Boeing and Embraer Are Closing In on a Commercial Jet Alliance

Late last year, Boeing (NYSE: BA) began negotiating the potential purchase of its smaller rival, Embraer (NYSE: ERJ). While the Brazilian government quickly vetoed the concept of a full takeover of Embraer by a foreign company, it has proven highly receptive to a joint venture or other partnership arrangement that keeps Embraer’s defense business under local control.

Recent reports indicate that Boeing and Embraer are finally close to signing a formal agreement — and that they will receive approval from the Brazilian administration to go ahead with the deal. With Airbus (NASDAQOTH: EADSY) set to take control of the CSeries aircraft program on July 1, Boeing and Embraer should clarify the future of the latter’s commercial jet business sooner rather than later.

There has been a pause in orders

Airbus first unveiled its agreement to take control of Bombardier‘s struggling CSeries aircraft program last October. It is receiving a 50.01% stake in the program in return for a nominal payment and a variety of in-kind support structured to bring in more orders and improve the program’s profitability.

This unexpected deal was likely the key catalyst for the subsequent Boeing-Embraer merger talks. Embraer’s E-Jet family — along with the second-generation E2 family that is just entering production — is the CSeries program’s most direct competitor.

Embraer’s E190-E2 is a direct competitor to the CS100 jet. Image source: Embraer.

This upheaval in the 100- to 140-seat market segment has caused airlines to hold off on placing orders. (Airlines may be hoping for a price war as Airbus and Boeing fight for market share, assuming that Boeing eventually completes a deal with Embraer.) Bombardier has been able to bag some new orders just within the past few weeks, but Embraer’s E2-series jets haven’t been selling, despite a smooth entry into service in April.

Airbus is likely to hit the ground running at next month’s Farnborough Airshow, talking to as many airlines as possible about potential CSeries orders. Embraer’s best shot at keeping up is to reach an agreement with Boeing as soon as possible.

Most hurdles have been resolved

The Brazilian government has been supportive of Embraer’s interest in joining forces with Boeing, while insisting that Embraer must keep its defense unit separate. In recent months, the talks between Boeing and Embraer have centered on the concept of Boeing paying cash for an 80% stake in a new company that would hold Embraer’s commercial aviation business.

Brazilian President Michel Temer recently gave conditional approval to this structure, removing one potential obstacle to completing a deal. Furthermore, Boeing and Embraer have resolved 90% of the details of creating a joint venture, according to Bloomberg. This means there’s a good chance they will sign an agreement within the next month or two.

Time to reach the finish line

In recent months, executives at both Boeing and Embraer have insisted that completing a joint venture for the latter’s commercial jet division would be beneficial, but not vital. However, this may just be a negotiating tactic. After all, in order to strike the most favorable deal, neither side wants to appear too desperate.

Airbus would have a significant competitive advantage over both Boeing and Embraer if it were the only jet maker to offer a full range of planes, from 100 seats to 300 or more seats. Neither rival would be doomed in this scenario, but they would clearly be stronger together. In the short term, Airbus may also benefit from airlines’ uncertainty about whether the proposed Boeing-Embraer joint venture will come to fruition.

It now seems virtually certain that Boeing will eventually take majority control of Embraer’s commercial jet business. There’s no reason for the two companies to drag the process out any longer than necessary.

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Adam Levine-Weinberg owns shares of Embraer. The Motley Fool recommends Embraer. The Motley Fool has a disclosure policy.

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