Business

ON A WING AND A PRAYER

For years, Bombardier has existed on government subsidies. It’s time for that to end, says PETER HADEKEL.

September 19 2005
Business

ON A WING AND A PRAYER

For years, Bombardier has existed on government subsidies. It’s time for that to end, says PETER HADEKEL.

September 19 2005

ON A WING AND A PRAYER

Business

For years, Bombardier has existed on government subsidies. It’s time for that to end, says PETER HADEKEL.

TO HEAR BOMBARDIER chairman Laurent Beaudoin tell it, the Montreal-based maker of airplanes and trains is in the midst of a long-awaited turnaround. But if the events of the past few weeks are any indication, it is still a company in a tailspin.

Paul Edwards, the highly regarded head of Bombardier’s business jet division, resigned suddenly last week without explanation, raising troubling questions about what’s happening behind the scenes at the company. His defection comes on the heels of unsettling secondquarter results, which triggered a seven-per-cent drop in the stock in late August, as in-

vestors fretted about declining sales of 50seat regional jets.

On the surface, things looked to be improving—earnings and profit margins are up. But the market isn’t biting. All this turmoil has only sharpened the focus on Bombardier’s turnaround plan, which relies heavily on a proposed new jet with no engine supplier, no launch date, and so far, no buyers. If Bombardier’s proposed C-Series can carve out a piece of the market for larger, more fuel-efficient passenger planes, it could mean stable revenues and jobs for years to come. But that’s a very big if, and without it, the company’s future may be in jeopardy.

Bombardier says it’ll decide by the end of the year whether it can proceed with the CSeries. But now it must do so against a backdrop of a dismal share price, management upheaval, and fresh questions about the company’s long-standing reliance on government aid. The project would be backed by hundreds of millions of taxpayer dollars, and the critics are out in force, asking, isn’t it time for government to get out of the aerospace business? And isn’t it time Bombardier was left to sink or swim on its own?

IT WAS SPRINGTIME in Quebec’s business capital, and the heavy scent of pre-election politics was in the air. In Ottawa, a federal government was on the brink of defeat, and in Montreal, transportation giant Bom-

bardier Inc. was in need of a helping hand.

Transport Minister Jean Lapierre chose an aeronautical research centre on the campus of Université de Montréal to announce Bombardier would get up to $350 million in federal aid for the proposed C-Series family of passenger jets with 110 to 130 seats. At a May 13 press conference, packed with applauding scientists and engineers, Lapierre said the government must support the company because of the innovation, research and development it generates. “We cannot let our national champions fail,” said Stéphane Dion, the Liberal cabinet minister whose riding is home to one of Bombardier’s plants. “It would be like cutting off one of our arms.”

But the critics aren’t convinced. True national champions should be able to stand on their own two feet, and to many, Ottawa’s talk was thin justification for another round of corporate welfare to a company that’s had a free ride from taxpayers for years. Even in Quebec, where Bombardier is a corporate icon, people are asking why the world’s largest maker of rail equipment and the third largest manufacturer of commercial aircraft: has to depend so heavily on the public purse.

Investors are starting to ask some tough questions, too. Would Bombardier be worth anything without the government standing behind it? And will continued taxpayer support simply prolong the agony of a company struggling with losses and cutthroat com-

petition? “There are good businesses and bad businesses and usually governments are in the bad ones,” says Montreal investment manager Jean-Luc Landry of Landry Morin Inc. “People say, ‘Well, other countries do it, so we should do it, too.’ But that’s not an argument in the long run. If others want to spend money and throw it down the drain, why should we do the same?”

It’s become increasingly clear that taxpayers around the world are indeed throwing vast public subsidies down the drain in support of the aircraft industry. Boeing Co. was awarded US$17.3 billion in U.S. military contracts in 2003—plus the rights to the technology that comes with it. Airbus S.A.S., the European consortium, rolled out its new A-380 super-jumbo jet with the help of US$4 billion in direct investment from EU governments. Brazilian manufacturer Embraer SA, Bombardier’s main competitor in the regional jet market, has been backed by a government export-credit program even more generous than Canada’s.

Staying in the game is becoming more expensive all the time. “The stakes are getting higher and higher,” argues University

of Toronto management professor Joseph D’Cruz. “In fact, they are so high that no commercial company can afford to play. It’s only governments that can play this game.” But at what price? And how much is Canada prepared to spend before it declares victory, or defeat? The game is not only expensive, it’s often illegal. Handouts to aerospace companies frequently break international trade rules. Brazil and Canada fought a long war over the issue at the World Trade Organization, which in March 1999 ruled that both countries used improper

subsidies. And with its latest commitment to the C-Series, Canada risks triggering another costly trade dispute.

Besides the $350 million from Ottawa, Bombardier will get at least $110 million from Quebec to assemble the plane at a facility in the Montreal area—employing about 2,500 people. It’s also getting a $430million package from the United Kingdom so that its plant in Belfast can produce the wings, engine housings and rear assembly. (The remaining two-thirds of the $2.65-billion project would be financed by

suppliers and by the company itself.)

It’s a big gamble for taxpayers. Government contributions would be repayable only if sales of the new plane exceed an unspecified threshold—not very likely, given today’s troubled airline market. Sales of regional jets, which boomed in the 1990s, have fallen hard in the years following Sept. 11, 2001, and airline traffic in the U.S. has only just recovered to pre-attack levels. Airlines are in terrible financial shape, with huge debts and record fuel costs. Two major U.S. carriers— United Air Lines Inc. and U.S. Airways fricare in bankruptcy protection, while another, Delta Air Lines Inc., teeters on the brink.

Bombardier is hoping that a larger, more efficient plane, with operating savings of 15 per cent, will appeal to airline buyers. But there’s been little enthusiasm for the CSeries so far. While the board has given its conditional approval, no formal launch has been announced. Industry experts question whether there’s any demand for the proposed plane. “This thing has been dysfunctional from the word go, both on the supply side and the demand side,” says Richard Aboulafia, an industry consultant at the Teal Group in the U.S. The company has yet to find an engine supplier willing to risk the $ 1.25-billion investment required. It has also come up short in trying to find a key customer willing to order at least 50 of the aircraft. An autumn deadline has now been set to line up firm orders—and the significance of that deadline is hard to overstate.

The C-Series project appears critical to Bombardier’s survival. The company needs the new plane to extend its product line, and to counter tough competition from its Brazilian rival Embraer, explains the University ofToronto’s D’Cruz. “Without the CSeries, the whole regional jet business of Bombardier is probably in jeopardy,” he says. The uncertainty surrounding the project has not gone unnoticed in Ottawa, where the Liberal government took months to formalize an aid package. Officials at Industry Canada are not convinced it’s a good investment, says one industry source. “They had their doubts. They are not dumb.”

Political pressure tipped the balance in favour of providing aid. Leaving Bombardier hanging might have doomed the fading hopes of the minority Liberal government in a handful of key Quebec ridings. After all, the surging Bloc Québécois has become a champion of state aid to Bombardier, along

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with trade unions and Montreal business leaders like Isabelle Hudon, president of the Chambre de Commerce de Montréal. “Our policy is to support the aerospace industry in Quebec,” she says. “When other countries have support programs to keep the investment in their country, we need to make sure we have all the aid necessary to keep that industry here in Quebec.”

But Bombardier is already Canada’s corporate welfare king, complains John Williamson, director of the Canadian Taxpayers Federation. He points to over $700 million in direct aid and billions more lent to its customers as inducements by Export Development Canada (EDC), the federal government’s export credit agency, over the years. “If this is such a great investment, then investors should contribute the funds, not taxpayers,” says Williamson. “This company has a long history of buying distressed assets from governments, getting government contracts, and then turning around and asking for handouts. On top of that, Canadian taxpayers are expected to finance new projects. It seems that wherever you turn, Bombardier has its hands deep into the public’s pockets.” Indeed, over the past 30 years, Bombardier’s history is inextricably linked to its relationship with government. In the 1970s, Montreal mayor Jean Drapeau awarded a subway contract to the then-floundering snowmobile company. In the mid-1980s, Bombardier scooped up Canadair from the government for just $123 million. Later, it would receive the maintenance contract for Canada’s fleet of CF-18 fighters, despite a lower tender from a Winnipeg company. Lately, Ottawa has gone to even greater lengths to help the company. The government this year authorized US$230 million in loans to two subsidiaries of near-bankrupt Delta Air Lines to complete purchases of Bombardier jets. The money didn’t come from the EDC itself, which has reached its limit on Bombardier debt. Ottawa instead used a loophole called the Canada Account, which is basically the government’s consolidated operating fund, financed directly by taxpayers.

With 80,000 jobs and $20 billion in revenue at stake in Canada’s aerospace industry, taxpayer funding is justified, argues Dave Chartrand, a union leader at one of Bombardier’s plants in Montreal. “They’re creating middle-class jobs,” he says. “We pay millions in taxes to the government. If the government wants to have Wal-Mart jobs all across the

country, I’ve got a problem with that.”

The real alternative, however, is not necessarily a minimum-wage economy, it’s one where subsidies to corporations are eliminated and taxes are cut for every company. That’s far more likely to spur innovation and investment, economists say. “Any subsidized industry can become big, provided the state continues to subsidize

INVESTORS are

asking tough questions: would Bombardier be worth anything without government backing?

it big,” says Pierre Lemieux, an economist at the Université du Québec à Hull. “With the kind of subsidies granted to Bombardier or Embraer or Airbus over the years, anybody could create a big industry of, say, four-finger glove manufacturers.”

Markets only work when buyers pay the real cost of goods and services. And in the aircraft business, subsidies have distorted that market. Government support winds up paying for part of the purchase cost, encouraging indebted airlines to buy more planes than they otherwise would or should, says Valentin Petkantchin, director of research at the Montreal Economic Institute.

Aid to Bombardier is complicated by other issues, such as the company’s record of mismanagement in recent years, making government help look more like a bailout than a sound investment. It has taken hundreds of millions in writeoffs for bad investments in the rail business and in financial services. Its share price has plunged from above $25 at the end of2000 to just over $3 today. The company reported a loss of US$85 million in 2004, while its debt rating was cut to junk status and its dividend suspended for the first time in more than 30 years.

The turmoil cost chief executive Paul Tellier his job last December. Chairman Laurent Beaudoin, who represents the Bombardier family’s controlling interest, took back the reins, while his son Pierre, 43, has been charged with bringing the C-Series to market. With Edwards’s departure, Pierre is now also in charge of the business jet division as well.

The family’s ownership raises other nettlesome questions. Aboulafia points out that as Bombardier gets generous government help, family shareholders are entrenched in a dual-class share structure that gives them more votes than other investors, even though they own just 20 per cent of the equity. The end result, he says, is “state aid for rich people.”

Could Bombardier stand on its own, without the taxpayer behind it? “Looking at what Bombardier’s share prices have done since 2001, one could think that it is not worth much, even with government support,” says Lemieux. “But the real answer is that we don’t know what Bombardier is worth on the market until we let it try to survive there.”

Its regional jet business would certainly be threatened, but its other core products— business jets and rail cars—depend less on government subsidies. That suggests the company could survive; and maybe even prosper, if it kicked its addiction to public money and got out of the passenger jet market. But that would mean lost jobs and lost votes in the key Quebec battleground. And, unfortunately for Canadian taxpayers, that is a risk government is not willing to take, lïïl

Peter Hadekel is author of Silent Partners: Taxpayers and the Bankrolling of Bombardier, published in 2004 by Key Porter Books.