Analyst: Brazilian Government An Obstacle To Boeing-Embraer Merger

On Thursday, Boeing Co (NYSE: BA) confirmed a Wall Street Journal report that the aerospace giant is looking to buy Brazilian commercial jet maker Embraer SA (ADR) (NYSE: ERJ).

The companies said in a release they are engaged in discussions regarding a potential combination.

The Analyst

Buckingham Research Group analyst Richard Safran reiterated a Neutral rating and $203 price target for Boeing, suggesting 31 percent downside from current levels.

The analyst said his view on Boeing remains intact despite the M&A discussion, as he projects little upside to production rates, deliveries, earnings or cash flow expectations.

The Thesis

The talks could result in an outright acquisition, joint venture, minority interest or other link, Safran said in a Thursday note. (See Safran's track record here.) 

The analyst said he's skeptical about a Boeing-Embraer combination, given the challenge of securing approval from the Brazilian government.

"We don't think the Brazilian government will look favorably on foreign ownership (in this case U.S.) of a strategic asset like ERJ," he said.

Even if a deal isn't reached, Buckingham Research expects both companies to move closer through either a joint venture or Boeing taking a minority interest in Embraer. Some new agreement between the companies could come out of the ongoing discussions, according to Buckingham. 

Although regional jet and business jet segments have not been on Boeing's radar historically, that has changed with the recent executive management changes at Boeing and Boeing Commercial Aircraft, Safran said. 

See also: Can Boeing Shares Lift Off Soon? Credit Suisse Sees 29% Upside From Here

Going by the 10-14 times next-12-months EBITDA valuations for recent aerospace deals, the firm said Boeing's potential buy of Embraer could be priced in the $6 billion to $9 billion range, a premium to Embraer's valuation of $3.7 billion. With Boeing recently announcing a $18-billion share repurchase authorization, Safran said it may have to use a combination of debt and/or free cash flow in the event of an all-cash deal.

Boeing's interest in Embraer could have been motivated by AIRBUS SE (OTC: EADSY)'s recent CSeries joint venture with Bombardier Inc (OTC: BDRBF), which could pose a challenge to the B737 MAX 7 and other MAX models.

"In our view, a BA acquisition of ERJ would not appreciably change the dynamic between BA and Bombardier and the issues surrounding Canadian subsidies and MAX pricing," Safran said. 

Another motivation for a Boeing-Embraer deal could be to acquire lower-cost manufacturing and development sites, the analyst said: Boeing could view Embraer as a potential site for manufacturing its next-gen narrow body aircraft.

With Boeing's sales force and global services likely to enhance Embraer's product offerings, the firm views a Boeing-Embraer tie-up as a potential negative to Dassault Systemes SE (ADR) (OTC: DASTY), General Dynamics Corporation (NYSE: GD)'s Gulfstream and Textron Inc. (NYSE: TXT).

The Price Action

Boeing has gained over 87 percent year-to-date.

Related Link:

The Boeing-Bombardier Feud Intensified Thanks To Airbus

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