's management indicated in late October that it would likely sign a binding agreement with Boeing in December. (It's possible that the timeline has shifted since then.) However, it did not expect to close the deal until the second half of 2019, due to the transaction's complexity and the number of antitrust approvals needed.
A few days ago, it looked like the timeline could get stretched out even further. Last Thursday, a federal judge in Brazil blocked Embraer's board from signing a final joint venture agreement with Boeing, siding with four left-wing lawmakers who had filed a lawsuit to stop the deal.
The judge justified his decision as follows: "The reason is very simple, Boeing is not giving up anything" (via Reuters) -- while Embraer would lose control of its profitable commercial jet business. Embraer responded by noting that the decision did not block the company from continuing its ongoing negotiations with Boeing. Embraer also said it would appeal the ruling.
On Monday, this temporary roadblock was removed, after an appeals court overturned the lower court's decision. The Brazilian government sided with Embraer and argued for the injunction to be thrown out, saying that interfering in the negotiations between Boeing and Embraer violated the latter's freedom of enterprise.
Indeed, the original injunction seemed to have little justification other than the belief that Embraer should remain under Brazilian control. The contention that Boeing wasn't "giving up anything" conveniently ignored the $3.8 billion it will pay, which should put Embraer on a much more stable financial footing.
Embraer needs Boeing
Setting aside the substantial cash proceeds of the deal, Embraer also needs to join up with Boeing to remain competitive in the small-jet market.
While Embraer has had a fair amount of success with U.S. regional airlines, that's a limited market that can't come close to filling Embraer's production capacity. The Brazilian aerospace company has had more trouble breaking through with major airlines. Instead, Embraer has relied heavily on deals with smaller airlines -- mainly in developing countries -- to build up its order backlog for its new E2-series jets.
Unfortunately, many of these smaller airlines are not financially or operationally stable. Earlier this year, Embraer had to remove 50 E2-series jets from its backlog -- one of its largest firm orders -- after Indian airline start-up Air Costa folded. A recent firm order for 10 E195-E2s from Kuwait's Wataniya Airways is also in jeopardy after the Kuwaiti aviation authority revoked the airline's license due to its poor operational reliability.
Tapping into Boeing's massive customer base and its sales force is the best way for Embraer to land some significant orders from major airlines. Given that Embraer was down to just 132 firm orders for E2-series jets by the end of the third quarter, it wouldn't take much to move the needle.
Now that Boeing and Embraer have escaped this close call, hopefully they will move swiftly to finalize the details of their joint venture so they can go on the offensive in the small-jet market.
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