(Bloomberg Opinion) -- It was a week that began in tragedy with the second fatal crash of Boeing Co.’s 737 Max jet in five months, and it ended with the first of what could be many short-term financial warnings as the aviation industry grapples with only the third fleet-wide grounding by the Federal Aviation Administration since the 1970s.
We still don’t know exactly what happened to cause an Ethiopian Airlines flight carrying 157 people to crash shortly after takeoff; the country’s transport minister plans a weekend update. But evidence collected thus far – including a jackscrew retrieved from the wreckage – indicate the plane was pushed into a dive similar to that of a Lion Air jet that crashed in October, killing 189 people. The screw-like device was reportedly what helped convince the U.S. to abandon an increasingly solitary defense of the Max’s airworthiness. It was a decision that should have been made much earlier, as Ray LaHood – the former U.S. Secretary of Transportation who grounded Boeing’s 787 Dreamliner in 2013 for other safety reasons – told my colleague David Fickling. And when the decision did come, it was too little, too late to save both Boeing and the FAA from significant reputational blowback.
Instead of embracing transparency and accountability from the start, the planemaker and the regulator were made to look like defenders of profits rather than passenger safety as China, not the U.S., took the lead in grounding the Max. Perhaps most stunning is Ethiopia’s snub of the U.S. in deciding where to send the black boxes. If there is a political takeaway from this, it’s that the word of the U.S. no longer means what it once did in a presidential administration that has a penchant for bending the truth. The situation has also cast a harsh pall on the tight-knit relationship between Boeing and the FAA, and the lack of a confirmed leader for the regulatory agency. If in fact both the Lion Air and Ethiopian Airlines crash are linked to the same flight-control safety system, then that raises questions about why the design updates for the Max weren’t tested more rigorously in the first place and why Boeing and the FAA didn’t act with more urgency to fix the problem after the first incident.
Air Canada on Friday said it was suspending all 2019 financial guidance given the uncertainty caused by the grounding of the Max, which carries an average of 9,000 to 12,000 customers a day for the airline. Citigroup Inc. warned that Southwest Airlines Co. may need to lower its earnings outlook given a large aircraft shortage on little notice. As my colleague Chris Bryant has written, Norwegian Air Shuttle ASA, which has one of the largest Max fleets among European carriers, can ill afford a hit to its finances right now and it’s no wonder the airline expects Boeing to compensate it for what DNB analysts estimate will be a 5 million-to-15 million kroner ($585,000- to-$1.75 million) per-day cost. The rejiggering of airline fleets could generate maintenance and repair work for Boeing suppliers in the short term. But as with the airlines and Boeing itself, the longer this grounding drags on, the more acute the financial pain, particularly if there’s any hit to production targets or significant order cancellations.
IMAGINATION AT WORK
General Electric Co. released its much-anticipated 2019 outlook on Thursday and the stock remains a tug of war between confidence in CEO Larry Culp and a cold, hard look at the fundamentals. The wheels of faith were greased by GE’s decision to lay out its guidance in amorphous terms. The industrial businesses will burn as much as $2 billion in cash in 2019, before a meaningful improvement in 2020 and an acceleration in 2021. It sounds like a nice turnaround story, but the specific numbers do matter here – or at least they should, especially in the eyes of the credit-rating firms. Asked about the troubled power unit in an interview with Bloomberg Television, Culp said he anticipates more of an L-shaped recovery, a scenario that would seem to fly in the face of some analysts’ forecasts for a dramatic spike in free cash flow in 2020 and 2021. Indeed, GE expects free cash flow for the power unit to remain negative in 2020, although to a lesser degree than this year. GE’s industrial free cash flow may not broach the $4.5 billion pace from last year – which, by the way, was itself a major step down from the past – until 2021 at the earliest, and maybe not even then if the macroeconomic environment moves against the company. On the positive front, an ongoing overhaul of the board and the decision to disclose cash flow on a unit basis (even if earnings figures are still heavily adjusted) were steps forward on the transparency and accountability front. This was the first time in a long while that I felt like GE management had its arms around the company’s challenges. Determining and accepting the problems is no small feat so I applaud this, but fixing them is a different challenge.
DON’T LET THE DOOR HIT YOU
XPO Logistics Inc. announced this week that its chief operating officer would be leaving after less than a year. XPO says it hired Kenny Wagers last April to free up former chief operating officer Troy Cooper to focus on M&A. After multiple cuts to its outlook and a negative (if misleading) report from a short-seller weighed on the shares, XPO decided it would spend its money on buybacks instead. So by that logic, Cooper, now president, could go back to his day job and it didn’t need Wagers anymore. XPO seems to have had a similar change of heart when it comes to hiring a permanent CFO: M&A experience is no longer a must. But this seems like a very bizarre way to manage your executive team. Wagers wasn’t a temp worker hired for a seasonal rush. And M&A is in XPO’s DNA: CEO Brad Jacobs built the company through a series of deals since taking the helm in 2011, replicating a formula he used at United Waste Systems Inc. and United Rentals Inc. He hasn’t done a deal of size since 2015, despite saying in 2017 that he was ready to spend up to $8 billion. With XPO now recalibrating its hiring decisions, it’s fair to ask how long this M&A freeze is going to last and what the reason is to own the stock at this point given macroeconomic questions. There’s a competing theory for Wagers’s departure: he previously oversaw Amazon’s logistics, Prime Now and Amazon Fresh operations and the day after XPO announced his hiring, it said it was launching XPO Direct, a network of warehouses, last-mile hubs and transportation services similar to Fulfillment by Amazon. Come February, XPO said that one of its largest customers had pulled $600 million of business and analysts suspect (but XPO didn’t say) that customer was Amazon, which is aggressively building up its own logistics operations and has a history of being rather uptight about employees switching sides. So analysts now wonder if perhaps Wagers was a sacrificial lamb. Regardless, it seems unlikely that the Amazon business will come back.
DEALS, ACTIVISTS AND CORPORATE GOVERNANCE UPDATE
Genesee & Wyoming Inc., an operator of short-line and regional railroads, is reportedly exploring options include a sale or an investment by a private equity company. Potential suitors include Brookfield Asset Management Inc. Genesee & Wyoming has a history of drawing on private equity money to accomplish its M&A goals. It worked with Brown Brothers Harriman in 2000 to invest in Australia’s Westrail Freight operations; tapped Carlyle Group LP in 2012 for an up to $800 million investment that allowed it to acquire RailAmerica Inc.; and partnered with Macquarie Infrastructure and Real Assets on a deal for Glencore Plc’s rail unit in 2016. So that may be the more likely outcome of these latest talks than an outright sale of Genesee & Wyoming. That said, Credit Suisse sees a dearth of possible targets in North America and Genesee & Wyoming’s foreign escapades haven’t always worked out well for the company.
Eaton Corp. announced plans earlier this month to spin off its lighting operations and sell an automotive fluid conveyance business that makes power-steering and air-conditioning lines. Stephens Inc. analyst Rob McCarthy raises the question of whether Eaton could instead combine its lighting assets in a joint venture with Hubbell Inc. or sell them to Acuity Brands Inc. outright. Cree Inc. announced on Friday that it would sell LED lighting businesses to Ideal Industries Inc. for $310 million. Eaton is a company whose portfolio structure has long looked outdated to me. Back in 2016, I advocated for a more dramatic separation of Eaton’s electrical-equipment division. At the time, that was easier to do on a tax basis than a divestiture of the vehicle or hydraulics businesses. CEO Craig Arnold re-emphasized Eaton’s desire to protect its profits from volatility in an economic downturn and pointed to the lighting and automotive divestitures as a testament to that. But if smoother profits are his goal, a divestiture of the vehicle parts or hydraulics business would have a bigger impact.
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To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.
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