Boeing's Bad Decisions Seem Boundless
October 18, 2019, 3:13 PM EDT
Bloomberg
The extent of Boeing Co.’s wrong decisions when it comes to the 737 Max seemingly has no bounds.
Newly unearthed messages show a high-ranking Boeing pilot expressed concern during the Max’s certification process in 2016 about the flight-control system believed to have played a key role in the two fatal crashes of the jet. Mark Forkner, then Boeing’s chief technical pilot for the 737 and a top contact for the Federal Aviation Administration, expressed misgivings about pilots’ ability to handle the system after encountering troubling behavior in flight simulators, according to the messages, which were reviewed by Bloomberg News. Boeing doesn’t appear to have communicated this concern to the FAA at the time, and Forkner expressed concern that he may have misled regulators. The New York Times reports that the messages were sent in November 2016, eight months after Forkner had requested that the FAA remove a mention of the flight-control system in question from pilots’ manuals on the grounds that it was unlikely to activate and wasn’t particularly dangerous.
Potentially more damning: the FAA says that, like the rest of us, it’s only now finding out about these messages. FAA Administrator Stephen Dickson sent Boeing CEO Dennis Muilenburg a letter demanding an explanation for why the company didn't come forward after discovering the documents "months ago."
This is likely to further derail the process for returning to Max to service. Muilenburg’s goal of a fourth-quarter return was already looking like a pipe dream. No airline expects to have the plane as part of its fleet in that time frame. Southwest Airlines Co. this week pulled the Max from its schedule through Feb. 8, while Air Canada yanked it through Feb. 14. But on a bigger level, this turn of events is a sign that for all of Boeing’s talk about recommitting itself to safety, the company appears reluctant to fully come clean about its role in the crisis and hold itself accountable.
Boeing last month unveiled an organizational overhaul that created a new division within the company focused on the safety of its products and services and sought to insulate engineers from profit concerns. On Oct. 11, Boeing announced it was stripping CEO Muilenburg of his chairman title and putting lead director Dave Calhoun in charge of the board. The board said splitting the CEO and chairman roles is meant to enable Muilenburg to “focus full time on running the company as it works to return the 737 Max safely to service,” which begs the question of what exactly directors think he’s been focusing on for the seven months the jet has been grounded. These were steps in the right direction, although clearly reactionary. To be charitable, perhaps these changes are what brought the messages to management’s attention. But whatever good will Boeing hoped to earn through these efforts is now washed out, just in time for the company’s third-quarter earnings report next week and Muilenburg’s testimony to Congress on Oct. 30. Separately, Bloomberg News reports that photographs a Lion Air employee gave to investigators purporting to show a crucial repair had been made properly in the days before the 2018 crash of the Max may not in fact show that.
THE BLESSING AND CURSE OF LOW EXPECTATIONS
The industrial earnings season kicked off in earnest this week with results from CSX Corp., United Rentals Inc., Dover Corp. and Honeywell International Inc., among others. Investors’ main takeaway for each of these four companies was similar: good enough for now. All of the companies either tamped down their revenue guidance for 2019 or, in the case of CSX, reported a slump in shipments that justified the sharp cut the railroad made to its outlook in July. But the sales slowdown was already anticipated by investors and priced in to the stocks after a string of increasingly dire-looking economic data on the manufacturing sector over the past few weeks. Earnings-per-share expectations were similarly lowered in many cases. At CSX, for example, analysts had trimmed their third-quarter earnings estimates by more than 8% since July and its stock had fallen 13% heading into earnings. Cue a 1% rally when the actual numbers weren’t any worse than feared.
When you peel back the veil of expectations, though, the underlying numbers point to a deepening manufacturing slowdown that should remind investors why those estimates had come down in the first place. Volumes at CSX fell 5% in the third quarter, while West Coast railroad Union Pacific Corp. reported a broad-based 8% slump in carloads led by declines in coal, automotive and consumer goods. Both companies notched further improvements in their productivity as they worked to implement the “precision scheduled railroading” strategy of doing more with less, but those profitability gains came at the expense of several hundred jobs. Union Pacific’s headcount is down 13% from a year earlier, while CSX, which started the transition to the method earlier, has trimmed 6% of its workforce over the same period. Thus far, the labor market has been healthy enough to absorb these cutbacks, but at a certain point, these layoffs in the name of profitability will leave fewer people with the resources to buy the cars and consumer goods ferried by Union Pacific and CSX’s trains. Without any uptick in shipments (and that seems unlikely in the near-term), Union Pacific plans more job cuts in the fourth quarter as well as 2020. Fourth-quarter head count is expected to be down 15% versus the year-earlier level.)
While a Federal Reserve report this week showed U.S. factory output dropped by the most in five months in September, one optimistic interpretation is that the General Motors Co. labor strike likely had an outsize impact, and the strike now appears to be near a resolution. The United Auto Workers union reached a tentative agreement with GM this week that includes wage increases and a shorter path for temporary workers to achieve permanent status and higher pay. It doesn’t, however, save three plants that GM has planned to idle, most notably a Lordstown, Ohio, facility. The automaker has offered to build an electric battery factory nearby (and pay employees less to work there) but it wants to sell the existing Lordstown plant to an electric truckmaker that reported just $6,000 of revenue last quarter. Union leaders, wary of pushback from those who wanted to see the plant saved and likely also conscious of their own credibility problems amid a corruption scandal, decided to keep their members on the picket line over the next week while they vote on the deal. The strike has already cost GM $2 billion in operating profit and will cost an additional $100 million for each day it drags on, according to estimates from Bank of America Merrill Lynch. The concessions GM made to its workforce will likely inspire the union to seek similar benefits from Ford Motor Co. and Fiat Chrysler Automobiles; those companies are likely eager to avoid similar financial pain from a prolonged strike.
FEDEX FRIGHT WEEK
As if things weren’t bad enough for the package-delivery company, Moody’s Investors Service this week lowered its outlook on FedEx Corp.’s unsecured bonds to negative, saying the company will be “hard-pressed to grow its earnings and cash flow to levels that will allow it to reduce debt.” That’s a nice way of saying that FedEx, in no particular order, is: stuck with a trade war that’s putting a drag on international commerce out of China and Europe; hobbled by a disastrous acquisition of TNT Express that demands ever more money to integrate; forced to adapt its network to more profitably handle a flood of e-commerce shipments; and losing the support of investors to do so after investments thus far have yielded little returns. Oh, and there's Amazon.com Inc., which accounts for nearly 40% of the U.S. e-commerce market, according to eMarketer, and is increasingly becoming a competitor. Should Moody’s follow through with a downgrade, FedEx’s credit rating would slip to just one level above junk status. That could further hinder CEO Fred Smith’s efforts to turn the company around.
Smith, who founded FedEx in the 1970s, talked to the Wall Street Journal for a story published this week about the challenges the company faces and his thoughts on Amazon. The story is worth a read but I just wanted to point out a few things. Smith reiterates that the idea of FedEx being disrupted by Amazon is “fantastical.” Never mind that FedEx lists Amazon as a competitor in its annual filings and Smith on FedEx’s third-quarter earnings call included the company as one of five entities that make up the “ecosphere” of logistics. “That's who we wake up every day trying to think about how we compete,” Smith said. Hence why FedEx decided to stop delivering U.S. packages for Amazon earlier this year. Smith’s continued reluctance to recognize the Amazon threat is symbolic of the kind of defensive attitude and slow thinking that’s compounded the company’s problems. Smith elaborated that “You can’t just overnight decide, ‘I’m going to pick up from every person in the world and every business in the world and be able to deliver it to every other.’” I’ve said it before and I’ll say it again: this is the wrong way to think about Amazon’s ambitions. The company doesn’t need to become FedEx 2.0 to disrupt the industry; it’s already doing that.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
Emerson Electric Co.’s interactions with activist investor D.E. Shaw Group went from closed-door discussions to a feisty public dispute this week. The hedge fund published a letter and presentation calling on management to break up the company, reduce what it says are more than $1 billion in excess costs, and improve corporate governance. It recommends making its directors subject to annual elections and wants the company to do more to align CEO Dave Farr’s compensation with the share price. The activist also would like Emerson’s corporate aviation department – complete with eight jets, a helicopter, more than 40 employees and an intern – to be treated like the relic that it is. Analysts have pushed back on D.E. Shaw’s estimate of the cost-cutting opportunity, pointing out that some of its margin comparisons are unfair because other companies strip out restructuring, pension and other costs. But they generally agree that there’s room for productivity improvement; it’s hard to defend things like eight corporate jets or a staggered board in this day and age. The net of this is that Emerson likely no longer has the luxury of contemplating a breakup on its own time frame and will need to speed up the process of its strategic review. CNBC reported on Friday that D.E. Shaw has considered nominating as many as four candidates for Emerson’s board. The problem is, even D.E. Shaw’s baseline sum of the parts estimate doesn’t reflect all that much value creation. You really need the cost-cutting benefits to make the argument work. History has shown that companies find ways to get a lot more efficient than previously imagined once they stand alone, but I would expect this to be the key point of debate going forward.
Eaton Corp. agreed to sell its Cooper Lighting Solutions business to Dutch rival Signify NV for $1.4 billion in cash. Signify was spun off from Royal Philips NV in 2016 and views the deal as a way to expand in the North American market for professional lighting. The purchase price is less than the $1.7 billion in sales the Eaton lighting unit generated in 2018 and about 7.5 times its Ebitda in that year, meaning that the valuation is a discount to what lighting company Acuity Brands Inc. trades for in the public market. Recall that Eaton in March had said it would explore a sale or spinoff of the lower-margin, underperforming lighting business. The decision to proceed with a sale at this kind of underwhelming multiple could reflect a wariness around the trajectory of that business amid signs the U.S. economy is starting to slow down. And with a sale, Eaton gets cash that it can use for buybacks. CEO Craig Arnold in May touted the company’s ability to use share repurchases to help keep a lid on earnings-per-share volatility in a recession environment.
Kone Oyj is working on a way to make a potential takeover of Thyssenkrupp AG’s rival elevator unit more palatable to antitrust regulators. The Finnish company is reportedly in talks with CVC Capital Partners about a joint bid that would see the private equity firm take control of certain European Thyssenkrupp assets that have a lot of overlap with Kone. CVC has played a similar role before: The firm partnered with Messer Group GmbH to buy more than $3 billion in assets that industrial gas companies Linde AG and Praxair Inc. needed to sell to win U.S. regulatory approval for their merger last year. But a CVC-Kone joint offer will have competition. Blackstone Group Inc. is partnering with Carlyle Group LP on a proposal, while Brookfield Asset Management Inc., Hitachi Ltd. and a consortium of Advent International, Cinven and the Abu Dhabi Investment Authority also remain in the running, people familiar with the matter told Bloomberg News. The abrupt replacement of Thyssenkrupp CEO Guido Kerkhoff with board member Martina Merz as interim head created the impression that the company was trying to speed up the sales process, and its need for cash could make it more open to selling the entire elevator unit, versus just a partial stake as Kerkhoff reportedly preferred. That could ultimately lead it to favor private equity buyers, with Germany’s Handelsblatt reporting that Kone’s most recent offer was 1 billion to 2 billion euros ($1.1 billion to $2.2 billion) less than those of rival suitors and was composed of both cash and its own stock.
Aecom, an engineering and design group targeted by activist investor Starboard Value, agreed this week to sell its management-services division for $2.4 billion to a group of private equity firms including Lindsay Goldberg and American Securities. Aecom had previously announced plans to spin off the business, but Starboard advocated that it instead pursue an outright sale. The activist also wants Aecom to make operational improvements and consider a divestiture of the company’s construction arm. The sale values the management-services operations at almost 12 times its expected 2019 adjusted Ebitda, a premium to the total company’s valuation. Aecom will use the cash for debt reduction and share repurchases.
Bloomberg
The extent of Boeing Co.’s wrong decisions when it comes to the 737 Max seemingly has no bounds.
Newly unearthed messages show a high-ranking Boeing pilot expressed concern during the Max’s certification process in 2016 about the flight-control system believed to have played a key role in the two fatal crashes of the jet. Mark Forkner, then Boeing’s chief technical pilot for the 737 and a top contact for the Federal Aviation Administration, expressed misgivings about pilots’ ability to handle the system after encountering troubling behavior in flight simulators, according to the messages, which were reviewed by Bloomberg News. Boeing doesn’t appear to have communicated this concern to the FAA at the time, and Forkner expressed concern that he may have misled regulators. The New York Times reports that the messages were sent in November 2016, eight months after Forkner had requested that the FAA remove a mention of the flight-control system in question from pilots’ manuals on the grounds that it was unlikely to activate and wasn’t particularly dangerous.
Potentially more damning: the FAA says that, like the rest of us, it’s only now finding out about these messages. FAA Administrator Stephen Dickson sent Boeing CEO Dennis Muilenburg a letter demanding an explanation for why the company didn't come forward after discovering the documents "months ago."
This is likely to further derail the process for returning to Max to service. Muilenburg’s goal of a fourth-quarter return was already looking like a pipe dream. No airline expects to have the plane as part of its fleet in that time frame. Southwest Airlines Co. this week pulled the Max from its schedule through Feb. 8, while Air Canada yanked it through Feb. 14. But on a bigger level, this turn of events is a sign that for all of Boeing’s talk about recommitting itself to safety, the company appears reluctant to fully come clean about its role in the crisis and hold itself accountable.
Boeing last month unveiled an organizational overhaul that created a new division within the company focused on the safety of its products and services and sought to insulate engineers from profit concerns. On Oct. 11, Boeing announced it was stripping CEO Muilenburg of his chairman title and putting lead director Dave Calhoun in charge of the board. The board said splitting the CEO and chairman roles is meant to enable Muilenburg to “focus full time on running the company as it works to return the 737 Max safely to service,” which begs the question of what exactly directors think he’s been focusing on for the seven months the jet has been grounded. These were steps in the right direction, although clearly reactionary. To be charitable, perhaps these changes are what brought the messages to management’s attention. But whatever good will Boeing hoped to earn through these efforts is now washed out, just in time for the company’s third-quarter earnings report next week and Muilenburg’s testimony to Congress on Oct. 30. Separately, Bloomberg News reports that photographs a Lion Air employee gave to investigators purporting to show a crucial repair had been made properly in the days before the 2018 crash of the Max may not in fact show that.
THE BLESSING AND CURSE OF LOW EXPECTATIONS
The industrial earnings season kicked off in earnest this week with results from CSX Corp., United Rentals Inc., Dover Corp. and Honeywell International Inc., among others. Investors’ main takeaway for each of these four companies was similar: good enough for now. All of the companies either tamped down their revenue guidance for 2019 or, in the case of CSX, reported a slump in shipments that justified the sharp cut the railroad made to its outlook in July. But the sales slowdown was already anticipated by investors and priced in to the stocks after a string of increasingly dire-looking economic data on the manufacturing sector over the past few weeks. Earnings-per-share expectations were similarly lowered in many cases. At CSX, for example, analysts had trimmed their third-quarter earnings estimates by more than 8% since July and its stock had fallen 13% heading into earnings. Cue a 1% rally when the actual numbers weren’t any worse than feared.
When you peel back the veil of expectations, though, the underlying numbers point to a deepening manufacturing slowdown that should remind investors why those estimates had come down in the first place. Volumes at CSX fell 5% in the third quarter, while West Coast railroad Union Pacific Corp. reported a broad-based 8% slump in carloads led by declines in coal, automotive and consumer goods. Both companies notched further improvements in their productivity as they worked to implement the “precision scheduled railroading” strategy of doing more with less, but those profitability gains came at the expense of several hundred jobs. Union Pacific’s headcount is down 13% from a year earlier, while CSX, which started the transition to the method earlier, has trimmed 6% of its workforce over the same period. Thus far, the labor market has been healthy enough to absorb these cutbacks, but at a certain point, these layoffs in the name of profitability will leave fewer people with the resources to buy the cars and consumer goods ferried by Union Pacific and CSX’s trains. Without any uptick in shipments (and that seems unlikely in the near-term), Union Pacific plans more job cuts in the fourth quarter as well as 2020. Fourth-quarter head count is expected to be down 15% versus the year-earlier level.)
While a Federal Reserve report this week showed U.S. factory output dropped by the most in five months in September, one optimistic interpretation is that the General Motors Co. labor strike likely had an outsize impact, and the strike now appears to be near a resolution. The United Auto Workers union reached a tentative agreement with GM this week that includes wage increases and a shorter path for temporary workers to achieve permanent status and higher pay. It doesn’t, however, save three plants that GM has planned to idle, most notably a Lordstown, Ohio, facility. The automaker has offered to build an electric battery factory nearby (and pay employees less to work there) but it wants to sell the existing Lordstown plant to an electric truckmaker that reported just $6,000 of revenue last quarter. Union leaders, wary of pushback from those who wanted to see the plant saved and likely also conscious of their own credibility problems amid a corruption scandal, decided to keep their members on the picket line over the next week while they vote on the deal. The strike has already cost GM $2 billion in operating profit and will cost an additional $100 million for each day it drags on, according to estimates from Bank of America Merrill Lynch. The concessions GM made to its workforce will likely inspire the union to seek similar benefits from Ford Motor Co. and Fiat Chrysler Automobiles; those companies are likely eager to avoid similar financial pain from a prolonged strike.
FEDEX FRIGHT WEEK
As if things weren’t bad enough for the package-delivery company, Moody’s Investors Service this week lowered its outlook on FedEx Corp.’s unsecured bonds to negative, saying the company will be “hard-pressed to grow its earnings and cash flow to levels that will allow it to reduce debt.” That’s a nice way of saying that FedEx, in no particular order, is: stuck with a trade war that’s putting a drag on international commerce out of China and Europe; hobbled by a disastrous acquisition of TNT Express that demands ever more money to integrate; forced to adapt its network to more profitably handle a flood of e-commerce shipments; and losing the support of investors to do so after investments thus far have yielded little returns. Oh, and there's Amazon.com Inc., which accounts for nearly 40% of the U.S. e-commerce market, according to eMarketer, and is increasingly becoming a competitor. Should Moody’s follow through with a downgrade, FedEx’s credit rating would slip to just one level above junk status. That could further hinder CEO Fred Smith’s efforts to turn the company around.
Smith, who founded FedEx in the 1970s, talked to the Wall Street Journal for a story published this week about the challenges the company faces and his thoughts on Amazon. The story is worth a read but I just wanted to point out a few things. Smith reiterates that the idea of FedEx being disrupted by Amazon is “fantastical.” Never mind that FedEx lists Amazon as a competitor in its annual filings and Smith on FedEx’s third-quarter earnings call included the company as one of five entities that make up the “ecosphere” of logistics. “That's who we wake up every day trying to think about how we compete,” Smith said. Hence why FedEx decided to stop delivering U.S. packages for Amazon earlier this year. Smith’s continued reluctance to recognize the Amazon threat is symbolic of the kind of defensive attitude and slow thinking that’s compounded the company’s problems. Smith elaborated that “You can’t just overnight decide, ‘I’m going to pick up from every person in the world and every business in the world and be able to deliver it to every other.’” I’ve said it before and I’ll say it again: this is the wrong way to think about Amazon’s ambitions. The company doesn’t need to become FedEx 2.0 to disrupt the industry; it’s already doing that.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE
Emerson Electric Co.’s interactions with activist investor D.E. Shaw Group went from closed-door discussions to a feisty public dispute this week. The hedge fund published a letter and presentation calling on management to break up the company, reduce what it says are more than $1 billion in excess costs, and improve corporate governance. It recommends making its directors subject to annual elections and wants the company to do more to align CEO Dave Farr’s compensation with the share price. The activist also would like Emerson’s corporate aviation department – complete with eight jets, a helicopter, more than 40 employees and an intern – to be treated like the relic that it is. Analysts have pushed back on D.E. Shaw’s estimate of the cost-cutting opportunity, pointing out that some of its margin comparisons are unfair because other companies strip out restructuring, pension and other costs. But they generally agree that there’s room for productivity improvement; it’s hard to defend things like eight corporate jets or a staggered board in this day and age. The net of this is that Emerson likely no longer has the luxury of contemplating a breakup on its own time frame and will need to speed up the process of its strategic review. CNBC reported on Friday that D.E. Shaw has considered nominating as many as four candidates for Emerson’s board. The problem is, even D.E. Shaw’s baseline sum of the parts estimate doesn’t reflect all that much value creation. You really need the cost-cutting benefits to make the argument work. History has shown that companies find ways to get a lot more efficient than previously imagined once they stand alone, but I would expect this to be the key point of debate going forward.
Eaton Corp. agreed to sell its Cooper Lighting Solutions business to Dutch rival Signify NV for $1.4 billion in cash. Signify was spun off from Royal Philips NV in 2016 and views the deal as a way to expand in the North American market for professional lighting. The purchase price is less than the $1.7 billion in sales the Eaton lighting unit generated in 2018 and about 7.5 times its Ebitda in that year, meaning that the valuation is a discount to what lighting company Acuity Brands Inc. trades for in the public market. Recall that Eaton in March had said it would explore a sale or spinoff of the lower-margin, underperforming lighting business. The decision to proceed with a sale at this kind of underwhelming multiple could reflect a wariness around the trajectory of that business amid signs the U.S. economy is starting to slow down. And with a sale, Eaton gets cash that it can use for buybacks. CEO Craig Arnold in May touted the company’s ability to use share repurchases to help keep a lid on earnings-per-share volatility in a recession environment.
Kone Oyj is working on a way to make a potential takeover of Thyssenkrupp AG’s rival elevator unit more palatable to antitrust regulators. The Finnish company is reportedly in talks with CVC Capital Partners about a joint bid that would see the private equity firm take control of certain European Thyssenkrupp assets that have a lot of overlap with Kone. CVC has played a similar role before: The firm partnered with Messer Group GmbH to buy more than $3 billion in assets that industrial gas companies Linde AG and Praxair Inc. needed to sell to win U.S. regulatory approval for their merger last year. But a CVC-Kone joint offer will have competition. Blackstone Group Inc. is partnering with Carlyle Group LP on a proposal, while Brookfield Asset Management Inc., Hitachi Ltd. and a consortium of Advent International, Cinven and the Abu Dhabi Investment Authority also remain in the running, people familiar with the matter told Bloomberg News. The abrupt replacement of Thyssenkrupp CEO Guido Kerkhoff with board member Martina Merz as interim head created the impression that the company was trying to speed up the sales process, and its need for cash could make it more open to selling the entire elevator unit, versus just a partial stake as Kerkhoff reportedly preferred. That could ultimately lead it to favor private equity buyers, with Germany’s Handelsblatt reporting that Kone’s most recent offer was 1 billion to 2 billion euros ($1.1 billion to $2.2 billion) less than those of rival suitors and was composed of both cash and its own stock.
Aecom, an engineering and design group targeted by activist investor Starboard Value, agreed this week to sell its management-services division for $2.4 billion to a group of private equity firms including Lindsay Goldberg and American Securities. Aecom had previously announced plans to spin off the business, but Starboard advocated that it instead pursue an outright sale. The activist also wants Aecom to make operational improvements and consider a divestiture of the company’s construction arm. The sale values the management-services operations at almost 12 times its expected 2019 adjusted Ebitda, a premium to the total company’s valuation. Aecom will use the cash for debt reduction and share repurchases.
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