One of many casualties of the coming corporate debt implosion.
How Wall Street Eggheads Tanked The “Flying Fortress”
If you’ve ever seen this iconic World War II photo, you likely have one question: How in the world is this plane still flying?
You’re looking at pilot Kenneth Bragg’s B-17 bomber. Both starboard engines are destroyed, and the electrical system, radios, and oxygen delivery system are wrecked. The tail is virtually ripped off, leaving the tail gunner stranded at the back of the plane.
The plane, known as a Flying Fortress, had just survived a “hit and run” collision with a German aircraft in 1943. But that isn’t the end of the story…
After the crash, the B-17 stayed airborne and fended off two additional German fighter planes on its way back to base. Bragg’s midsection gunners poked their heads above the holes in the fuselage to zero in on their targets.
Soon after that, Bragg was able to radio in help from American P-51 fighters from England to escort the crew home. Along the way, one of the P-51 pilots took the famous snapshot of the ravaged – but still airborne – B-17.
Incredibly, everyone on board the plane landed safely and walked off without a scratch.
Kenneth Bragg’s bravery and nervy flying have become the stuff of legend. But he couldn’t have done it without a legendary plane – the Boeing Flying Fortress, proudly crafted in America.
Behind Every Hero Is A Great Plane
Boeing built an unshakable reputation for trustworthiness during WWII, as the B-17 “Flying Fortress” and B-52 “Stratosphere” routinely shook off pummelings from anti-aircraft guns and enemy fighter planes, helping their crews deliver payloads and return home safely to base.
By then, Boeing planes had been in the skies for 27 years. In 1916, lumber entrepreneur William E. Boeing built the very first Boeing plane in a repurposed boat factory, using master craftsmen and materials from the boat business. He started a legacy of durability and reliability that would continue unbroken for nearly a century… before things went horribly wrong.
After the war, Boeing launched America into the jet age, starting with the Boeing 707 in 1957 – the world’s first widely used jet airliner. This was followed by the three-engine 727 in 1963, and then Boeing’s hallmark 737 in 1967.
The Boeing 737, which became the best-selling commercial plane of all time, made the name “Boeing” synonymous with safety, with an average of 12.5 million safe flights for every fatal crash.
Pilots worldwide repeated a pithy mantra that said it all: “If it ain’t Boeing, I ain’t going.”
What made Boeing planes the best in the world? The fact that engineers ran the joint.
The company made a conscious choice to hire hands-on aircraft builders as top executives. CEOs like Clairmont Egtvedt, “the father of the B-17”, and Thornton Wilson were patent-owning engineers and aircraft designers, who’d gotten oil under their nails building and designing planes before moving into the C-suite.
Predictably, these results-oriented builders wanted little to do with Wall Street eggheads. As one long-time aerospace reporter recalled about Boeing’s former culture in a 2019 article:
“Finance wasn’t a primary language. Even Boeing’s bean counters didn’t act the part. As late as the mid-’90s, the company’s chief financial officer had minimal contact with Wall Street and answered colleagues’ requests for basic financial data with a curt ‘Tell them not to worry.’”
But that all changed in a fateful corporate transaction in the late 1990s, which set the stage for Boeing’s spectacular fall from grace twenty years later.
The Financiers Take Over – and Destroy an 80 Year-Old Legacy
In August 1997, Boeing merged with fellow aerospace manufacturer McDonnell Douglas in a $13 billion stock swap. It was a match made in hell.
Boeing was known for quality, and McDonnell was known for financial engineering – with a focus on cost cutting and the company’s share price. And though the Boeing name survived, it was the McDonnell Douglas attitude that prevailed.
As one aviation reporter recalled from his coverage of the company in 2000:
“One of the most successful engineering cultures of all time was quickly giving way to the McDonnell mind-set. Another McDonnell executive had recently been elevated to chief financial officer. (“A further indication of who in the hell was controlling this company,” a union leader told me.)”
McDonnell CEO Harry Stonecipher, who took over day-to-day operations at Boeing, immediately took a carving knife to Boeing’s highly-paid engineering staff. The resulting labor strike shut down production for 40 days in 2000.
And in May 2001, Boeing management made a physical break with its engineering staff: manufacturing headquarters stayed in Seattle, while corporate moved to downtown Chicago, 1,700 miles away.
That split symbolized the growing distance between builders and bosses, as aerospace analyst Richard Aboulafia explained in a 2019 article:
“You had this weird combination of a distant building with a few hundred people in it and a non-engineer with no technical skills whatsoever at the helm…It wasn’t just technical knowledge that was lost. It was the ability to comfortably interact with an engineer who in turn feels comfortable telling you their reservations, versus calling a manager [more than] 1,500 miles away who you know has a reputation for wanting to take your pension away. It’s a very different dynamic. As a recipe for disempowering engineers in particular, you couldn’t come up with a better format.”
Then Boeing’s upstanding reputation took a beating as the company was rocked by a series of scandals, including violations of government contracting laws that landed one Boeing CFO in jail. But nothing changed at the top. In fact, Harry Stonecipher took over as sole CEO, erasing Boeing execs entirely.
In the wake of the executive shakeup, Stonecipher explained:
“When people say I changed the culture of Boeing, that was the intent, so that it’s run like a business rather than a great engineering firm.”
In an ironic turn, Stonecipher himself was eventually forced out due to an affair with a subordinate. But the damage remained. He had indeed changed Boeing culture… for the worse.
And he set the stage for a series of disastrous decisions that have brought Boeing to the brink of bankruptcy today.
Boeing’s Fall from Grace
Most jets in the sky are made by either America’s Boeing or Europe’s Airbus. The long-running battle shifted in favor of Airbus in 2010.
That year, the rival company unveiled the A320neo single-body jet, which offered significantly better mileage than Boeing’s 737, thanks to a larger, high-efficiency engine.
Boeing executives had to come up with a response, and fast…
Of course, by 2010, Boeing’s C-suite was entirely made up of financial engineers, whose main concern was the bottom line and the share price. And while they wanted a fuel-efficient plane, they didn’t want to spend the money or time needed to overhaul the entire 737 design.
So they simply tacked the bigger engines onto the wings of the existing 737-400 frame, moving them slightly forward to achieve the same ground clearance. The trouble was, the more forward placement made the planes (now called 737 Max-8) top-heavy.
The new engine placement created a high risk of aerodynamic instability, especially under high thrust. But instead of focusing on the engineering of keeping its planes in the air, Boeing created a workaround software solution, ignoring pushback from its engineers.
One cardinal engineering rule is “Always build in redundancy.” In other words, make sure your systems have back-up…and the back-up has back-up. Predictably, Boeing executives ignored this rule when launching the flight-stabilization software. They didn’t want extra costs or complexity, so they skipped the backup and left the system vulnerable to a single point of failure.
That easy fix left Boeing with a lot of extra cash, which it used on… you guessed it… financial engineering. From 2010 to 2019, Boeing spent $44 billion on share buybacks, cutting the share count by 23% over that same period:
Slashing the share count helped boost the all-important Wall Street metric of earnings per share, which rose by 290% from 2016 to 2019. In turn, that sent Boeing’s stock price flying high. Meanwhile, over this period, free cash flow – a measure of the underlying profitability of a company – plunged from $7.9 billion in ‘16, to negative $4.3 billion in ‘19. The share price took off.
Boeing’s suits made out like air pirates. Stock-based compensation soared six-fold from $32 million in 2015 to around $200 million per year in 2016 – 2019.
But shareholders, and passengers, paid the price.
Two years after delivering the first of its 737 Max-8 planes in 2017, two deadly crashes were directly attributed to faulty software — Lion Air Flight 610 and Ethiopian Airlines Flight 302 – killing all 346 passengers and crew on board both flights.
A Department of Justice investigation found Boeing guilty of “conspiracy to defraud the United States over the 737 MAX certification.” The company paid $2.5 billion in fines.
It got worse. Boeing was forced to ground its entire fleet of 737 Max-8 planes from March 2019 through December 2020 in the U.S., and longer in other jurisdictions. Then in 2020, COVID-19 travel restrictions kneecapped the airline industry, and Boeing’s cash flow plummeted.
Boeing was forced to borrow a mountain of money to keep itself afloat. The company’s debt burden exploded from $12 billion in 2018, to $57 billion today:
Boeing has since addressed the problems by adding new redundant safety features into the flight stabilizing software, and received global clearance to resume flights of the 737 Max-8. But they’re still digging their way out from that mountain of debt, while dealing with depressed cash flows.
In the last 12 months, Boeing generated just $2.3 billion in free cash flow – not nearly enough to support its bloated balance sheet in the long run.
And over the next four years alone, Boeing faces a wall of $22 billion in debt maturing.
Keep in mind that interest rates are higher now, and Boeing’s stressed finances put it in an uncomfortable headlock. Boeing will likely find itself unable to repay or refinance these bonds at anything less than usurious interest rates. Throw in the potential for a sharp recession – bad for travel, worse for airlines – and Boeing’s financial situation goes from precarious to impossible.
Boeing’s Bad Judgment May Lead to a Bond Bargain
Boeing’s balance sheet is in distress, and it will only falter further as the credit cycle turns and recession hits.
The table below shows Boeing at the top of a list of companies that have painted themselves into a corner with debt. Some of these companies have strong enough core businesses to make it through the other side of the coming default cycle. Others will disappear into the black hole of insolvency.
But they all have declining sales, growing debt loads, and an unsustainable amount of leverage relative to their earning power and cash on hand.
Avoid the shares of these companies at all costs.
However, even in companies headed for big trouble, there’s opportunity – in their bonds.
Boeing’s shares are toxic. But once investors start to price in the company’s distress, its bonds might be worth a long, hard look. After all, there are no bad bonds… only bad prices.
For all its missteps, it’s unlikely that Boeing – a key U.S. national defense supplier, and a national champion company – will go out of business. Boeing, like hundreds of other companies with distressed balance sheets, will soon become a part of what we’re calling the “greatest legal wealth transfer in history.”
When today’s corporate default cycle turns, many companies will kick the bucket. But in other cases where a sound underlying business (or a steady government client) remains, the capital structure will merely get re-arranged.
Shareholders will lose everything. And the bondholders with a senior claim on the company’s assets will be left to pick up the pieces. Always remember, bondholders get paid first.
There will be many other opportunities like the one we see coming in Boeing, when a once-in-a-generation credit cycle creates an opportunity to buy distressed debt at pennies on the dollar. Fortunes will be made by the few who can identify which bonds to buy, and at what prices.
That’s why we’ve recently partnered with a legend in the world of distressed debt investing — Martin Fridson, known on Wall Street as the “Dean of High Yield.”
Simply put, there’s no one better in the world to help investors find the hidden gems that will emerge from the aftermath of the coming corporate debt implosion. Life-time Partner Pass Members will have access to our distressed investing product when we launch it in coming weeks, as part of their membership. All other subscribers can learn more about how to access Martin’s recommendations — before our prices go up — here.
We’ll also be sending you a series of in-depth articles, right here in Something You Don’t Know, educating you on distressed debt and showing you how to participate in this once-in-a-lifetime wealth-building opportunity. Watch your inbox over the next several weeks.
Porter & Co.
P.S. Kenneth Bragg’s indestructible B-17 was repaired and continued flying missions until 1945. It also inspired the “praying puppy” emblem for the 414th Bombardment Squadron, which seems fitting for the situation Boeing finds itself in today.