By Cameron Caldwell and Callum Magee (University of Glasgow), Udhaav Jhunjhunwala (Singapore Management University), Chirag Gupta (New York University)
Overview of the Deal
On the 27th of April, it was announced that Boeing would tap into the Capital Markets and seek $25 billion through an open subscription coupon offering. This ensures Boeing has enough liquidity to survive the impact of the coronavirus crisis while gradually resuming normal operations and eliminating the need for any government funding.
The bonds are spread across seven different maturity dates, from three to forty years, and offer a coupon rate ranging between 4.51-5.93%. Boeing, like everyone in the aviation industry, is facing a magnitude of challenges as a result of COVID-19. This coupled with order cancellations for their 737 MAX Jet is central to their reasons for requiring a significant cash injection.
The popularity of the issuance resulted in an initially planned raise of $10 billion, increasing to $25 billion. However, credit rating agencies remain pessimistic regarding Boeing’s future cash flows and earnings. Fitch and Moody’s downgraded Boeing two notches since the start of 2020 and S&P has downgraded Boeing three notches, placing the company on the verge of being junk-rated with an already negative outlook.
With the rapid and widespread of the coronavirus pandemic bringing economic activity to a standstill, governments and central banks across the world have been forced to step in and intervene in the markets. This has created a unique set of circumstances where economic activity is strained and output is reduced drastically across industries. Companies have been able to access a huge pool of credit through a low-interest-rate environment and central bank intervention.
Bond issuances have been at record highs throughout 2020. In the first five months of the year, $584 billion of investment-grade corporate bonds were issued by US-based non-financial institutions, more than double the amount raised in the same period of 2019. Issuances are on track to easily surpass the yearly record of $644 billion worth of such bonds issued in 2017. A key factor in this flurry of bond issuance activity is the support provided by the Federal Reserve as part of its $750 billion emergency program to buy corporate debt. Notably, companies are enhancing their liquidity by maximising existing credit lines and tapping the credit markets to prepare themselves for the growing economic, global, and social uncertainties.
The pandemic has been particularly terrible for the aviation industry as they're significantly affected given the direct impact of travel restrictions. Given the prevailing uncertainty, the International Air Transport Association expects air travel to reach pre-pandemic levels by 2023. With demand for air travel being subdued, Boeing’s biggest source of revenue will be affected as airlines will not require as many aircraft. Additionally, many airlines have already declared bankruptcy such as Flybe and Virgin Australia, while many more are on track to follow suit if the current circumstances persist. This situation will increase the availability of used aircraft for companies trying to optimize their fleet, further affecting new aircraft demand. Combined with the negative consumer sentiment as a result of the 737 MAX crisis, Boeing’s business and operations will be impacted in the short-term.
The Boeing Company (also known as Boeing), is an American multinational corporation that designs, manufactures, and sells aeroplanes, satellites, rockets, missiles, telecommunications equipment and rotorcraft, while also providing leasing and product support services. Boeing is one of the largest aerospace manufacturers in the world and the largest exporter in the USA by dollar value. Boeing’s stock is included in the Dow Jones Industrial Average (NYSE: BA).
Founded in: 1916
Headquartered in: Chicago, USA
CEO: David L. Calhoun
Number of Employees: 161,133
Market Cap: $101.67 billion
EV: $130.62 billion
LTM Revenue: $66.61 billion
LTM EBITDA: $-1.03 billion
LTM EV/Revenue: 1.96x
LTM EV/EBITDA: -126.82x
Debt Asset Ratio: 0.38x
Table 1: Current Capital Structure of Boeing (Capital IQ)
Bond Details of Boeing
Table 2: Credit Ratings of Boeing (Capital IQ)
Boeing’s credit rating has seen downgrades of two notches from Fitch and Moody’s and 3 notches from S&P in 2020 alone, leaving it in a precarious position as it lies on the verge of being classified as junk with a BBB- rating and negative outlook by S&P. Entering into 2020, Boeing was under pressure due to the ongoing grounding of the 737 MAX and the uncertainty surrounding its return to service. With the onset of the coronavirus pandemic devastating air travel demand, the financial position of airlines has also been weakened. The fragility of airlines’ payment ability and the uncertainty regarding when the 737 MAX can take to the skies, Boeing has lost over 800 orders this year, with more in jeopardy. Boeing’s debt more than doubled to $27 billion in 2019 and is expected to rise further in 2020 to deal with the ongoing pandemic, potentially reaching as much as $45 billion.
Table 3: Bond Structure of Boeing (Cbonds)
Projections and Assumptions
Why was this deal done?
With Federal Reserves support driving the credit markets to new records, companies have been borrowing at a rampant pace. Even companies with troubled near-term outlooks and huge short-term liquidity requirements, such as Boeing, have been able to borrow from the market without compromising on interest rates. Boeing’s $25 billion bond offering was driven by a couple of key factors.
Firstly, the company was in need of funds to sustain its operations this year. According to Moody’s, Boeing’s estimated funding needs in 2020 could be over $30 billion, showcasing the need to strengthen their balance sheet. In order to further improve liquidity in the company, Boeing asked employees to take early retirements or voluntary work leave, drew down a $13.8 billion facility, cut their dividends and put off their proposed acquisition of Embraer.
Secondly, the bond issuance allows Boeing to avoid direct government aid. By doing so, Boeing has sidestepped potential hurdles which come with it, such as limits on executive compensation and giving the government an equity stake in the company.
While Boeing has sufficient strength and access to capital to weather the pandemic, the uncertainty surrounding the return of the 737 MAX to service adds to the stress on their books. These factors combined together could be the reason for Boeing to undertake this bond issue.
Several factors have brought Boeing’s Q1 2020 cash burn to a heightened $4.7 billion, the largest quarterly cash burn since the 737 MAX was grounded. Most notably, in the first half of the year, Boeing faced 800 order cancellations from aviation companies due to weak demand for passenger flights. The Airports Council International (ACI) reported a global passenger decline of -94.4% YoY in April 2020, causing a ripple effect through the supply chain. Boeing delivered a total of only 70 commercial aeroplanes (or military derivatives) in the first half of 2020, 71% lower than the first half of 2019. In June alone, Boeing wiped off 183 orders from its backlog due to cancellations from customers or likely cancellations. With passenger confidence at levels not seen since 9/11, British Airways retiring their entire fleet of Boeing 747s and extenuating international travel restrictions, are adding pressure to Boeing's long-haul aircraft fleet. Nervous passengers are expected to spend as little time in the air and in transit as they can. This will mark the end of large planes, such as the Boeing 747 and the Airbus A380, and give rise to more short-haul and efficient aircrafts such as the Boeing 787 and Airbus A350 to facilitate faster travel.
Risk-averse passengers concerned about COVID-19, along with the two deadly crashes of Boeing’s 737 MAX that killed all 346 people, are likely to cause further order deferrals for Boeing and increase their cash burn to year-end. Ongoing litigation fees, fines, materially higher business risk from regulatory challenges, and the re-building of Boeing’s reputation and brand damage from the 737 MAX incident will only increase their costs through 2020. Several cost-cutting and cash saving measures will need to be implemented by Boeing, along with the $25 billion already raised, if they want to avoid falling victim to the $60+ billion US government-supported liquidity package for aerospace manufacturers and suppliers, of which $17 billion is specifically available for businesses important to maintaining national security, a category Boeing falls into. Accepting this package would tarnish Boeing's brand reputation in the eyes of the taxpayer and impact their ability to shore up liquidity. The government would demand a stake in Boeing, delay the layoff of staff and ban share buybacks. As a result, Boeing has taken another route to survive the current turmoil.
Other than their $25 billion debt issuance, Boeing has taken a vast array of cost-cutting and cash saving measures to prevent them from falling behind rival Airbus during the current crisis. Suspended share buybacks and dividends, coupled with CEO David Calhoun and Chairman Lawrence Kellner forgoing this year's pay, are only small contributions to Boeing’s goal of shoring up liquidity. Boeing also tapped the full amount of a $13.8bn loan arranged barely a month ago. The loan, originally set at $13bn from a syndicate of more than a dozen banks including Bank of America, Citigroup, JPMorgan Chase, Wells Fargo and Morgan Stanley, has now been increased to $13.8bn and drawn down in full. Such loans are typically expected to be used fully, but the two-year loan is structured as a delayed-draw term loan, which allows Boeing to wait to use the money until needed. Boeing also instituted a hiring freeze, limited overtime for all employees except for those working to return the MAX to service and customer support, announced a 10% cut to its 161,133 person workforce and simultaneously encouraged as many early retirement packages as possible. These measures hope to improve Boeing's financial metrics and rebuild their credit ratings in the near-term. However, through strong barriers to entry and relentless state subsidies, short-term survival will not be a problem for the industry giant.
Despite a $641 million net loss for the first quarter, and S&P Global analysts forecasting Boeing to be in difficult territory for the next two years, there are some positive long-term prospects. It isn’t for a few years that aviation is expected to rebound from pre-COVID-19 levels. However, orders are expected to pick up as demand slowly begins to increase and planes are returned to the skies. The demand rate of growth will be influential in terms of revenues. Only time will tell whether the demand for aircraft will take a major hit in the long-run, as there is potential that airlines will delay upgrading their fleet over current liquidity concerns.
In the long-run, we could see Boeing use its bargaining power to raise prices on its aircraft to offset demand if it is substantially reduced due to airline bankruptcies as a result of the pandemic. While unlikely, as orders are placed 5-10 years in advance, this is also not a short-term solution as Boeing’s customers (airlines) liquidity positions are generally poor, but as they recover and even if some of the demand-side shocks are permanent, Boeing may be forced to raise prices to keep revenues on track.
The collapse of the $4.2 billion Boeing-Embraer joint venture will impact both Boeing and Embraer over time. The deal was intended to balance out the market by giving Embraer the ability to expand into larger aircraft and Boeing the chance to expand into smaller aircraft. This represents a potential loss in market share of the small aircraft market that could be vital given the potential increase in short-haul flights. Indeed, Guillaume Faury, the CEO of Airbus, called the collapse of the deal “a positive” for his company.
Financial Ratio Analysis
Table 4: Ratios of Boeing (Capital IQ)
Declining Return on Assets and Return on Capital indicates Boeing's struggle to utilize their resources effectively. Given the most recent shutdown of their factories, along with social distancing measures in place, these ratios are likely to worsen
Rising Debt/Equity levels suggests the numerator is increasing substantially. This may help Boeing’s short-term liquidity, but prove problematic when the debt needs to be repaid. Given Boeing's ambiguous future, it's likely the company will frequently make use of their credit lines to refinance and sustain themselves
As a result of Boeing's 737 MAX crashes and declining demand for airlines, their EBITDA Margin has entered negative territory. This decline could significantly affect Boeing's ability to raise more capital in the future given their risky profile
Risks and Uncertainties
The major risks Boeing faces in the next few months extend to the possibility of COVID-19 aviation restrictions being extended, no easing of social distancing measures, and further factory closures. This would be another huge blow to the airline industry and would have a huge knock-on effect for Boeing. However, during the crisis, one of Boeing’s main revenue streams has come from the US military, as the US Air Force placed an order for its first batch of F-15EXs in July, awarding Boeing a contract that puts a ceiling value for the entire program close to $23 billion. However, while unpredictable, defence spending is expected to reduce in the next few years, and if Boeing cannot recover its commercial revenue streams by then, there is still a probability they will require a government bailout or would be forced to file for bankruptcy. While credit agencies have a negative outlook on Boeing, investors think the former outcome is very unlikely given their optimism and interest in the recent issuance.
To recover its commercial aircraft revenue through orders, Boeing must minimise significant deferrals or cancellations of orders. There is a risk of this happening as customers will prioritize liquidity issues over upgrading their fleet in order to survive. Indeed, Southwest Airlines have requested the deferral on some of their 737 MAX Jet orders, while Boeing has already logged an increasing number of cancellations on orders. While order cancellations are costly, orders could be delayed further if Boeing's factories are forced to shut again (such as the closure of their South Carolina plant). Boeing may also have to re-evaluate its supply chain as there is a risk some of their many suppliers, especially small family-owned businesses who make niche parts for Boeing, may not survive, whereas larger suppliers such as Rolls Royce may still struggle. Boeing’s 737 MAX also poses a significant threat to revenues if it remains grounded for a further extended period of time. Boeing suggested the aircraft would be back flying within a year after its grounding in March 2019. However, the aircraft has still not returned to commercial service. The delivery ramp-up could be affected which is important as the increased and mass production of aircraft, leading to a lower average cost, are key to profitability in the industry.
Boeing’s debt and liquidity profile are also changing. Their capital structure, while helping liquidity in the short-run, maybe concerning for long-term investors since debt nearly doubled in 2019 to around $27 billion and rose to $38.9 billion at the end of Q1 2020. This increase in debt may limit Boeing’s ability to use revenues/profits for product development in future because they will have to repay creditors. Boeing may also have to borrow at a higher cost if it seeks further financing in the future if rating agencies maintain their negative outlook.
Will they be able to repay?
Boeing's turbulent environment in the last few months is likely to extrapolate into the near-future given the uncertainty of travel restrictions being imposed by countries on their borders. This will severely hit Boeing's margins and ability to scrape positive profit by year's end. Boeing's decision to issue $25 billion in debt seems logical since their cash burn has accelerated lately. And spreading the debt across seven tranches with different maturities reduces their risk of default. But, with Boeing's connections to the US government through lobbying and subsidies, it's unlikely these parties will ever let them default on their debt, or worse, collapse. Notably, the easing of lockdowns in certain countries which are increasing short-haul flights, along with flight-friendly social distancing measures and international travel bubbles, passenger numbers are likely to improve. This derived demand is likely to trickle on to Boeing's orders, reducing their backlog and improving margins.
“As a result of the response, and pending the closure of this transaction expected Monday, May 4, we do not plan to seek additional funding through the capital markets or the US government options at this time”
Said Boeing in a statement