Moby Jet?

Airbus crashed this week. Not an actual airplane, but the stock price of its parent, EADS, which fell by almost a third yesterday, before recovering and posting a mere 26% loss in a single day, making it down a third this year. The most fascinating business battle in the world is getting a lot more interesting. 'Interesting,' as in the apocryphal Chinese curse, 'May you live in interesting times.'

In choosing le gloire of producing the world's biggest airliner, which will require many passengers to change planes in crowded hub airports, Airbus may have made a very bad bet. Bragging rights and the pride of seeing the biggest plane at the busiest of airports being their own product may cost Airbus, and the European taxpayers who guarantee the loans which financed the A 380's development, a lot of euros.

The theory behind the superjumbo project was that with landing slots at the busiest hubs like London Heathrow and Tokyo Narita strictly limited, more passengers per landing slot made sense. But just this week, problems with air turbulence caused by the behemoth bird may limit this advantage, as the International Herald Tribune reported:  

...the International Civil Aviation Organization has set an interim rule that requires trailing airplanes to stay twice as far behind the A380 as behind other planes.
 
At airports, therefore, each A380 could take up two landing slots, reducing its potential to cut traffic congestion. Leahy said he was confident that Airbus would persuade regulators to let the A380 fit into traffic patterns with the normal spacing. [emphasis added]

Maybe, as Airbus claims, the turbulence problems with A 380 will be no worse than with the B 747.  But Airbus has lost a lot of credibility lately.

Passengers increasingly prefer point—to—point nonstop service, saving hours on tedious long air journeys. For such routes a smaller passenger capacity, as Boeing's new 787 Dreamliner features, is ideal. Very few intercontinental city pairs generate 500 or more passengers per day unless they are part of a hub—and—spoke network, which passengers prefer to bypass, if offered a similarly—priced nonstop choice.

The massive plane is also proving more difficult and complex to manufacture than was expected, resulting in series of delivery delays. The latest, a six month setback of the deadline scheduled this year, was the trigger of the stock sell—off. But other serious problems loom.

Boeing and Airbus are battling for dominance of the world's commercial  jetliner market. Each is in the process of spending billions producing innovative and technologically challenging products: the A 380 superjumbo, capable of carrying 550 passengers in a three class configuration, and the B—787 Dreamliner, utilizing highly advanced carbon fiber composites in place of metals in the fuselage and wings, and thereby achieving unprecedented fuel efficiency to carry 250 passengers (or 300 in a recently announced 'stretch' version). Both planes promise long range capabilities, although the Boeing bird has the edge.

Dual setbacks

Airbus is not alone in its trouble. Both companies faced setbacks this week.

Boeing faced publicity about a series of glitches that Business Week reported:

'Boeing's engineers are wrestling with several significant technical and production problems that could threaten the scheduled 2008 delivery of the jetliner.'

A section of fuselage built out of composites failed some tests, and the difficult process of layering the lightweight yet strong components is proving more prone to faults than had been earlier hoped by Boeing.

The article alluded to issues in coordinating the work of subcontractors, who account for 80% of the fabrication work on the Dreamliner, versus 50% on previous generation planes. Boeing has self—consciously tapped into technological and financial resources of partner companies in an effort to obtain better quality, lower costs, and to lower the massive financial risk it faces. BW worried that inter—organizational coordination issues could hobble Boeing. Airbus, which was originally a consortium of separate companies, is presumably more experienced and more skilled at such coordination.

At this point, it is hard to judge the seriousness of the issues at Boeing. They may merely be normal teething issues in the process of producing state—of—the art complex aircraft. Potentially, they are serious, though. Only insiders could know, and even they may need to wait and see. The Dreamliner has yet to take its maiden flight, and airlines are not on public notice of problems in meeting delivery commitments or performance guarantees.

Airbus has jumbo troubles

The problems at Airbus are regarded as a lot more serious, at least judging by the stock prices of the two companies. Boeing jumped 6.5% as EADS fell.

There are signs of extreme discontent among the major customers for the A 380. Emirates of Dubai, which has by far the largest order, 45, has announced  it will seek unspecified discussions with Airbus. If Emirates demands late—delivery penalties, these could run to hundreds of millions of dollars, as it cannot fly routes anticipated, or has to line up alternative capacity at higher costs. Such late delivery penalties are commonplace in contracts for new model airliners.

That would be better than an outright order cancellation or reduction, which might also be possible. Other major customers like Singapore Airlines, Qantas  and Malaysian are all indicating they are reviewing their orders and seeking talks with Airbus. Singapore has specified that it will seek compensation payments.

Instead of billions of dollars of revenue coming in soon, Airbus will see hundreds of millions, or perhaps billions flowing outward in the next few fiscal periods. Business Week reports:

More than 90% of an aircraft's purchase price is paid upon delivery, and Airbus originally expected to start pocketing fat payments, close to $200 million per plane, as the first planes were delivered this year. But now the first delivery, to Singapore Airlines, has been pushed back to the end of 2006, and Airbus says only nine planes will roll out of the factory in 2007, down from the 25 planned earlier.

Production schedules for 2008 and 2009 have been scaled back, too. The result: Some $2.5 billion in operating profits that EADS had been expecting over the next four years have vanished. By comparison, EADS is projecting operating profits this year of $4 billion to $4.2 billion

Such massive shifts in cash flow are a corporate treasurer's nightmare.

Airbus problems grow

Even worse, there are signs of serious discontent on the part of customers tainting other planes. Airbus was humiliated when two major and highly respected aircraft buyers, Singapore Airlines and International Lease Finance, publicly criticized its planned competitor for the 787, the A 350, a derivative upgrade of its existing A 330 two engine midsize jumbo jet. In response, Airbus scrapped the 350 and made plans for an all—new model designed to take on the 787 with a composite materials fuselage and wings.

After the latest delay in the A 380 was announced, Singapore Airlines announced an order for 20 Dreamliners, an implicit rebuke of the new Airbus competitor, which will arrive on the market years after the 787 is flying, from the very customer whose complaint prompted the new airplane's development.

Scandal?

The Wall Street Journal reports this morning:

The troubles have raised doubts about EADS's management and strategy, presenting a challenge to EADS Co—Chief Executive Noel Forgeard, who oversaw the A380's development and dismissed the early success of the Boeing Dreamliner while he was the previous head of Airbus.

Mr. Forgeard will now come under increasing pressure to explain how Airbus miscalculated. According to official declarations made to France's stock—market regulator, AMF, Mr. Forgeard and other EADS managers sold shares in EADS in early March. Mr. Forgeard exercised two groups of stock options for a total of $3.1 million, before commissions. An EADS spokesperson said yesterday that, at that time, Mr. Forgeard wasn't informed of delivery problems with the A380. [....]

In a conference call with analysts, Mr. Forgeard rejected suggestions that the setbacks could cost him his job. "We have now to find the right ways forward rather than finger pointing the responsibilities of the past," Mr. Forgeard said. "We are working on managerial measures inside Airbus.

But in an interview with Le Monde newspaper on Thursday, Arnaud Lagardere, EADS co—chair, said the company will launch a probe into the latest delays of the A380 to determine whether Mr. Forgeard would keep his job.

The single aisle short range market

One possible bright spot for Airbus is China, where it has just announced plans to produce the A 320 single—aisle shorter range jet, and where, in response, it is receiving orders from Chinese carriers. Single aisle non—jumbo airliners like the A 320 and the B 737 are by far the largest sellers in terms of aircraft deliveries.

But the A 320 is an aging airplane, and will eventually face a new Boeing competitor, a composite fuselage and winged replacement for the 737 model. With its engineering resources tied up in finishing the 380 and developing the new 350 model, Airbus would have a hard time defending against a new Boeing 737 replacement.

Boeing, once it has learned to fabricate the 787 (and assuming no crippling problems there), will have its engineering resources available to focus on a single aisle composite technology twin—jet. With its head start in advanced composites, it could have years of production ahead with no Airbus competitor on the market. This is the dream of every aircraft manufacturer, because competition forces down prices and profits.

Boeing aims for the pricing jugular

Speaking of competition and pricing, Boeing is placing potentially serious pricing pressure on the 380, with a recently announced stretch version of its venerable 747 jumbo, the 747—800. The derivate is a relatively cheap re—engining (using the same engines as the 787) and fuselage stretch of the jumbo.

So far only a handful have been sold, almost all to cargo carriers. But the importance of the model may not lie in its actual sales, but rather in its effect on the prices Airbus is able to charge for the 380.

Airbus has to amortize perhaps 12 billion dollars or more in development costs for the 380. Boeing has a much, much smaller sum to repay for the 747—800. Boeing can manufacture a derivative 747 at a per copy variable cost that Airbus cannot hope to match. The accumulated experience in producing 747s means that workers are skilled and production processes are highly refined. Airbus will be at the top of the learning curve as it fills orders for the 380, while Boeing's new stretch model will be turned out with the efficiencies of mass production.

So Boeing can offer the 747—800 are a very low price to potential customers. Even if they don't eventually buy the Boeing plane, they can go to Airbus and demand lower prices for the 380, which will cut into the margins available to pay back all those many billions of euros in development costs.

The United States is bringing a trade complaint against Airbus, based on the forgivable loans underwritten by EU governments that have financed new model development at Airbus. If it is to complete development of the A 350, much less finance a replacement for the A 320, Airbus is going to need even more concessionary financing. The last thing it needs is difficulty in paying off its A 380 loans. And it is already facing cash flow challenges.

Europeans are inclined to look down on Americans for many reasons, among them our seeming fascination with 'bigger is better' thinking, from our SUVs to our restaurant portion sizes. Yet it was an American, writing the great American novel, Moby Dick, who most artfully described the dangers of obsession with the biggest and greatest. Maybe Airbus has produced a Moby Jet of its own.

Grateful thanks to Ed Lasky and Dennis Sevakis for research assistance on this article.

Thomas Lifson is the editor and publisher of The American Thinker.