Gone Is My Co Pilot?

The cover of McDonnell Douglas Corp.'s latest annual report sports a dramatic photograph of five planes from the Navy's Blue Angels team, white smoke billowing from their tails as they miraculously pull out of a steep dive. In case you don't get it, a helpful caption drives home the point: "Turning the corner."

It's catchy--but more than a little overoptimistic. McDonnell Douglas, the nation's largest defense contractor, has indeed survived the severe cash crunch that almost sent it into a tailspin 18 months ago. But an upward flight path for the $18.4 billion-a-year company still seems a distant possibility. Its core defense market is shrinking. Its finances are fragile. And it remains to be seen if a company that for so long prospered on military largess can make the transition to civvies.

FLIGHT CAPITAL. Strategically, Chairman John F. McDonnell is in a corner, not turning it. He could radically shrink the company and remain primarily a weapons maker, as General Dynamics Corp. is doing. But that would require sharp cost-management--never McDonnell's strong suit. The company could diversify away from its aerospace core, but diversification has also been a problem for McDonnell Douglas. John McDonnell's dream of building a $4 billion computer services business, for instance, resulted in $362 million in losses over seven years before the company threw in the towel in 1989. So McDonnell executives see little choice but to continue targeting commercial aviation, a technology that their engineering-trained managers understand.

What it most needs to pursue that strategy, however, is money. McDonnell's proposed MD-12 jumbo jet, designed to compete with Boeing Co.'s lucrative 747, is expected to cost about $5 billion to develop. But the company, which narrowly skirted a liquidity crisis in 1990 as it completed the cheaper MD-11, simply cannot afford to build the new plane without a wealthy partner.

Executives thought they had found one late last year. In November, the government-backed Taiwan Aerospace Corp. agreed to buy a maximum of 40% of McDonnell's commercial aircraft business for up to $2 billion. But the Taiwanese recently stunned McDonnell by unveiling a radically different second proposal in which any major direct investment would be put off for a couple of years. Within weeks, McDonnell postponed the MD-12's launch indefinitely. Wall Street is shell-shocked. McDonnell shares have plunged nearly 48%, to under 38, since the Taiwanese investment was proposed on Nov. 19 (chart).

PLAYING HARD TO GET. McDonnell officials aren't about to concede defeat, though. They contend that Taiwan's unwillingness to consummate the original deal is a bargaining ploy. "We think they're trying to do a little negotiating in the press," says John D. Wolf, executive vice-president of Douglas Aircraft Co., McDonnell's commercial unit. Taiwanese officials hint there may be room for compromise. Says Taiwan Aerospace Vice-President George K. C. Liu: "It may be that the final result will be a combination of the latest Taiwanese proposal and the early proposals."

While continuing its awkward mating rite with the Taiwanese, McDonnell is cutting back current production. It aims to shutter a 2,000-worker parts plant in Torrance, Calif., by next year, and in June it began a new cost and budget review at Douglas. The likely result: still more layoffs.

There's no doubt that these are tough times for selling to the airline industry. But the contraction is especially bad for Douglas because it markets only two plane types, compared with five at kingpin Boeing. That narrow product line leaves it little shelter when demand softens in one area. Cancellations have been another problem. McDonnell had a net loss of 27 narrowbody orders and six MD-11 widebody orders last year. Boeing Marketing Vice-President Richard L. James says his company has had a net gain of 133 single-aisle plane orders since the end of 1990.

The immediate future doesn't look much better for Douglas. Its share of the commercial jetliner order backlog is currently a paltry 12%, trailing a 31% share for Europe's Airbus Industrie and way behind Boeing's 55% share. Despite a record $200 million in operating earnings at the $8.6 billion transport aircraft unit in 1991, Douglas risks joining Convair, Sud Aviation, and Lockheed in the annals of former commercial planebuilders. Even John McDonnell refers to Douglas' position in jetliners as "No. 3 and fading."

NEW LEASE. The MD-12 could go a long way toward changing that. But for now, the project depends on Taiwan Aerospace. In its revised proposal, TA says it will spend about $2.5 billion to set up a manufacturing company in Taiwan to make parts for the MD-12 and to establish a leasing company to buy 20 of the planes. The leasing company would give McDonnell letters of credit worth about $2.5 billion to fund some development expenses. But first, Taiwan Aerospace wants McDonnell to secure at least 27 more orders. McDonnell executives haven't responded formally to the idea, but they aren't likely to welcome it. They still want an infusion of cash before embarking on such a risky, expensive development project.

Not all of the news out of McDonnell is bad. Analysts expect its C-17 military transport, more than a year behind schedule and $1 billion over budget, will withstand heavy congressional flak and bring in up to $35 billion in sales. And despite a recent Pentagon inspector general's report critical of the Navy's efforts to ease regulatory hurdles for new versions of McDonnell's venerable F/A-18, the fighter will probably win approval. That would pave the way for up to $20 billion in additional sales.

Still, the days when McDonnell could count on a steady stream of new combat-aircraft contracts are history. That means the Far Eastern negotiations will continue. "Our position has remained steady from the word go," says Nissen Davis, McDonnell's vice-president for the Pacific and Asia. "We are interested in an equity partnership." But with McDonnell's weak financial position and limited strategic alternatives, refusing to compromise may not be an option.