April 2010

By John Lippert and Susanna Ray April 26 (Bloomberg) — As Boeing Co. Chief Executive Officer Jim McNerney held court in Airbus SAS’s backyard at the Paris Air Show last June, he made a promise: He told Wall Street analysts he’d be throwing a party in two weeks — after the 787 Dreamliner’s first test flight. The plane, which is so radical that its fuselage is formed by wrapping composite-plastic tape around a mold and then baking it, was already two years late for its trial. The delays had crushed Boeing’s credibility and helped drive shares down to $51.44 as the show opened from a record $107.83 in 2007. The celebration wasn’t to be, Bloomberg Markets magazine reports in its June issue. Back in the U.S., as McNerney was driving home from Waukegan Regional Airport in Illinois, he got a call from Scott Carson , who was then president of Boeing’s commercial aircraft division. Engineers had found separations in layers of plastic where the 787 fuselage meets the wing. The only option was another delay. News of the postponed flight sent shares tumbling a further 6.5 percent on June 23. Boeing reinforced the wing joint with titanium, and the Dreamliner flew its much-anticipated three-hour test over Washington state on Dec. 15, almost six months later. ‘Tough Day’ Seated in a Boeing conference room 36 floors above the Chicago River on a blustery March afternoon, McNerney, 60, recalls the June delay. “It was a tough day, but you’ve got to be levelheaded around here,” he says. “If I get as excited as I want to be about all the cool stuff that happens and as disappointed as I want to feel when stuff doesn’t go well, I’d be a Raggedy Ann doll,” he says. Shareholders , who are gathering in Chicago for the company’s annual meeting today, can relate to that. After watching Boeing stock hit so many peaks and valleys in two decades that its price graph resembles a mountain range, investors are betting the Dreamliner will put Boeing back on the upswing. “Once Boeing starts delivering the 787, the earnings power will double and the stock will double,” predicts David Pearl , co-chief investment officer at New York-based Epoch Investment Partners Inc., which owned 2 million shares of the Chicago-based company as of Dec. 31. Boeing shares jumped 51 percent to $75.13 in the six months ended on April 23. The rise, almost four times that of the Standard & Poor’s 500 Index , lifted the company’s price-earnings ratio to 39.7, greater than 88 percent of the index’s members. High Flier From July 2005 — when McNerney took the reins as chairman and CEO after two ethics scandals had rocked the world’s biggest aerospace and defense company — to April 23, the shares returned 26 percent, double the 13 percent gain for the S&P 500. Boeing is the only stock with enough liquidity for large- cap portfolio managers looking for aerospace growth, says David Rowlett , a Baltimore-based analyst at T. Rowe Price Group Inc. “They can generate a lot of cash if they get the 787 right,” says Rowlett, whose firm owned 7.9 million shares in December. Getting it right hasn’t been Boeing’s forte. The Dreamliner, a two-engine jet that will travel 8,500 nautical miles (15,742 kilometers) while burning 20 percent less fuel than competitors, won’t earn back Boeing’s original investment of about $15 billion until 2018 or later, predicts Heidi Wood , an analyst at Morgan Stanley in New York. Falling Orders Last year, Boeing’s aircraft orders tumbled 79 percent to 142 amid the worst travel slump since World War II. Profit plummeted 51 percent to $1.3 billion. The company swallowed $1.8 billion in reduced income because of an International Association of Machinists and Aerospace Workers strike in 2008. And it lost its lead contractor role when the Pentagon canceled the $159 billion Future Combat Systems program, hurting the defense business that delivered 49.1 percent of Boeing’s $68.3 billion in 2009 revenue. On April 21, Boeing said first-quarter net income fell 15 percent to $519 million and revenue dropped 7.8 percent to $15.2 billion. The 787 has added to the misery. Not only was the Dreamliner the first airliner designed largely with composite materials instead of metals; Boeing also farmed out entire pieces for suppliers to design and build. The company planned to assemble the plane in three days at its Everett, Washington, campus, joining the nose, wings and fuselage into a wide-body jet that could seat up to 290 people. Losing Focus McNerney was late to recognize the Dreamliner was drifting off course, says Joseph Campbell , a Barclays Capital analyst in New York. “McNerney initially made the mistake of not personally being on top of the details of the 787,” Campbell says. “Once he realized that he needed to be personally focused on the 787 details, he did much better.” The rocky start cost Boeing the chance to exploit Airbus’s fumbles with its A350 wide-body plane, A380 superjumbo jet and A400M military transport, Chief Financial Officer James Bell says. The A380, the largest-ever commercial aircraft with 525 seats, contributed to parent European Aeronautic, Defence & Space Co.’s 763 million euro ($1.03 billion) loss in 2009. In one recent delay, Korean Air Lines Co. said in April it will take delivery of its first A380 in the second quarter of 2011 instead of in December 2010. ‘Destroyed the Competition’ “We stumbled when we could have just destroyed the competition,” Bell says. The transatlantic rivals have been dueling for a quarter century. Toulouse, France-based Airbus, formed by combining European aerospace companies, started winning sales from Boeing’s mainstay 737 with its 150-seat A320 in 1988. In the 1990s, Boeing tried to boost productivity by studying Toyota Motor Corp.’s lean-style manufacturing. After expanding in defense, Boeing moved its headquarters to Chicago in 2001, inflaming unions that represent 48,000 machinists and engineers at its commercial manufacturing hub around Seattle. Now, both Boeing and Airbus are wrestling with composites, the biggest plane-making leap since the switch to metal from wood in the 1930s. In 2006, Airbus fired executives and delayed the A350, its 787 competitor whose fuselage and wings are made of carbon fiber-reinforced plastic. Both have asked lawmakers to fight what they consider unfair subsidies by governments overseas. And both are feeling heat from customers to create jobs worldwide — often with catastrophic results. Airbus says it spent two years and 6 billion euros fixing glitches such as mismatched wiring after French and German planners used different computer-design tools for the A380. ‘Extraordinarily Difficult’ Because they’re the only makers of large commercial jetliners, Boeing and Airbus constantly jockey for orders from the world’s 100 major global airlines, New York-based aerospace consultant Wolfgang Demisch says. Winning can come down to price, shrinking pretax profit margins below 10 percent and forcing endless restructurings. “Moving the technology forward while ruthlessly cutting costs has been extraordinarily difficult,” Demisch says. Investors must wait a decade to see whether the moves worked, because that’s how long creating an airliner takes. ‘Behind Eight Ball’ “McNerney is trying to do something that’s really hard to do,” says Charles Smith , chief investment officer at Pittsburgh-based Fort Pitt Capital Group Inc., which owned 236,000 shares in March. “Boeing got caught up in the idea they could produce a new generation of aircraft on time and on budget. Their chief competitor is just as far behind the eight ball.” Boeing has been experimenting with composites to trim cost and weight since the 1970s. It began using lightweight materials for the tail of its 777 jetliner in 1995 and for the “flying wing” that’s the primary structure of the B-2 bomber in 1997. Today, Spirit AeroSystems Holdings Inc. in Wichita, Kansas, is one of four companies building composite pieces for the Dreamliner fuselage. Spirit was part of Boeing until Boeing sold its Wichita commercial operations in 2005. Boeing is also bringing some composite work in-house, perhaps including wings on future aircraft. In July 2009, it paid $1 billion for a North Charleston, South Carolina, factory owned by Vought Aircraft Industries Inc. that builds a third of the 787 fuselage. On this sunny March morning in Wichita, several dozen Spirit workers are fashioning the Dreamliner’s front nose section. They wear blue lab coats to stay lint-free. Unlike in most aircraft factories, there’s no industrial noise in the football stadium-sized room. Baking a Plane Instead, workers check computers as a dispenser spools out epoxy-soaked carbon-fiber tape a few inches wide. As the tape wraps around a rotating, railroad car-sized cylindrical mold, the black shape of an airplane becomes recognizable like a butterfly emerging from a cocoon. Workers stroke the newly formed fuselage with white gloves to spot defects and then manipulate a giant forklift to place it in a pressurized oven, where heat hardens the body. A laser cuts out the windows. Factory director Terry George helped write patents protecting construction of one-piece fuselages. Composites are revolutionary, he says. “Suddenly, you’re talking about reductions of 10, 20, 30 percent in cost and weight,” he says. Spirit ships each fuselage to Everett, about 30 miles (48 kilometers) north of Seattle, in a converted 747 freighter. About 20 percent of Boeing’s 157,000 employees work at the campus, with snow-covered Mt. Baker as a backdrop. Factory Ballet Inside, the 787 team choreographs a ballet of composite parts. Workers direct machines to roll the wings — which have arrived from Japan — plus pieces of the fuselage and tail toward one another. A blue-and-yellow metal cage steadies the chunks as robots install fasteners for holding the parts together. Boeing still uses production methods rooted in the 1970s for other jetliners. In the same building, a worker in a black baseball cap crawls on the wing of a 747 with a hand-held drill to assemble a flap. Boeing’s largest plane, with up to 467 seats, is made largely of metal. Other workers manipulate cranes to lift green pieces of the jet, with its distinctive hump, like a jigsaw puzzle. The bam-bam of rivet guns echoes off the wall. Customers are eager for the 787. It will fly 37 percent farther than the 30-year-old, 218-seat 767 it replaces, making nonstop routes such as Chicago to Beijing routine. ‘Cleaning It Up’ In April, Boeing had 866 orders worth $150 billion at list prices. It plans to deliver the first 787 to All Nippon Airways Co. in the fourth quarter. Airbus is further behind. Its A350 is due in mid-2013; airlines have ordered 530. “They’ve got to get the aircraft in service,” Virgin Atlantic Airways Ltd. CEO Steve Ridgway says, referring to the 787. Virgin ordered 15 of them in 2007. It hasn’t ordered any A350s. McNerney’s scandal-free half decade has further restored Boeing’s shine. CEO Phil Condit left in 2003, ending his six- year tenure, after Boeing hired an Air Force official who had negotiated a contract with the company while in the military. Harry Stonecipher resigned in 2005 following an affair with a subordinate. “He’s cleaning it up,” says Jack Welch , retired chief of General Electric Co. McNerney has authenticity, an essential leadership quality, says Welch, 74, who considered McNerney as his own successor before choosing Jeffrey Immelt in 2000. McNerney, a Harvard University MBA who competes with boyhood friends in the U.S. Pond Hockey Championships in Minneapolis each January, spent 19 years at GE. He led 3M Co. for 4 1/2 years before joining Boeing in July 2005. ‘Strong Leader’ “He’s a very thoughtful, careful but strong, leader,” Welch says. McNerney is making headway in Washington after the 2003 scandal. Boeing is in the running for a $35 billion Pentagon contract for refueling tankers. Northrop Grumman Corp. pulled out in March, saying the guidelines favored Boeing. French President Nicolas Sarkozy protested to U.S. President Barack Obama on behalf of Northrop’s partner, Airbus parent EADS. “We have always opposed protectionism,” Sarkozy told reporters on March 12. EADS said in April it plans to submit a new bid on July 9. Pick Up Pace Even though the 787 appears to be on track, McNerney worries he waited too long to replace Carson — the executive who delivered news of the wing-joint problem — and put Jim Albaugh in charge. Albaugh, 59, had been running Boeing’s defense business and McNerney liked his ability to multitask as he developed dozens of military aircraft simultaneously. “Could we have moved months earlier? Probably,” McNerney says. McNerney says Boeing has to pick up the pace because rivals are muscling in on its duopoly with Airbus. He’s bringing the company together under what he calls “one Boeing.” The company can save $2 billion to $3 billion a year by using one purchasing system, sharing research and enlisting pilots from the defense division to test commercial planes, McNerney says. “I’m focusing our company on delivering on its promises, having the low cost and being the most innovative,” he says. “The price will be bigger in the future if we don’t do those things.” ‘Pay the Price’ Bombardier Inc ., a Montreal-based maker of business and regional jets, will challenge Boeing’s 737 and Airbus’s A319 with the 130-seat CSeries in 2013. China Development Bank Corp. is providing $3.85 billion in financing to help sell the planes. Shenyang Aircraft Corp., a unit of Aviation Industry Corp. of China, builds the fuselage, giving China experience in composites. Commercial Aircraft Corp. of China’s 168-seat C919 is due in 2016. “By the end of the decade, Boeing and Airbus will pay the price,” consultant Demisch says, referring to China’s expertise. Boeing, which started building seaplanes in 1916, was so dominant for most of the 20th century that it charged what it wanted. When Airbus shocked executives with rising sales and lower costs, Boeing tried to spend itself out of the threat. It bought Rockwell International Corp.’s space and defense business in 1996, McDonnell Douglas Corp. in 1997 and Hughes Space & Communications in 2000. In the four years ended on Dec. 31, 1999, aircraft deliveries more than doubled to 620. Suppliers couldn’t keep up, and planes waiting for parts snarled factories. Boeing shut down for a month to sort out the mess. Then, after the Sept. 11, 2001, attacks, orders evaporated. Boeing cut 43,000 jobs, one- fifth of its workforce. ‘We Lost Control’ That was just a hint of things to come. Alan Mulally , who ran commercial aircraft from 1998 to 2006 and is now CEO of Ford Motor Co., began developing the 787 by mimicking the outsourcing at McDonnell Douglas. He hired Fuji Heavy Industries Ltd. and Mitsubishi Heavy Industries Ltd. to build 787 wings. Alenia Aeronautica SpA in Rome; Kawasaki Heavy Industries Ltd. in Nagoya, Japan; Spirit; and Vought made fuselage sections. “We lost control,” Albaugh says. “We gave work to people that did not have, in hindsight, as much experience as we wish they had.” Mulally declined to comment. When Boeing rushed out the 787 for the world to see in July 2007, partly to lure airlines that planned to fly to the Olympics in Beijing the following year, it was held together with temporary bolts. Suppliers felt overwhelmed. “There were too many changes at the same time,” says Aravind Melligeri, chairman of Quest Global , which makes cargo- door and landing-gear components in Bangalore, India. ‘Bass-Ackwards’ Boeing leaders forgot basic plane-making rules, McNerney says. “We stretched for volume to respond to a very real Airbus threat,” he says. “The 787 was characterized by making promises to the marketplace before you’d satisfied yourself you had the engineering in bed to get it done. That’s bass- ackwards.” McNerney is also defending the rest of his lineup. Boeing is redesigning both the 737, the world’s most widely flown plane, and the 777, Boeing’s most profitable jet. “Airbus is responding to the 787,” he says. “They’ll again be forced to respond to what we do with the 777.” McNerney will unveil plans for the 777 by March 2011. “You look at the engine,” he says. “You look at the wings.” Both companies will decide this year whether to offer new engines for their 737-style planes by 2013 to boost fuel efficiency or to introduce a new jet after 2020. Boeing’s preference is to wait, CFO Bell says. ‘Better Product’ Allan McArtor , chairman of Airbus Americas Inc., says he’s not worried. “The A350 is a better product,” he says of the plane, which competes with the 777 and 787. “They’ve eaten up their marketing advantage with the delays.” Even as the 787 buoys investor enthusiasm, Boeing’s defense business maybe in for turbulence. Obama proposed a 1.8 percent increase over inflation for Pentagon spending for 2011, down from an average of 4 percent under President George W. Bush . Boeing contracts for cargo planes, reconnaissance satellites, space exploration and border security have been scaled back. “Defense revenue is going to contract,” says T. Rowe Price’s Rowlett. “The question is whether it will reset at a point 5 to 10 percent lower and then grow or whether we’re in for a much bigger drop.” Dennis Muilenburg , Boeing’s defense chief, is looking for orders overseas and updating the 34-year-old F-15 fighter with stealth coatings. At 45, he’s one of the youngest Boeing executives to hold such a senior position. ‘Big Action’ “You’re going to see some big action on the F-15 over the next couple months,” McNerney said after a March trip to Saudi Arabia. McNerney is cutting the price of his planes to exploit the four-year delay, until 2016, of Lockheed Martin Corp. ’s F-35 jet fighter. He’s offering the Pentagon 124 F-18 variants called Super Hornets and Growlers for $49.9 million each, down from $68 million in 2000. Boeing plans to make 50 F-18 variants this year compared with 26 a decade ago, with less manpower. To reduce labor costs, the company redesigned metal spars that are used inside wings so they arrive in grids instead of separately. Boeing began studying such techniques at Toyota in the 1990s. A decade ago, Boeing used to stuff 30 of the 737s into an assembly bay in Renton , Washington. It parked the aircraft with wingtips a few feet from the next fuselage, moving them for the next day’s work. More With Less Today, the bay holds 12 planes, with 5 on an assembly line. Carts come to workers loaded with tools and parts for the day’s work. In 2001, about 6,000 workers made 326 planes, according to the machinists association. In 2009, a workforce two-thirds that size built 372 planes. Renton workers also make the P-8A submarine chaser, a 737 with torpedoes and missiles. Eighty percent of the parts are different from those in stock 737s, yet Boeing schedules their delivery so precisely that P-8A fuselages coming from Wichita are built on the same assembly lines as 737s, one after the other. McNerney’s biggest challenge may be establishing labor peace. Ever since McDonnell Douglas executives replaced longtime Boeing directors and the company moved its headquarters, union members have blasted their bosses. “If Phil Condit was talking with a guy with a rivet gun, he knew what that person did,” says Mark Blondin , the machinists association’s aerospace coordinator. “People running this company now have never touched an airplane.” Inciting a Strike? One of Albaugh’s first decisions was to build a second 787 plant in South Carolina, where workers can’t be required to join unions. After four strikes in two decades, Boeing needs to keep up deliveries, Albaugh says. Association President Tom Buffenbarger says Boeing is inciting a walkout in 2012, when the contract for 27,000 workers runs out. “Their ability to sustain a long strike: I don’t know what it would be at that point,” he says. McNerney says he’s puzzled when machinists, who earn $26 an hour, demand more money. “The Chinese are coming,” he says. “The cozy world of just the two of us is almost over.” Place in History Above all, the 787 will determine McNerney’s place in history, says Fort Pitt’s Smith. “If two years from now he’s producing eight or ten 787s a month, we’ll say he was very capable,” he says. “Until then, the jury’s out.” McNerney says he could have moved faster to fix production glitches on the world’s most innovative airliner. Lapses in the next 4 1/2 years, before he retires at 65, could be disastrous for a company with a history of stretching shareholders’ patience. With the first 787s due by year-end, investors want to be sure McNerney can deliver steady profits and keep the stock price — like the Dreamliner — flying. To contact the reporters on this story: John Lippert at jlippert@bloomberg.net ;