Embraer’s Brazilian shareholders have a message for Boeing: ‘the price is NOT right.’
After the two companies announced the terms of their strategic partnership, Embraer’s stock — instead of taking off — had to make an emergency landing; the stock collapsed 14% yesterday.
The consensus among local managers: the offer price fails to recognize Embraer’s intrinsic value, and the synergies announced are underestimated.
In addition to the BNDES development bank and the Previ pension fund, Embraer’s largest Brazilian shareholders are investment funds managed by Itaú Asset Management, Bahia Asset, XP Gestão, Tempo Capital and RPS Capital. Some of them have started discussing how to take action to demand a higher price.
Boeing needs the Brazilians to close the deal: a clause in Embraer’s bylaws — written in when the company was privatized — gives Brazilian shareholders substantially more voting power than foreign shareholders. Article 14 states that the Brazilian shareholders’ vote will always be at least 60% of all the votes that can be exercised at a shareholders’ meeting.
But Embraer also stands to benefit a lot from being married to Boeing.
Embraer makes a highly competitive regional aviation product. Its jets are universally praised for being user friendly, economical and elegant in design. But that market seems headed towards a duopoly.
In April of last year, Boeing complained to the US government that Bombardier was selling its C-Series regional jets in the US below the cost price thanks to subsidies received from the Canadian and English governments. The US Commerce Department agreed with Boeing and slapped a 300% import tariff on the C-Series, putting the Bombardier program’s continuity at risk. Months later, Airbus took control of the program, buying a 50.1% stake.
“It is true that there is a global consolidation movement and, if Embraer does not participate in it, it could be isolated,” says Flávio Clemente, an analyst at Jardim Botânico Investimentos, a firm that invested in Embraer in 2016 when the stock traded at R$ 16. “But Embraer has no reason to panic and make a deal at any cost.” 
Under the terms of the deal — which creates a joint venture in commercial aviation — Boeing valued the regional jet business of Embraer at US$ 4.75 billion and proposed to pay US$ 3.8 billion for an 80% stake in the JV. That price is in line with the multiple Embraer already trades on the public market: 10x EBITDA. (Boeing trades at 15 times.)
Any Embraer shareholder would prefer an outright sale, but Embraer is a company loaded with symbolism. Its engineers are an island of excellence that is the envy of the world, and the intelligence developed in its São José dos Campos headquarters travels a two-way street connecting the Brazilian Air Force to Embraer. (When the company was privatized, Brasilia kept a golden share.) Approving an outright sale of the entire company would be a tall order for any government, let alone for a politically weak administration approaching the end of its term.
The JV is what is possible, but investors say the offer price does not reflect the company’s potential.
“Boeing’s biggest problem today is a scarcity of engineers. About 25% of their engineers will retire over the next five years, and half over the next 10 years,” said Gustavo Daibert, a portfolio manager at Bahia Asset Management, whose funds collectively own 1% of Embraer. “If this is not the main focus of the JV, it is certainly one of them. How much does it cost to relocate ITA [the military college most Embraer engineers graduate from] to the United States?”
“The Embraer model is very difficult to replicate,” Daibert says.  “The Chinese have tried for years to replicate and produce a regional jet but they can’t, because they don’t have the same technical basis.”
Daibert speaks from experience: he earned his degree in aeronautical engineering from ITA and worked at Embraer before crossing over to the buyside.
There is also the issue of timing. “Given that Embraer is bringing a new product [the E2 jet family] to market, it is recognizing costs but still no revenue from the new line,” says one PM. “But this moment of poor operating results will quickly reverse when sales start. Buying Embraer at this price is like buying a commodity company at the lowest point in the cycle.”
Another longtime shareholder claims that cost synergies announced yesterday — US$ 150 million/year starting in 2020 — do not show the whole picture. In his view, the JV’s commercial synergies could be even more important than cost synergies. “The pairing of Boeing with Embraer brings the regional aviation business to the next level: by using its sales channel, Boeing can even foster the regional-jet market, and the JV will have bargaining power that Embraer does not.”
In addition to the JV in commercial aviation, the two companies will also create a JV for trade promotion and development of new markets in ​​defense products, particularly the KC-390 freighter, a multi-mission aircraft coming out of the development phase that should start generating revenue soon.
After yesterday’s decline, Embraer is trading at 8.5x EV/EBITDA for 2018 and 6.5x for 2019.
Another factor contributing to the stock’s dive was investors’ frustration with the fact that the deal announced was preliminary and non-binding. After at leasr six months of negotiations, the level of uncertainty remains relatively high — and making matters worse, the companies estimated the transaction will close by the end of 2019 (with one presidential election in between).
The talks between Boeing and Embraer apparently covered all of the JV’s angles: from the division of assets to the allocation of engineers, from corporate governance to the demands of the Brazilian Government. “The only thing they forgot was the price,” says a Sao Paulo portfolio manager. “Did anyone on the board think the financial side through?”
A government source told Brazil Journal that the memorandum of understanding published yesterday is “a starting point, not the finish line,” and that an agreeent on price is up to the shareholders of both companies. According to this source, Boeing has not had access to Embraer’s financial information until now.

The two companies prepared six MOUs covering the various aspects of the JV. Only one of those memos was published yesterday and, from now on, the two sides will work out the details. “Today there are maybe 60 pages of understanding, but when this process is over, they will have more than 1,000 pages detailing everything.”

“Is this ‘David against Goliath’? Yes, it is,” said Daibert, the fund manager. “But all the shareholders are investment funds, and I am not sure they need this deal as much as Boeing.”
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