Saturday, February 14, 2015

Will Bombardier be another Canadian technology bust?

The patriotic hearts of Canadians who fear that Corporate Canada is turning into a branch plant a mari usque ad mare no doubt sank on Thursday when Bombardier unveiled a financial and executive shakeup that highlighted the company’s tribulations. Out went the CEO, Pierre Beaudoin, along with the dividend. In came a commitment to pour more debt onto a company already drowning in debt.

The shares plunged, taking their one-month loss to more than 30 percent and their five-year loss to a cruel 50 percent. Surely this was a company in distress and companies in distress often seek saviours. Is Bombardier a goner as an independent aerospace and train company? Certainly, the official statement that Bombardier would explore various initiatives, including “potential participation in industry consolidation,” raised suspicions.

Bombardier is Canada’s premier technology company, which, sadly, isn’t saying a lot after nearly two decades of corporate blowups, foreign takeovers and grind-downs that eliminated Nortel and turned once-mighty BlackBerry, whose market value at its peak was more than 15 times greater than Bombardier’s today, into a fringe player. Tech wasn’t alone. Entire Canadian industries – steel, brewing, mining, forestry – got hollowed out, leaving a few sorry subsidiaries behind. Today, the biggies in Corporate Canada are largely limited to the five banks, a couple of insurers, gold companies and energy names such as Suncor and TransCanada.

Bombardier still stands proud amid the diminished ranks. It is the world’s third-biggest aerospace company and invented a whole new category of plane – the regional jet – that is the equivalent of a flying minivan. Its private jets are the toys of choice for the Fortune 500 set. Its fire-fighting aircraft, which look like Second World War bombers painted yellow, are terrific global ambassadors (the ones in Italy and elsewhere are known as Canadairs). Bombardier Transportation, as the train division is called, is (barely) the top name in the industry and its high-speed trains are marvels. With a little help from taxpayers, the company takes big risks as big companies should if they want to build a future instead of resting on their laurels, doling out dividends to pensioners. The long delayed C Series jet is the biggest risk Bombardier has taken and could make or break the aerospace division.

The bad news is that Bombardier is starting to look like more victim than victor. The long-delayed C Series has, so far, been a sales disappointment and its costs have climbed 29 per cent, to $5.9-billion (U.S.), above last year’s estimate. Bombardier wholly miscalculated the competitive response from Airbus and Boeing, which are in no mood to let the upstart Canadians bite into their bread-and-butter Airbus A320 and Boeing 737 market. The ambitious Learjet 85 business jet development project was dropped. The train division is feeling the heat from formidable European and Asian competitors.

With development costs soaring, debt has climbed to a fearsome $7.4-billion. The loss in the fourth quarter was $1.6-billion, mostly due to the ending of the Learjet 85 program. High cash burn meant the dividend had to be sacrificed and Bombardier is going cap in hand to shareholders for $600-million in new equity. It has all been too much pain for shareholders and Mr. Beaudoin is handing the control stick to Alain Bellemare, the former boss of the propulsion and aerospace business of United Technologies, the U.S. tech giant that makes the Pratt & Whitney engines used in the C Series. Mr. Beaudoin becomes executive chairman of the family controlled company, where he will direct overall strategy, including mergers and acquisitions.

Already, speculation is rife that he and the Bombardier family members will explore the sale of the company, in whole or in parts, on the theory that Bombardier may already have lost the war with Boeing and Airbus and may lose the train war to the Chinese, who have apparently made global train domination their goal. In December, the two train giants controlled by the Chinese state, CSR and CNR, agreed to merge. Since cash-strapped, austerity-minded state and municipal governments are the main train customers, the relatively cheap prices that CSRC/CNR can offer is bound to attract customers everywhere. CNR has already found an American customer.

My own view is that Bombardier will not break the company up and sell the aerospace side to, say, Boeing, and the train side to a competitor such as Germany’s Siemens. While planes and trains offer little industrial synergy, there is a lot of financial synergy. Capital-intensive manufacturers that live and die on innovation need the vast financial resources that come with sheer bulk. That’s not just because of the hefty development costs for any big project, but because the banks have to guarantee warranty and penalty costs. The bank guarantee would kick in, for example, if Bombardier were required to pay a penalty for the delayed delivery of an airplane or train.

Keeping planes and trains together also makes sense because of the down payment system for each. Planes are generally paid for upon delivery, whereas train orders demand somewhere between a third and half the payment up front. This allows the cash flow from train orders to subsidize aircraft development costs. Barring a breakup, the options are the outright sale of the whole company or a series of joint ventures. The latter has enormous attractions and is already used by Bombardier to some degree. The JVs, as they’re called, might see entire planes and train systems manufactured in, say, China, India or Brazil. Cheaper labour costs are not the only attraction; it’s market access. If you want to sell in China, you have to build in China. Under this scenario, Bombardier’s Montreal operations would evolve into a commercial business charged with development, financing and marketing, while the JVs would do the grunt work on the assembly lines.

An outright sale seems unlikely in the next few years. The C Series jet could still be a winner and a JV strategy could open up new markets. The Bombardiers and Beaudoins are industrialists, not coupon clippers, and would be loath to sell. But if Bombardier cannot revive itself, however slowly, they would certainly act rationally and get out. Were that to happen, the Canadian tech sector would be a wasteland. 

 Story and comments: http://www.theglobeandmail.com

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