MCDONNELL BOUNCES THROUGH THE FLAK
For a man who spends much of his time lately reading obituaries about McDonnell Douglas Corp., John F. McDonnell seems surprisingly sanguine. "Rumors of our demise have proved to be greatly exaggerated," says McDonnell, the company's 55-year-old chief executive and son of its scrappy founder. "We're obviously still afloat."
McDonnell's calm demeanor is understandable. His company's operating profits more than doubled in the first quarter, to a record $222 million. For the year, analyst George J. Podrasky of Duff & Phelps Inc. says profits before special charges could triple to $352 million, thanks largely to improved cash flow from McDonnell's C-17 military transport and other military programs. Buoyed by such numbers and a growing conviction that last year's bashing of the stock may have been excessive, McDonnell's shares have recovered to around 63. That's far better than September's 34 1/4.
While McDonnell's stock may have been undervalued, plenty of long-term problems still loom. Thanks to the global airline recession, orders for McDonnell's commercial jets have nose-dived. Development of its new superjumbo jet, the MD-12, is on hold until the company finds foreign partners to help foot the bill. And it's uncertain whether the troubled C-17 will ever reach full production.
Together, these crises spell one huge headache for the St. Louis-based defense contractor. Revenues are dropping--down 11% in the first quarter to $3.6 billion. Analyst Podrasky forecasts a 10% fall to $15.6 billion for the year. Even worse: McDonnell's cash reserves, needed in part as a cushion against unexpected financial hits, stand at a meager $110 million, a fraction of the reserves held by competitors. Boeing Co., for one, has $3.6 billion in reserves.
Given its status as the No.1 U.S. defense contractor, McDonnell's finances have come under unusual public scrutiny. In testimony before a House subcommittee on Apr. 22, a Pentagon auditor warned of the company's "unfavorable" financial condition. A week later, Defense Secretary Les Aspin fired Major General Michael J. Butchko Jr., the Air Force's top C-17 program officer, and disciplined other officials after Pentagon investigators disclosed that the Air Force improperly sped payments of $349 million to McDonnell in late 1990. "In other words, we bailed them out," says Representative John Conyers Jr. (D-Mich.).
PENALTIES. The bad news is disappointing at a time when McDonnell has made headway on its problems. As part of a cost-cutting push, the company jettisoned some businesses and slashed its staff to 78,000, from a high of 125,000 in 1990. Moreover, it trimmed the debt load of its aerospace unit by 10%, to $2.5 billion, in the first quarter of 1993. Excluding its finance subsidiary, McDonnell's overall debt-to-equity ratio is expected to drop to 0.66 this year, compared with 1.01 in 1992 (chart). Still, analysts fear that the cost-cutting and debt-trimming may not offset further unpleasant surprises in McDonnell's businesses. "The reported liabilities have been whittled down," sighs a Wall Street analyst. "But with McDonnell Douglas, it's the unknowns that make you worry."
The biggest unknown may be the fate of the C-17 transport program. McDonnell hoped the jet, which can carry an M1 tank and land on makeshift airstrips, would generate $35 billion in sales, beginning in 1993. But Congress, annoyed at Air Force efforts to funnel cash to McDonnell, is eager to save money. Many lawmakers talk of funding only half the 120 planes originally sought by the Bush Administration. Representative John P. Murtha (D-Pa.), chairman of the House subcommittee on defense appropriations, says he wouldn't fight a move to kill the project.
McDonnell already has lost a bundle on the project. Last year, it swallowed $383 million in C-17 cost overruns, contributing to a 95% plunge in its military-aircraft earnings, to $19 million. The company still is pursuing an additional $208 million in C-17 costs, which it wants the Air Force to pay. If McDonnell loses, it will be forced to write off those claims, as well.
The C-17 isn't McDonnell's only government program flying under a cloud. The company is in U.S. Claims Court fighting penalties related to the A-12 attack plane. The Navy canceled the plane--jointly developed by McDonnell and General Dynamics Corp.--in 1991. Nonetheless, the Navy wants the two contractors to reimburse $1.35 billion spent on the project. McDonnell has established a $350 million loss provision for its share of A-12 losses, but it could be forced to eat an additional $300 million in charges if its claims don't prevail. To make matters worse, McDonnell is pursuing similar claims on its T-45 Navy trainer aircraft. If it loses, it could take $142 million in additional charges.
Although the potential losses are steep, McDonnell insists it can withstand the hits. Its F-15 fighter program remains solid thanks to a 72-plane order from Saudi Arabia. And even if it loses every claim, Chief Financial Officer Herbert J. Lanese says the bottom-line charge against equity would total only $300 million, taking into account current loss reserves and tax benefits. "That's only 10% of our equity," says Lanese, "and in no way will lead to a crisis."
A bigger worry could be McDonnell's ailing commercial business, which analysts say is the biggest threat to its health. Douglas has been moderately profitable for the past 10 quarters, after slashing more than a third of its work force. But it hasn't bagged a major new order in almost two years. Last year, earnings fell 63%, to $109 million, as revenues slipped 2%, to $6.6 billion. The results would have been worse if not for a $23 million forfeiture by a customer who canceled an order. And the future doesn't look much brighter. The workhorse MD-80, an update of Douglas' DC-9, has been eclipsed by newer narrowbodies. Even the MD-11 is under attack by Boeing's 777 and Airbus Industrie's A330/A340 widebodies. "I find it very hard to believe McDonnell Douglas can survive in this business," says Daniel J. Shine of Arthur D. Little Inc.
POOR PAPER. New aircraft would help. But it costs up to $5 billion to develop and produce a new plane, and McDonnell isn't about to borrow the money. In February, Moody's Investors Service lowered its ratings on $5 billion of debt issued by McDonnell and its finance company. Moody's also downgraded its commercial paper, to a below-investment-grade rating.
That's why John McDonnell has been on a quest for partners to help fund the MD-12 superjumbo. Since a $2 billion deal with Taiwanese investors fell apart last year, he hasn't found much interest. But he vows to hold onto Douglas, arguing that someday the division could retake the No.2 spot in commercial aircraft sales from Airbus. "I don't mean it's something we'll do in the next one or two years," says McDonnell. He admits it probably won't happen this decade.
For now, few analysts are willing to predict McDonnell Douglas' demise, especially given its stature as a leading defense contractor. But until it can develop new products and find willing customers, the company's biggest risk may not be an untimely death, but an uncertain, impoverished future.James E. Ellis in St. Louis