Abstract Airbus has been making headlines in the past few months for all the wrong reasons. This iconic European corporation has undergone a turbulent period due to the problems surrounding the Airbus A380 project. A new flagship product that should have curved out an unassailable advantage for Airbus over Boeing went completely wrong. The Airbus A380 aircraft was a ground breaking concept that was meant to push EADS into a unique market segment.
Instead, it threatened the very existence of the company and served as a catalyst for major surgery and a complete reorganization of the corporation starting from the top management down to the production floors. Numerous studies have been undertaken that have documented details of the Airbus A380 project and what, how and why it all went wrong. The company and other stakeholders have been undertaking drastic steps to try and put the company back on track and ensure the survival of the commercial aircraft business unit. In this study we look at how the problems surrounding the Airbus A380 project have affected the financial health of EADS.
The background to the problems and the financial performance of Airbus is studied and presented. A brief discussion of how the data we collected and used for the study and the data that we could not get access to is also presented early in the paper. From the data and analysis, a comparison of the two dominant players in the commercial aircraft manufacturing industry, Airbus and Boeing, is also undertaken. A brief highlight of the financial impact of a project in the computer/consumer electronics industry is also presented. Finally from these data and prior studies on this subject, we have tried to highlight the
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impact of the project on the short and long term financial direction of EADS. Table of Contents List of Tables6 6 List of Figures7 1 Introduction8 2 Theoretical Framework14 3 Data Collection25 4 EADS – Background and Analysis27 5 Boeing – Background and Financial Data50 6 Comparative Analysis of EADS and Boeing 59 7 Other Factors that Affected the Financial Health of EADS69 8 Long-Term Prospects72 9 Comparison to a Project in a different Industry78 10 Conclusions79 81 11 Future Work82 12 Reference List83 List of Tables Table 4. 1 Business Segment Data of EADS……………………
36 Table 4. 2 Consolidated Cash Flow Statements of EADS…. 36-37 Table 4. 3 Consolidated Income Statement of EADS………….. 40 Table 4. 4 Consolidated Balance Sheet of EADS……………… 40-41 Table 5. 1: Consolidated Statements for Boeing……………… 55-57 Table 5. 2: Income Statements for Boeing………………………. 57-58 Table 5. 3: Consolidated Cash Flow Statements of Boeing… 58-59 Table 8. 1: The Order Book for A380 Aircraft…………………… 76-77 List of Figures Figure 4. 1: EADS stock ownership…………………. 29 Figure 4.
2: EADS management structure…………….. 31 Figure 4. 3: Airbus management structure…………… 32 Figure 4. 4: EADS divisions and revenue……………. 34 Figure 4. 5: EADS share price (25 Nov 05 to 25 Jun 07)…. 49 Figure 5. 1: Boeing distribution of stock……………. 51 Figure 5. 2: Boeing divisions, revenue and activities.. 52 Figure 5. 4: The management structure of Boeing…….. 54 Figure 6. 1: Working Capital – Boeing Vs EADS………… 61 Figure 6. 2: Revenue – Boeing Vs EADS………………… 64 Figure 6. 3: Airplane Delivery – Boeing Vs EADS……….
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65 1 Introduction The commercial aircraft industry requires huge capital investments in manufacturing and research and development. This is a very competitive sector where industry consolidation has resulted in the emergence of two major players from either side of the Atlantic, EADS in Europe and Boeing in the United States of America. The two form a duopoly with market leadership in the sector largely rotating between these two corporate giants depending on the market dynamics. Commercial airlines and other air transport operators form the bulk of the customers.
Governments are also important customers. The government involvement in the sector extends to investing, supporting (Aboulafia, Richard, 2000; O’Neal, Michael, 1990) and regulating. Any problems in the industry have implications that go well beyond the confines of the affected companies. Governments therefore subsidize and invest in aircraft manufacturing and research and development. This also serves to protect the highly skilled jobs in this sector and ensures that the respective countries remain technologically competitive (Wall, R.
& Sparaco, P, 2007).
Big companies play an important role in the economics of the countries they operate in. They influence the conditions in the industries and directly impact employment rate in the countries where the manufacturing takes place. EADS and Boeing are the leading competitors in the aircraft manufacturing industry and demonstrate the high level of political interest in this sector and the way governments try to influence the business decisions made by such corporations (Wall, Robert & Jens, Flottau 2007; Barrie, Douglas 2007).
1 Problem Definition Airbus is a subsidiary of EADS that has been a global leader in the manufacture of commercial aircraft. The launch of the A380 aircraft project was expected to become a huge success and elevate EADS to a new level of market domination. But following production delays and the cancellation of some orders for the A380 aircraft by some customers, the company found itself in a difficult position. The failure of a challenging project such as the A380 project can have far reaching financial consequences that could lead to bankruptcy.
... .For airline companies to survive, they now have to find other means of acquiring aircraft. Boeing Capital Corporation offers these airline operators financial alternatives ... many strong alliances with many other globally powerful companies. In defence projects Boeing works closely with Northrop Grumman in programs such as the ...
It could also serve to expose weaknesses and inefficiencies in the structure of an organization that could be a major hindrance to the success of a company. The popular media and professional journals have been full of news and articles concerning the problems with the A380 aircraft and Airbus in particular. The list of problems include workforce discontent, possible reduction in production activities, delivery delays, customer dissatisfaction and a lack of new orders, to mention only a few. The complex set of problems extends to the influence EADS has that can cause significant economic problems in the concerned countries.
Numerous studies and articles have been written about EADS and the A380 project that catalogue the various organisational, technical and financial problems associated with the manufacture of the A380 super-jumbo aircraft. A systematic evaluation of the financial consequences of the project has not been carried out. 1. 2 Purpose The purpose of this research work is to evaluate the impact of the A380 project on the financial health of EADS. The following questions will be addressed: In the short run, what effect has the A380 project had on the financial performance of EADS?
In the same period, what was the financial performance of Boeing, the direct competitor of EADS? Should EADS continue supporting the A380 project with additional financing? What long term financial impact will the A380 project have on the future of EADS? Finally, in order to fulfil the purpose we will also briefly discuss other factors that influenced the financial health of EADS, in addition to the A380 project 1. 3 Research Methodology The first stage of this research will involve reviewing the information that is available about the aircraft manufacturing industry with a focus on information about EADS and Airbus.
Our focus will be on financial information. As a public company, EADS is obliged to publish financial data about the corporate structure and financial information containing revenues, profits and sales orders per EADS division such as Airbus. The A380 has been a major project at EADS for the past few years that has taken substantial preparations and investments amounting to significant annual expenditures (Thomas, J. , 2001; Gummesson, E, 2006).
The main thrust of our research will be quantitative for aspects where we shall obtain the financial data needed to do the analysis.
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We shall also employ a qualitative approach to evaluate the leadership and organizational structure at EADS. To evaluate the financial impact of the A380 project on EADS, our primary focus will be on financial and ratio analysis of the company. We will examine the financial statements from EADS. This quantitative analysis will include the period from 2004 to 2005 that preceded the initial announcements delivery delay of the A380 as well as the period following the announcements, from 2006 to the first quarter of 2007.
To analyze the changes in profits, revenues and cash flows, we will perform a comparative analysis of the years from 2004 to 2006 and evaluate the first quarter of 2007 in comparison to the first quarter of 2006. We will explore what influence the Airbus A380 project has had on the financial health of EADS. In order to get a clearer picture of the financial health of EADS, we will compare the financial performances of EADS and its main competitor, Boeing. The financial statements of Boeing Company are also generally available as it is a public corporation.
Boeing has a similar structure, is engaged in the same activities and is comparable in size with EADS. Boeing also operates in the aircraft manufacturing industry, with its commercial aircraft unit also being the major part of the company’s activities. Therefore, the cross-company financial analysis between EADS and Boeing will provide some useful insights into the scale of the finanicial problems. Some A380 aircraft customers have already cancelled their orders and moved to Boeing instead. Since these two companies form a duopoly, most customers that leave EADS for Boeing increase the market share for Boeing.
The foreign currency exchange rates between the US dollar and the euro have had an impact on the competitiveness of EADS. The manufacturing plants of EADS are located in Europe. The basic bills are paid in Euros (salaries, taxes etc), while customers outside Europe settle their contractual obligations in US dollars. The lead time between contractual agreements and actual aircraft deliveries, coupled with fluctuating US dollar versus euro exchange rate influence the financial performance of EADS.
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Depending on the direction the change takes, it can add to the losses from the A380 project, especially with the lead time from the date of agreement to the date of delivery being stretched by the delays The US dollar to euro relationship is therefore an area of interest, we will therefore analyze trends in exchange rates and evaluate its impact on EADS. We will also evaluate trends in stock prices of EADS and compare them to ones of Boeing. This will allow us to see how the market value of the company was affected by the A380 crisis and delivery delays.
The market values of stocks are important indicators of financial stability and are of special interest to investors. Trends in the stock price will also show the possible direction of the company. A review of the financial position of EADS, that will include cash flows, revenues in total, total revenues and profits, revenues and profits by divisions in the period starting from 2005 to 2007 (both within the company and in comparison with Boeing), together with review of stock prices and exchange rates in 2005-2007, will help paint the picture of the A380 project impact on the short run financial performance of EADS.
Evaluation of trends in profits and cash flows of EADS and review of order and delivery book of Airbus, the major source of revenues and cash flows for EADS will reveal the possible future direction of the company. Upon reviewing the trends in financial position of EADS (through ratio analysis) and examining the order or delivery book of Airbus, taking into account that this type of business involves cash transfers and recognition of revenues upon fulfilment of contracts, we will be able to determine how much of a burden the A380 project is for EADS and if the company can carry on without significant financial reorganization.
Finally, we will briefly examine other factors which could additionally influence financial health of EADS. The corporate structure and leadership issues have important bearing on the operations of a company and could also influence financial state of a company. Our evaluation will be based on information from the companies on the existing organizational structures and scientific articles where available. Among others, the following issues will be examined: the composition of the Boards such as the number of independent directors and how focused the Boards are on business activities and how independent they are when making decisions.
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This will give us some insight into the efficiency of EADS as an organization, which has an indirect influence on profitability as well. The dynamics of exchange rates influence financial health of EADS as the company is based in Europe but sells big part of its products overseas. We will use data on exchange rates obtained from business media sources for this analysis. 1. 4 Possible Limitations We will be unable to accurately estimate certain values without sufficient data. This is a complex case, with several interrelated issues.
We will use the available data. The available data will be sufficient to make qualitative conclusions as is usual in case studies. For example, without knowing the values of discounts offered to some customers, the values of penalties incurred, the impact of some customers exercising the option to buy alternative aircraft from Airbus, we may be unable to make exact quantitative conclusions on losses and net cash outflows from the project. We cannot definitely determine sources and values of external (from other projects) financing for the A380 project.
We would liked to look at the A380 project appraisal (preferably with more comprehensive appraisal method, like NPV), but it will not be possible to do this as we will lack exact data necessary for this type of evaluation. The A380 project is an evolving story that has new developments all the time. The data from primary data that we sourced from some company’s websites may be skewed in favour of the respective companies as there is tendency for companies to put emphasis on positive information. 2 Theoretical Framework 2. 1 Introduction
According to Brealey et al, 2006, managers are agents of the owners of the company, the shareholders. The manager’s main goal is to increase the value of the shareholders’ wealth. The board of directors are part of the corporate governance system and are meant to oversee the performance of the managers and strategic direction of the company. The board ensures that the managers are adequately compensated for the day to day running of the corporation and have the mandate to replace the managers if they do not deliver shareholder value or , among other reasons do not conduct the operations ethically or legally.
There are several methods to evaluate potential success of a project in a company. This is an important step. In a large company and/or if a significant investment opportunity is considered, investment appraisal methods, such as NPV (Net Present Value) are applied. To analyse the impact of the A380 project on EADS, our approach was to look at the problem from three angles: the financial angle, the organisation structure (leadership and governance) and to compare EADS to a similar organisation. The theoretical foundations that we base our analysis on are described in the following sections of this chapter.
2. 2 Assessment of the Financial Health 2. 2. 1 Financial Statements – Ratio Analysis Potential investors, as well as other interested parties, always analyze past/present financial performance of a company before making investment. This is necessary to evaluate possibility of future returns. Trends in profits and cash flows of past few years not only show how effective was a company in the post, but can also indicate future direction of a company. Probably the best way to evaluate possible return from investment is by analyzing data available from financial statements of a company (40).
The major financial statements are: Statement of Balance Sheet, Statement of Cash Flows and Income Statement. Income Statement is intended to disclose revenues and expenses, as well as profits of a particular period. It should be noted, that profits are often different from cash flows, as items like depreciation of fixed assets are not taken into account in net cash flow calculations, but they do influence profits. Statement of Balance Sheet shows the financial position of a company at a particular point in time. Namely, it shows the values of assets (both current and non-current), liabilities (both current and non-current) and equity.
Following balance of Balance Sheet components is always maintained, if the statement is correctly prepared: Assets-Liabilities=Equity Statement of Cash flows discloses the way all cash resources have been used throughout a particular period of time. Cash Flow Statement consists of three basic parts: Cash Flows from Operating Activities, Cash Flows from Investment Activities and Cash Flows from Financing Activities. Income Statement, Statement of Balance Sheet and Cash Flow Statement can be analyzed to find out how effective the performance of a company in the past was and to forecast, what can be expected in the future.
It should be pointed out, that basic financial statements of listed (parent) companies are readily available to general public (through company web sites, etc), while financial statements of subsidies (“daughter” companies), like Airbus, usually are not readily available. A. Millichamp, 1997, suggests three methods for assessing financial performance. Each figure (or number) in the financial statement should be compared with: 1) The corresponding figure of previous statements 2) The corresponding forecasted (budgeted) figure 3) The corresponding figure of another company in the similar business
While comparison of subsequent statements of a company is important (to see improvements/backward steps etc), it is sometimes even more important and interesting to see how well a company is performing in comparison with direct competitor (e. g. in our case Boeing vs. EADS).
The first method of assessment shows trends within a company, while cross-company evaluation shows if those steps are more effective than the ones taken by a competitor. Third method of an evaluation (i. e. comparison with budgeted values), while definitely being important, usually cannot be performed by an outsider, as budgets (i.
e. internal data) are rarely disclosed by companies. While comparison of absolute values of financial statements is often performed, comparison through financial ratios is frequently more relevant. Many financial values are inter-related. Besides, some trends are better seen through relative analysis of values, for instance, when two companies construct their financial statements in different currencies. Boeing does this in US dollars while EADS uses the euro. According to Williams et al, 2005, (p606): “Ratio is a simple mathematical expression of the relationship, of one item to another.
Every percentage may be viewed ad a ratio-that is, one number expressed as a percentage of another”. 2. 2. 1. 1 Ratio Analysis Assessment of three basic types of activities can be conducted to evaluate overall financial performance of a company (35).
Changes since previous period show short term improvements/steps backward, while overall trends in years can also indicate what can be expected in the future. These three activities are: Liquidity, Profitability and Gearing/Leverage. It should be noted, though, that this is not a strict classification and some ratios may “belong” to more than one performance appraisal subgroups.
For better representation of subsequent statements, they are usually placed next to each other and percentages of each corresponding values are also given. 2. 2. 1. 2 Liquidity Measures Liquidity of a company refers to its ability to manage short term obligations. Short term obligations are those ones, which should be repaid within a year. In other words, it is an ability to repay current liabilities with available current assets. Current assets are assets readily convertible into cash. While current liability is an obligation which should be settled within a year.
The basic term often used in relation to Liquidity is Working Capital. Simply, it is an excess of current assets over current liabilities. Basic ratios used to assess liquidity of a company are: 1) Current Ratio=Current Assets/Current Liabilities It is a measure of how well are current liabilities covered by current assets. To some extent, the more it is (hopefully over 1. 5), the better it is for a company, but too high Current Ratio may imply that current assets are not entirely utilized. 2) Quick Ratio=(Current Assets-Inventories)/Current Liabilities
It is a similar measure to Current Ratio, but with the exclusion of inventories-the least liquid current assets. Sometimes it is a more relevant measure. Again, a value of Quick Ration in excess of 1 is usually expected, but it varies from industry to industry. 3) Working Capital Cycle is considered to be an important illustrative measure of Liquidity. It is calculated in days/months. By Working Capital Cycle we measure the period from the date purchase of raw materials to the date of cash collection from products manufactured from those materials.
Working Capital Cycle equals: Period to collect cash from customers+ period to turn over inventories- period to settle trade liabilities Days to collect cash from customers= (Average Receivables/Sales Revenues) x 365 Days to turn over inventories = (Average Value of Inventories/Cost of Sales) x 365 Days to settle trade obligations = (Average Payables/Cost of Sales) x 365 If average values are not available, year end values can also be used. Generally, the shorter is the Working Capital Cycle, the better it is for a company, as it is an indicator of effective performance. 2.
2. 1. 3 Profitability Measures Profitability ratios can help us evaluate trends in profitability and help us find out if a company earns sufficient profits in comparison with available resources. One thing should be noted here. If a company has a very high profitability but low cash balance, it can lead to a collapse-company can run out of cash. It is called Overtrading. On the other hand, excessive cash balance with corresponding low profitability is an indicator of Overcapitalization-sign of inefficient use of available resources (assets do not generate sufficient profits).
Trends in Profitability can be measured both in absolute terms and with the use of ratios. Following measures are used: 1) Gross Profit Percentage: Gross Profit/Sales Revenue It is an indicator of what is percentage of Gross Profit from Sales Revenue Earnings per Share: Earnings for Ordinary Shareholders/Number of Outstanding Shares is an indicator of earnings for one share. Two important measure of profitability are also used to evaluate the efficiency in use of assets and equity to generate profits. Return on Equity = Net Profits/Value of Equity
Return on Assets = Operating Profit / Value of Total Assets Maintenance of high levels of profitability is the primary objective of a company. It is a sign of relatively safe continuity. But as it was stated above, high levels of profitability should not be confronted with low Liquidity. 2. 2. 1. 4 Measures of Gearing and Leverage By Gearing we mean the ability of a company to meet long term debt obligations. Debt composition of Balance Sheet is an important indicator of Gearing. Higher share of long term debt in comparison with to equity is an indicator of higher Gearing.
While, generally, long term debt is considered to be the least expensive source of finance (less expensive than common stock issue), too much reliance on debts puts accompany into danger, as interest on debt should be repaid (unlike dividends) regardless of profitability level. Good indicator of Gearing is the Debt Ratio: Debt Ratio= Total Liabilities/Total Assets Another indicator of Gearing is Interest Cover: Interest Cover= Profit before Interest and Tax/Interest Expense The higher it is, the easier it is for a company to settle its long term debt interest.
This ratio is also related to Liquidity of a company. All above mentioned ratios are calculated from Statements of Balance Sheet and Statements of Income. Additionally, examination of Cash Flow Statements can reveal how cash is used in a company, which items of the statement are seem to generate more/less cash than was expected and by how much has cash decreased/increased in the considered period. 2. 2. 2 Limitations of Financial Evaluations using Ratios Financial analysis through ratios is an important and useful method to evaluate financial performance of a particular company.
But this type of evaluation has its limitations. One can never make convinced conclusions purely based on ratio analysis. One of the reasons can be so called “window dressing”, i. e. a case when a company intensively “improves” performance by the end of accounting period to make year end financial statements look “attractive”. This can lead to incorrect assessment of a company. Besides, measures used in financial analysis are relative measures, which indicate to relative changes and therefore do not always allow us to make absolute judgments on companies (Millichamp A, 1997; Williams R.
et al, 2005).
Nevertheless, comprehensive (including cross-company) evaluation of company performance through financial ratios can disclose not only past problems of a company but even allow us make forecasts on future financial health of the company. This evaluation is well supplemented by other non-ratio financial indicators, like stock price trends and (where relevant) trends in currency exchange rates. 2. 2. 3 Stock Prices The wealth of shareholders in a company is generated from: 1) Dividends received; 2) Market values of shares
Return from investment to shareholders can be generated from both received dividends and from capital gain due to increase in value of shares. Very important measures a company value is market value of all its outstanding shares. In order to increase the value of a company, management should achieve high profits so that it could distribute higher dividends and insure high values of shares (to allow higher capital gains).
When market value of shares is low, the possibility of takeover from an outsider company is more likely.
What is also significant, value of shares and trends of share prices are very important indicators of a company financial health for a potential investor. It is taken into account together with financial statements of a company (Millichamp A. 1997, Brealey R. et al, 2006).
2. 3 Additional Factors that can affect the Financial Health In this section we look at other factors that can have a bearing on the finances of EADS as factors like corporate structure, leadership and foreign exchange rates can have an influence on the financial stability of a company or indirect impact on projects within a company.
The indirect influence of factors like corporate structure and leadership is reflected in the ability to avoid or reduce the negative impacts caused by a project while fluctuations of exchange rates can magnify losses or profits from projects when exchange rates are either favorable or unfavorable. However, the primary purpose of this thesis is to look at the impact of the A380 project. 2. 3. 1 Leadership The corporate culture, leadership and governance of a corporation influences the way the success of a company. Dubrin A. , (2007) has further catalogued the types of leadership characteristics that are needed for organisational success.
These are especially relevant in organisations of the scale and complexity of EADS or Boeing that depend on the creativity and the innovation of the workforce. Dubrin also describes leadership traits needed to effectively manage international or geographically dispersed companies that are also culturally diverse are also. Other characteristics that have relevance to our subject matter relating to Airbus and EADS include teamwork, leadership development, succession and transformational leadership skills are required to lead an organisation through a crisis.
This list is not exhaustive, it only seeks to provide a brief background to some of the leadership failures that could have led to the problems at Airbus, impacted on organisational efficiency and subsequently translated into financial woes for the company. 2. 3. 2 Corporate and Governance Structure Organizational structure can play a vital role in the performance of a company. The way the board of directors coordinate performance of top management and the manner it communicates with groups of shareholders is often as important as contemporary financial health of a company.
The central role in organizational structure belongs to board of directors which usually consists of 8-15 members in a large corporation. The board should be independent to ensure independent and objective reporting and decision-making of the board (15).
According to Walter J. Salmon: “Inside directors are often too committed to tradition and their new ideas. Outside directors, without independent sources of information are usually only capable of anaemic discussion and dissent. The result: consumers, competition, technology, and the economy may all change, but the company fails to keep up” (15, p4).
According to Walter J. Salmon, a board of 8-15 members is optimum, with at least 2/3 of it being outside directors. An empowered board (15) has the ability and independence to monitor activities of management and to influence top management to revise their activities if their performance does not correspond to the strategic direction of a company determined earlier. The board should monitor the performance of the CEO and interfere if the company moves in the wrong direction to improve things before further damage occurs. The following steps are essential for Board empowerment (15):
Directors receive independent and competent information on the performance of a company in the most easy-to-understand format The board consists of independent, competent members. It is an integrated board. Members of the board freely and frequently communicate with each other The board members also monitor the performance of the board itself. They set objectives for themselves and try to achieve them. 2. 3. 3 Governed Corporation vs. Managed Corporation According to John Pound, there are two types of organizational structures: a governed corporation and a managed corporation.
The board of directors has a passive role in a managed corporation. Its main tasks are monitoring and selection and appointment of top management. The managers retain all leadership and decision-making rights (15).
It is not considered to be the best governance model nowadays. Today many problems of large organization do not stem from power imbalances, but rather from poor decision-making. The governed corporation model proposed by John Pound is designed to remove the imbalances of the managed corporation model. It is centred on the decision making process in the company.
The board of directors, top management and shareholders are more integrated and share responsibilities in decision making and formulation of the strategic direction of a company. Managerial duties are retained by CEO’s, but the board is not a passive onlooker. 2. 3. 4 The Impact of Foreign Exchange Rates Exchange rate of a currency is a rate at which one country’s currency can be traded in exchange to another country’s currency. Basically, exchange rate is determined by supply and demand of currencies at exchange markets.
Following factors influence exchange rates: Government policy to influence exchange rates (limitation of maximum exchange value etc) Interest rates in the countries of those currencies The rates of inflation in those countries Trends in exchange rates (Euro to Dollar) can become a source of troubles for both importers and exporters of products, because “actual” amount received by them can fluctuate as exchange rates vary (35).
There are some measures to be taken in order to avoid or reduce negative influence of exchange rates: 1) Contrac