US/EU: Boeing set to fly past Airbus

Analysis

Boeing's 787 aircraft, if successfully developed, represents a serious challenge to its rival Airbus. Launched just two years ago, the long-range middle market (250-300 seat) jet has secured almost 400 orders from some of the world's most prestigious carriers. The new airliner enters service in 2008, and Boeing is considering a second production line to accommodate high up-front demand. Airbus's position in the high-profit-margin wide-body jet market is not nearly as auspicious.

A380 market scepticism. Airbus is busy finishing its 550-seat A380, a 13-15 billion dollar programme with a December 2006 in-service date. The aircraft's order book is stuck at 159 planes after six years of marketing. Except for Emirates, no carriers have endorsed it with a major fleet commitment (more than 10-15 aircraft).

Airbus customer concerns. The A380's development challenges are hampering Airbus as it responds to Boeing in the middle market. Airbus has launched the A350 as its response to the 787, which leverages the existing A330 airframe with significant technology upgrades. While the A350 has garnered 100 orders, none are from first-tier carriers. Worse, several key Airbus customers, including leasing company ILFC and Singapore Airlines, say that the aircraft needs an all-new design, or the A350 will suffer low market share and weak pricing. In April, A350 launch customer USAirways said it would not fly an inadequate A350 against a competing airline that flew 787s.

Airbus wide-body softness. The A350's weak position against the 787 is bad news for Airbus, and it has been accompanied by other equally serious developments:

• A340 sales plummet. Negative comments about the A350 have been accompanied by problems with Airbus's larger mid-market wide-body, the 300-380 seat A340 500/600. Boeing's 777 aircraft outsold the A340 by 155-15 in 2005. The A340 order backlog is dwindling. Its only major customer, again Emirates, might cancel its orders.
• Boeing 747 update. Boeing has launched an updated 747, the 747-8. While it seats 450 passengers and will not compete directly with the A380, the 747-8's fuel efficiency could rule out the use of an A380 on routes that do not utilise its full 550 seats. This means that Airbus is at risk of losing most of the 200-500 seat market, apart from one derivative and uncompetitive plane (the A350).

Boeing resurgent. As a result of this wide-body product softness, Airbus saw the value of its backlog fall below Boeing's in the first quarter of 2006, for the first time in five years.

Zoom

Crucial wide-body battleground. The 200-400 seat long range wide-body market will generate over 600 billion dollars in orders over the next 20 years. If Airbus loses the 300-400 seat market when the A340 fails, and only gets 25% of the 200-300 seat market (which the 787 seems capable of snatching from the A350), it may capture less than 100 billion dollars of this market.

However, if Airbus launches an all-new wide-body family to replace both the A340 and A350, the company can potentially secure at least 50% of the market as soon as the new family comes on line (the current A350 is scheduled to arrive in 2011, implying that an all-new plane would not arrive until late 2012 or 2013).

Medium-term Airbus woes. A decision to abandon the current A350 and to create a new family would restore Airbus's market position in the long run. However, it would have painful consequences for the next 6-8 years:

• Credibility issues. Airbus would be forced to admit that it launched an aircraft and made performance promises to customers well before the design was finalised. It would also tell the financial community that none of the booked orders were truly firm, implying softness across the product line.
• Short-term sales losses. Current A350 customers might defect to the 787, and short-term sales prospects fall to Boeing. The 787 would have at least five years alone on the market.
• A340 programme failure. A new family would necessitate giving up hope for the current A340 500/600 line. This would represent Airbus's first programme failure.
• Design resource drain. Around 2010, both players will begin new narrow-body programmes to replace their current A320 and 737 aircraft. If Airbus must spend heavily on a new wide-body design, it will have a difficult time finding resources for a new narrow-body. Abandoning this market segment (low profit, but 40% of the market by volume) is not an option.

EADS's other priorities. Even with the A380 burden, Airbus unquestionably sees the wisdom of funding a new wide-body family. Yet its parent company, the European Aeronautic Defence and Space Company (EADS), has its own concerns and constraints. Airbus has historically provided most of EADS's profits. However, there is no guarantee that Airbus still enjoys the political clout needed to dictate EADS's spending decisions. EADS is also focused on other issues:

• Buying BAE's share. BAE Systems, which owns a minority 20% stake in Airbus, announced in April that it wanted to divest its Airbus share. Acquisition of this BAE share has long been one of EADS's highest priorities, but it will cost about 3.5 billion euros (4.5 billion dollars).
• Attracting new investors. As BAE announced plans to sell its Airbus stake, EADS stakeholders Lagardere and Daimler Chrysler announced that they would sell some of their EADS holdings. Daimler will sell 7.5%, with another 7.5% scheduled for divestment within the next few years (leaving the company with a 15% stake, half Daimler's current share). Lagardere will also sell 7.5%. There should not be a problem floating these shares, even if the French government joins them in selling its EADS shares. However, companies that are widely held typically give shareholder dividends a higher priority than spending on risky and expensive new commercial projects.
• Defence expansion plans. EADS has other acquisition ideas that would divert resources away from Airbus. One of EADS's highest priorities is to grow its defence market presence, cementing its status as the EU's defence champion. EADS has discussed acquiring Thales, an expensive prospect -- Thales 2005 sales were 10.3 billion euros (see INTERNATIONAL: EU defence firms vie for US contracts - June 24, 2005; and see WESTERN EUROPE/US: EADS seeks inroads in US - March 8, 2005). EADS not only wants to acquire defence assets as part of a new strategy; it also wants to reduce its dependence on Airbus revenue.