|By George A. Haloulakos, MBA, CFA and Dr. Farhang Mossavar-Rahmani, DBA|
August 14, 2013
Now the world’s largest aerospace company, Boeing was founded in 1916 by William E. Boeing in Seattle, Washington. The company is composed of multiple business units: Boeing Commercial Airplanes (BCA); Boeing Defense, Space & Security (BDS); Engineering, Operations & Technology; Boeing Capital; and Boeing Shared Services Group. As top U.S. exporter, the company supports airlines and U.S. and allied government customers in 150 countries. Boeing’s products and tailored services include commercial and military aircraft, satellites, weapons, electronic and defense systems, launch systems, advanced information and communication systems, and performance-based logistics and training.
A Boeing lineup
Boeing Commercial Airplanes
Boeing has been the premier manufacturer of commercial jetliners for over 40 years. Today, their main commercial products are the 737, 747, 767,777 and 787 families of airplanes and the Boeing Business Jet.
Click for large version
Photo © Kevin Scott - Jetwash Images
The company has nearly 12,000 commercial jetliners in service worldwide, which is roughly 75 percent of the world fleet.
Boeing 307 in service with PAA (1940)
Click for large version
Photo © RAScholefield Collection
Through Boeing Commercial Aviation Services, the company provides round-the-clock technical support to help operators maintain airplanes in peak operating condition. Commercial Aviation Services offers a full range of world-class engineering, modification, logistics and information services to its global customer base, which includes the world's passenger and cargo airlines, as well as maintenance, repair and overhaul facilities.
Capital Investment Decisions
Capital investment decisions at Boeing are unique and—to some degree—risky. For example, in the mid-1950s, despite failing to profit on civilian planes in two decades, Boeing spent $185 million to develop the first American all-jet transport, the 707, despite not having made money in a non-military plane in twenty years, Boeing spent $185 million to develop the 707, the first American all-jet transport. To put this in context, this capital investment was $36 million or 25% more than Boeing’s total net worth of $149 million in 1956!
Cockpit of one of the last Boeing 707s in commercial passenger service
Click for large version
Photo © Sam Chui
Boeing’s attitude toward risk can be better understood if we look at the company’s earnings during that time. From 1946-49, Boeing’s average annual net income was less than $1.4 million. From 1950-53, average net income increased to $12 million as the company benefited from its military aircraft business, led by its signature B-52 jet bomber. Since the cost of building a prototype commercial jet aircraft was estimated to be $15 million (versus the eventual/ actual cost of $16 million), Boeing determined it was too great a risk as a stand-alone project. The numbers implied such a project would put the entire company at grave financial risk. At that time airlines were reluctant themselves to commit their financial stake entirely on reliance or use of jet aircraft alone.
However, Boeing determined the risk of launching a commercial jet aircraft was worth undertaking given the following additional considerations. As it turned out, Boeing’s B-52 jet bomber fleet deployment worldwide necessitated demand for a tanker jet-aircraft for refueling purposes. Existing prop aircraft flew too slow and too low for efficient refueling. Given the aforementioned sharp increase in average net income, Boeing determined that the $15 million+ cost to develop a prototype 707 would be less risky because it would be designed to serve two (instead of one) potentially very large global markets, thereby lowering risk and increasing expected returns.
In 1955, Boeing secured an order for production of 400 military units from the US Air Force for its 707 model, equal to the projected (and eventual) installed base of B-52s for US Strategic Air Command.
KC-135 series still in service with USAF
Click for large version
Photo © Titan Miller
With this strong endorsement of the 707 aircraft and burgeoning world travel, commercial airlines started to express interest. Boeing was able to differentiate itself from both foreign and domestic competitors by maintaining flexibility with its own customers. Specifically, Boeing was able to widen its cabin space by four inches with minor engineering and tooling costs plus retain the core features incorporated into its military prototype. This enabled Boeing to have faster time-to-market deliveries and higher absorption rate of fixed overhead for both military-and-commercial aircraft assembly operations. Total 707 commercial deliveries were 1011 (from 1958-94).
During the 1954-58 cycle in which Boeing invested heavily in the 707, corporate Net Income was stable-to-lower while Total Liabilities increased 2.3 times. In 1954, Net Income and Total Liabilities, respectively, were $32.4 million and $171.9 million. By 1958, Net Income was $29.4 million and Total Liabilities were $403.7 million, or Total Liabilities exceed annual Net Income by a factor of 13.7. By comparison, during1950-53, average Total Liabilities exceeded average annual Net Income by a factor of 12.
Investors initially responded positively to the new project. The Company’s stock price reached a high of $79.63 in 1955 and then fluctuated for the next three years going down to $36.62 in 1957 and then up to $45.62 the following year.
In sum, Boeing did “risk the company,” as measured by the cost to develop the program ($185 million) versus its net worth ($149 million) with the prototype exceeding its average annual Net Income ($16 million versus $12 million) over the same period. But this risk was tempered by leveraging the cost over two end-user markets rather than one. Additionally, Boeing established a sales-and-earnings platform on an already strong, well-established business (defense/military) that could be adapted for creating a civilian commercial segment. Earning power as measured by Net Income increased at about the same rate (2.5x) as the increase in Total Liabilities (2.3x) when measuring the 1954-58 period with the pre-707 era of 1950-53.
The original 707 prototype after her refurbishment prior to enshrining at the Smithsonian Air and Space Museum.
Click for large version
Photo © Andy Vanderheyden
A close up view of the 707 prototype
Click for large version
Photo © Suresh A. Atapattu
Click for large version
Significant financial payback took longer to occur. While Boeing achieved breakeven with the 707 in late 1956, the long-term nature and large capital investment for the aircraft business meant that it took 10 years for the 707 to reach peak-production while simultaneously helping the company achieve peak-earnings in 1967-68. Unit deliveries for the 707 in 1967-68 were 118 and 111, respectively, as company Net Income exceeded $83 million both years.
After the 707: SST, Wide Body Jet Aircraft, Bigger Bets and Bigger Risk
By the mid-1960s, Boeing had firmly established itself as a leader in commercial jet aircraft with the 707 as its flagship product worldwide. In anticipation of demand for supersonic jet travel, and with airlines extrapolating the shift of passengers from trains and transoceanic ships into a need for wide-body jet aircraft, Boeing made an even bigger bet by simultaneously pursuing both markets. Boeing did this without having the military aircraft market as a “hedge” or back-up like it did with the 707. Boeing appeared to be flying high with Net Income topping $83 million in 1967 and 1968, concurrent with triple-digit unit deliveries of the flagship 707 aircraft each of those years. However, Net Income dropped 88% to $10.2 million in 1969 as economic slowdown, declining air travel and financial retrenchment by the airline industry caused 707 unit shipments to fall by nearly 50%. In such a weak economy, Boeing only delivered four 747s in 1969, which implied low absorption of fixed overhead and profit margin pressure. Federal funding of the SST was cancelled in 1971, forcing Boeing to take a loss on this project.
During a peak in the late 1960s and a bottom in 1971, the stock fell 88% as the development of a supersonic transport to compete against the Concorde was called off. And in response to the sharp decline in demand for commercial jet aircraft, Boeing cut its commercial aircraft workforce from 83,700 in 1968 to 20,750 in 1971.
The only reason Boeing did not fail was due to the financial offset by its strong, stable military business in the form of its Minuteman and Cruise missile programs. Eventually, the long-expected increase in air passenger travel materialized and the accompanying need for wide-body jet aircraft gained momentum with Boeing’s 747 as the prime beneficiary.
Boeing’s financial resurgence, its diverse family of aircraft (narrow-and-wide body models) able to serve all worldwide markets and its strong, stable military business enabled it to outlast and outdistance its competitors. Lockheed exited commercial aircraft in 1981, with McDonnell Douglas and European Air Bus remaining as prime competitors, but with far fewer product offerings versus Boeing. By 1997, McDonnell Douglas was acquired by Boeing, thereby eliminating it as a competitor.
The commitment of capital and time associated with being a leader in commercial aircraft would appear to support a “bet the company approach” with each successive generation of new jet aircraft. However, Boeing has utilized different tactics to achieve financial success and maintain its market leadership. The 767 was the company’s first twin-jet wide-body model; the 777 was the first “fly by wire” airliner and the first computer-designed commercial jet aircraft; the 787 is comprised of over 80% composite materials enabling it to be more fuel efficient due to significantly less weight. Boeing has diversified (and thereby lowered) its risk by outsourcing manufacture of key components and sections of its aircraft models while retaining the design, development and final assembly functions.
This lower degree of vertical and horizontal integration versus the approaches taken in its 707 and 747 models has enabled the company to more efficiently utilize all its resources while still taking the necessary risks to maintain its leadership. As noted earlier, the success of Boeing’s 707 and 747 programs can be partly attributed to the company’s core competency in military and defense sectors. The 707 was launched on the basis of potentially, and ultimately serving two very large markets, commercial and military. Thus, the company’s missile business was able to sustain Boeing’s overall financial viability while the company weathered the industry downturn in the early 1970s. As the company launched its later generations of jet aircraft, military/defense business remained a key contributor to overall corporate success for the same reasons noted for the 707 and 747. The company’s strategic posture was further strengthened when Boeing acquired McDonnell Douglas, which was the largest military aircraft player.
Photo © Ben Wang
Boeing’s “bet the company strategy” appears to have successively increased earnings power (measured by Net Income) with each generation of new commercial jet aircraft. Each new revolutionary jet aircraft program eventually is the primary driver in raising total Net Income by several-fold (versus the cycle immediately prior to it). The 707 led to a 2.5x increase in Net Income (late 1950s/early 1960s versus mid-1950s) and by 1967-68, Net Income was 2x higher than its 1961 level. The 747 helped Boeing surpass the 1967-68 peak by a factor of 7-times by 1980, with the 767 and 777 programs leading to an eventual 7-fold improvement in Net Income by 2011 versus 1980. For more information, please see Exhibit 1.
Boeing’s success in commercial jet aircraft stemmed from its military aircraft business in terms of risk sharing (e.g., 707 and its military KC-135 version) and diversification. The strong position in defense-related projects (e.g., Minuteman and Cruise missiles) provided stable, steady cash flow for the entire corporation thereby providing an additional financial cushion to undertake development of new generations of jet aircraft. The acquisition of the largest US military contractor, McDonnell Douglas, further strengthened Boeing’s corporate business portfolio in terms of earnings, cash flow and diversification.
Cyclical, financial and execution risks remain perennially relevant for the commercial jet aircraft business. However, Boeing has a proven performance record of being able to maintain its market leadership and increasing its earning power with each generation of new aircraft. This includes, but is not limited to, accommodating unique customer demand requirements on a global scale, rationalization in down cycles, improvement of assembly and manufacturing processes and either buying out (e.g., acquiring McDonnell Douglas) or driving out (e.g., Lockheed) its major US commercial jet aircraft competitors.
While Boeing’s stock price has been cyclical, investors have learned to be patient every time the company undertakes a bigger bet when launching a new generation of aircraft. In general, as shown in Exhibit II the price of stocks have been more in line with future orders rather than net profit.
Air International. “367-80(707 Prototype)” – N.P., N.D.
Boeing Company. Various public company documents, 1950 – 2012.
Boeing 747-400, Aircraft of the World. N.P.:International Master Publishers., N.D.
Boeing 777-400, Aircraft of the World. N.P.: International Master Publishers, N.D.
Connolly, Patrick. "'Old Bird' Ushered in Jet Era." Page A-40; The San Diego Union [San Diego, CA] 8 Oct. 1978, Weekend Edition, Business Section.
Fortune Magazine. “The Selling of the 707.” October, 1957.
Green, William (compiler) and Punnett, Dennis (silhouette artist). The Observer’s Book of Aircraft. Frederick Warne & Co. (London and New York). 1965.
Haloulakos, V.E. Aerospace Engineer, Scientist and Professor. (BSME, MSAE and ENGR.D. Viterbi School of Engineering, University of Southern California).
Harris, Neil. "Boeing 747: Constructing the Colossus." FLIGHT Internationa.l December 19. 1968: Page 1027.
History Link.Org – Washington State History.
The San Diego Union [San Diego, CA], "Boeing Jet's First Flight Called 'A-ok.'" September 27, 1981: Page A-4.
Securities & Exchange Commission (SEC) EDGAR System – 10 K Reports.
Thompson, R. G. "Dash 80." Air and Space Magazine. April-May 1987: Pages 63-65.
Wharton Research Data Service.
Ku, Yueh Su. Financial Research/Data Mining. UC San Diego Extension – Finance Certificate post graduate student.
Shannahan, MeglynAnne Price. Industry/Economic Research. UC San Diego Extension – Finance Certificate post graduate student.
George A. Haloulakos, MBA, CFA and Dr. Farhang Mossavar-Rahmani, DBA
George A. Haloulakos, MBA, is a Chartered Financial Analyst [CFA] and consultant: DBA Spartan Research and Consulting, Inc. specializing in finance, strategy and new business ventures (1995-to date). Author of DOLLAR$ AND SENSE: A Workbook on the ABCs of Investments, George has published over 300 security analyst reports on diversified companies and industries. Lifetime member of Strathmore's Who's Who Registry of Business Leaders with over 30 years of experience in the aforementioned areas that includes corporate business experience (1981-1994) in asset management, securities research and investment banking, and as a university instructor (1998-to date) in finance, economics, management and mathematics. George holds an MBA in Finance and BS (Summa Cum Laude) in Quantitative Business Analysis from the Marshall School of Business, University of Southern California, where he was a graduate assistant in finance & business economics. In addition, he holds Certificates of Completion from the Holy Cross Greek Orthodox School of Theology and Monterey Institute of International Studies. He is a member of the ordained clergy of the Orthodox Church in America with the rank/title of Reverend Protodeacon.
Co-author: Dr. Farhang Mossavar-Rahmani, DBA
Finance Department Chair, National University