Living on Corporate Welfare

When an aircraft manufacturer crashes, the rubble is the stuff of agony. John Diefenbaker’s destruction of the Avro Arrow is a legend of what might have been and more evidence, if it were needed, that eastern money has never given the west a chance. Today, the tables are turned, for in the crash of the stock market value of airplane and train maker Bombardier Inc. are signs that the Montreal-based industrial giant could fail and that the rest of the country might not be willing to maintain the bailouts that have kept it afloat.

In Silent Partners: Taxpayers and the Bankrolling of Bombardier, financial writer Peter Hadekel points to the lifeblood of the company— government subsidies—and asks whether, without the gusher of public cash that built and sustains it, the business is viable. It is a convoluted tale, but Hadekel unravels the machinations of Ottawa mandarins, Bombardier strategists, competing Brazilian plane makers and foreign governments that have happily handed over huge fortunes in assets to what some would say is an upstart snowmobile maker. His story, scholarly and yet gripping, never drags. It is a model of fine business writing.

Bombardier appears ready for last rites, according to critics who say it cannot survive without heavy transfusions of government cash. The naysayers claim that the remaining woes of the world’s airlines post-9/11 are sure to do it in. Others, notably the board of directors of Bombardier Inc., say that the company’s biggest business, building jets, has very good vital signs. Keeping the faith of founder Joseph-Armand Bombardier, the 2004 annual report points to its massive contributions to civil aviation. The common stock of the company has fallen to $3, down from the $25 high it reached in 2000, but Bombardier delivered its 1,000th regional jet in December 2003, making the company one of the most successful commercial airliners ever produced. The train business is a slow-growth affair, but Bombardier has $7.9 billion of work just in supplying cars for the renewal of the London subway system. Tales of the company’s death are premature, at least according to the Bombardier board, even though making train cars is not very profitable and competitors are eating up the core business of the company, namely regional jets.

Hadekel wades into this contest of facts to ask a single question: can Bombardier, which grew to be one of Canada’s greatest enterprises and its largest single exporter, exist without massive subsidies? In 336 pages of text (not including the index!), his answer is that it is wrong to think that federal subsidies will end.

“Canada’s government could take a vow of chastity when it came to public financing, but in the heat of the moment, what politician would not be seduced by the prospect of a sexy, hightech industry?” asks Hadekel in his conclusion. The reality of business is that Bombardier is too important to be allowed to fail. Its health is the health of Quebec and of Canadian industry. The implication: Bombardier is not going to be another Avro Arrow.

Hadekel’s study of Bombardier is not the first, although it is more probing than Larry MacDonald’s The Bombardier Story, a corporate history published by Wiley in 2001. Hadekel graciously acknowledges the help he got from Mac-Donald’s work and from the senior Bombardier management, including Laurent Beaudoin and CEO emeritus Bob Brown, and from others at Brazilian competitor Embraer.

What will keep Bombardier afloat, ironically, will be some of the things that have driven down its stock price. With the company still controlled by the Bombardier family through split class shares, Bombardier Inc. is a fossil of corporate oligarchy. Explains Hadekel: “[Board chairman] Beaudoin always tried to spin family control as a positive thing … At Bombardier, the founder’s heirs sat on the board and in the head office. Their investment was at stake.What better guarantee could there be that they would act in the interest of other shareholders?” Stir in the ability of an executive close to the family controllers to act quickly and decisively, and the case is closed, claims Beaudoin. Hadekel gives this analysis weight, although not without the counterbalance of the negativism of investors, especially in the United States, over split shares that give control
to a group that furnishes a minority of capital. Hadekel is too good a journalist to accept the company’s spiel without protest. But perhaps he protests too little, at least in the view of the real stakeholders and the moms and pops and institutions that have seen most of their investment vanish in Bombardier’s fall from grace.

Bombardier is as much a conundrum for Quebec politics as it is for the stock market. Hadekel shows Bombardier’s knack for walking a tightrope between Laurent Beaudoin’s federalist sympathies and the company’s need for support from both Quebec and Ottawa. The business that Armand Bombardier created is a talisman of what Quebeckers could do with money and brains and, for Ottawa, what Canadians could do in global industry. Beaudoin appealed to both sets of values in getting business, getting subsidies and getting sweet deals for its balance sheet.

An example suffices to show Bombardier’s knack for getting great assets cheap and Hadekel’s ability to explain the deals. In 1987, he recalls, Canadair was in trouble. It made a great water bomber for fighting forest fires and turned out a few Challenger businesses jets, but not enough to provide a decent return. Canadair had been shopped around the aerospace world without success, Hadekel says. It had to stay in Montreal, given Quebec’s political sensitivities, and so a deal was struck: Bombardier would buy it, and the feds would cough up $10 million for modifications to the Challenger, including new engines, spruced-up wings and maybe a body stretch. Bombardier would pay royalties to repay this largesse. It also got $14 million to modernize the water bomber, $5 million for new tooling, help from the Export Development Corporation and a factory in St. Laurent with an accompanying airport that could be closed when production shifted to other sites in Montreal. The land was worth $27 million at carrying cost, Hadekel says. “You could call Beaudoin an opportunist who’d profited from the public’s largesse, but you couldn’t deny his entrepreneurial vision, which turned Canadair into a world-class aerospace company, employing thousands and generating hundreds of millions in tax revenue for governments,” he explains.

Beaudoin performed the same kind of magic in taking over the troubled Northern Ireland company Shorts, accepting the risks of terrorism and the fact of a tough labour relations climate. The company had been subsidized by the British government with $1.5 billion in grants that wiped out its debt and fixed up its plants. Bombardier agreed to pay $60 million in cash for Shorts, but made no guarantees about keeping jobs. Superficially, it looked as if Bombardier had gotten an amazingly good deal, equivalent to paying four cents on the dollar for assets. Hadekel concedes the deal-making prowess of Laurent Beaudoin, but then asks the pertinent question: Was the business he ran just a “bottom feeder”? That is precisely the issue today for shareholders and potential buyers of its stock.

Bombardier’s niche in the plane business is regional jets that have been stretched from its corporate jets. It has the niche sewn up—except for a brilliant, well-financed, sharp and thoughtful competitor, Brazil’s Embraer, which makes a line of competitive and, some say, better regional jets. Canada and Brazil have both showered their plane makers with largesse, each country has whined to the World Trade Organization about the other’s subsidies, and each plane has virtues the other lacks. The Embraer plane is wider, a major selling point for airlines that like to give passengers the look and feel of being in bigger planes, and it is lighter. The Bombardier regional jet grew from a strong, stiff air frame originally developed to carry cargo for Federal Express, the U.S. cargo Behemoth. Tamed into a passenger jet, it established a customer base in the market ahead of Embraer, and was more powerful than the Brazilian upstart.

What makes the difference between manufacturing planes and selling them is trade finance. For that, Bombardier has relied on Canada’s Export Development Corporation. As Hadekel makes clear, EDC has a taste for aerospace finance, especially when it helps Bombardier. The largest chunk of EDC loans were to Bombardier customers, Hadekel says. “One out of every three dollars loaned by EDC was to aerospace, mostly to buyers of the regional jet. More than half of that money was to airlines with a credit rating below investment grade,” he explains. Offering cheap loans to New York City helped Bombardier sell its Acela high-speed trains to Amtrak and subway cars to the city of New York. “Without this financial support, Bombardier’s miracle in aerospace would never have happened,”Hadekel says.

Is it wrong for Bombardier to rely on EDC finance? One is inclined to say that if there is money on the table, only a fool would pass it up. Yet, as Hadekel says, “Bombardier had come to regard EDC as its personal line of credit.” For its part, the EDC saw the Bombardier loans as good, asset-backed business. If the buyers did not service the loans, EDC could seize the planes. EDC said aircraft lease finance, which is exactly what the loans and guarantees amounted to, was solid enough that it could finance other, shakier loans. To that, Hadekel asks the implicit question: if the business is so solid, why not just go to the bank and get the money? The answer, of course, is that commercial loans usually require payback in at most a few years, not the decades that it may take a plane to become profitable. Had Hadekel gone into mezzanine finance, so called because it is
halfway between lending and investing, he would have found that expected payoffs as a rate of return were many times higher than what EDC charges.

The WTO has ruled that both Brazil and Canada are wrong to subsidize their airplane makers. But there is a fundamental fact that works in favour of Bombardier: no matter what entity supplies the money, trade finance is nominally cheaper in Canada, where asset-backed, AAA-credits that Bombardier could structure are in a range of 4.5 percent to 5.0 percent. That is much less than the cost of funds in Brazil, a nation with a history of defaults on its debt, military dictatorship and high inflation. EDC deals could be made at market interest rates with all the bells and whistles that go with bank loans. Although it competes with private lenders for certain business, EDC is a Crown corporation that borrows at a rate priced close to the interest rate on Government of Canada bonds, pays no taxes on its surplus, need make no profit, and has a hotline to the Prime Minister’s Office that the heads of chartered banks would die for. And if EDC runs out of money to lend, it can dip into the so-called Canada Account, a slush fund that operates for national interests, as opposed to supposedly commercial interests (if anybody can separate the two).

Bombardier now protests that it can run profitably without EDC or other handouts from governments. The statement is tactical schmooze, for Brazil’s development bank has put up the cash for 80 percent of Embraer sales compared to the relatively modest 41 percent that EDC has put up to help Bombardier deliver its planes. Financing planes remains absolutely critical to selling them and, in the absence of EDC, the aircraft business post-9/11 is a banking desert. Explains Hadekel, “as many as 50 companies had once been in the business of financing the leveraged leases used to acquire aircraft … After September 11, this private- sector market shut down.”

The company coped, if one may call it that, with 9/11 by indulging in what turned out to be innovative accounting. Bob Brown, an Ottawa mandarin who became CEO of Bombardier’s manufacturing operations, had to make sense of the purchase of German train maker Adtranz. When it turned out that Adtranz was not the business expected, Bombardier sued for $1.4 billion, which was $300 million more than it agreed to pay for what turned out to be a dud. Then trains crashed, the plane business nose-dived, and Brown was turfed out.

Bombardier next hired Paul Tellier, former Clerk of the Privy Council (the top job in the Ottawa civil service), then the rescuer of CN Rail, fitness nut, a supposed Houdini who could climb out of any hole. The stock market price of Bombardier shares rose to $7 in mid December 2002, at news that Tellier would take the job, then fell when it became evident that his streak of miracles was over. Tellier dumped the recreational products division that had been Bombardier’s first business. In the recession, Hadekel says, recreational vehicles were not selling well. He might have noted that the margin of about 6.9 percent, down from 9 percent, did not justify the cost of capital devoted to it. Snowmobiles and jet ski watercraft had become an intensely competitive market. A year’s decline in profit margins was probably seen as a harbinger of the future.

The stock market, never known for keeping itstemper, remains dispirited about Bombardier and its fall from grace. Yet large investment funds have a major stake in the company, figuring that when the dust settles, Bombardier shares should rise strongly. Hadekel is not foolish enough to predict who is right, but Silent Partners is a graceful, scholarly, clear and provocative history of Bombardier. The implicit question in this history of public finance of a private company is unavoidable: if the governments of Canada, Ontario and Quebec, among others, financed the growth of the company, why doesn’t the public own it? The answer, again implicit in the book, is that Bombardier has been a huge entrepreneurial success, something that government could probably never have achieved. That is the dilemma: Hadekel illuminates it brilliantly.