Caught in United's Downdraft

How will Boeing's finance and leasing business be affected?

These are dark days for Boeing (BA ). Witness plummeting jet orders, a shrinking share of the commercial-airplane market, massive layoffs, and the likely cancellation of its great hope for the future, the Sonic Cruiser project. Now, United Airlines' (UAL ) bankruptcy spells more trouble for Boeing. The carrier owes the jetmaker's financing unit $1.3 billion for the purchase of a dozen Boeing jets.

Just goes to show how much the world has changed since Boeing created Boeing Capital Corp. three years ago. Back then, the Chicago-based aerospace giant promoted its financing arm as a potent source of profits and double-digit growth. The idea, modeled on General Electric Co.'s (GE ) ultraprofitable GE Capital Corp., was simple: The company would not only book profits on the sale of jetliners but also earn extra on the deals to lease or finance those same planes.

As long as the economy was strong, the concept worked perfectly. Net profits from leasing doubled, from $78 million in 1999 to $151 million in 2001, as the value of Boeing's leased equipment soared from $2.9 million to $11.5 billion. But the global downturn has sunk Boeing Capital as well. For the first nine months of this year, it has earned only $31.6 million. In the third quarter, it took a $149 million charge to boost reserves and reflect falling aircraft prices.

Now, United's massive bankruptcy filing exposes Boeing to new risks. In the event United and Boeing can't agree to new financing terms, Boeing will have to repossess about a dozen jets. That means months of lost revenue and the prospect of placing the planes back in service with other carriers at much lower rates. Says James F. Palmer, president of Boeing Capital: "[We are] obviously concerned by United's decision to file for bankruptcy." Still, he insists that the finance unit will be able to ride out the United storm.

Boeing isn't the only aircraft lessor to take a hit, which means already-weak aircraft prices probably will sink further. With United likely to ground more airplanes as it cuts costs, others will soon be trying to resell their planes or cut new deals at rock-bottom prices, too. The Airline Monitor, an industry newsletter, calculates that surplus aircraft now account for 13% of the world's fleet--the highest ever. "The risks are going up and the quality of the loans [is] going down," says William C. Becker, president of Bellevue (Wash.)-based aircraft appraiser DCB Consultants.

Yet Boeing Capital is uniquely vulnerable. Unlike the diversified GE Capital, where just 3% of $58 billion in revenues are from leased aircraft, more than 80% of Boeing Capital's business is aircraft financing. And Boeing archrival Airbus has steered clear of leasing altogether. Says John J. Leahy, Airbus chief commercial officer: "It's a concentration of risk we'd prefer not to have."

Boeing Capital has other headaches, too. Latin America's biggest airline, Brazil-based Varig, is teetering and could leave Boeing Capital on the hook for another $700 million and 11 McDonnell Douglas airplanes. Nearly half of Boeing Capital's fleet are older MD aircraft or the slow-selling 100-seat Boeing 717. Most of those planes are impossible to sell or lease for a decent price.

United has 60 days to renegotiate its loans and it will likely hold on to its planes. But it will be in a position to hammer down financing terms. Already, U.S. Airways is demanding a 25% reduction in payments from its lessors. Says George Hamlin, analyst for Global Aviation Services: "Prices are coming down, and it's only going to get worse."

So much for Boeing's financial-services growth strategy. Says Richard Aboulafia, Teal Group Corp. aerospace analyst: "This downturn really blindsided them." With no letup in sight, it could be a long while before Boeing Capital sees a break in the clouds.

By Stanley Holmes in Seattle, with Carol Matlack in Paris

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