Airbus Case Study

Airbus A3XX case study Group E10, MBA 2011 Airbus A3XX case study, Group E10 Airbus objectives Both Airbus and Boeing, as well as industry experts expected worldwide passenger traffic to grow at an average annual growth rate of 4. 8-4. 9% for the next 20 years (up until 2019). Given that the traffic was expected to almost triple in volume, both manufacturers expected a significant increase in aircraft sales, although their views on the market structure were different. Airbus expected hub-to-hub routes to become the dominant type of transportation in key regions (transatlantic and transpacific), opposing Boeing’s preference for point-topoint routes. Therefore, Airbus forecasted high growth rates in very large aircraft (VLA) segment, that was expected to reach 1,235 aircraft by 2019. Although Airbus had considerably increased its market share by 1999, it still did not have a product to compete with Boeing’s 747 in the highly-promising VLA market segment. Introduction of A3XX could help Airbus capture more than a half of this segment, and given the segment’s very positive prospects, it could position Airbus as the commercial aviation industry leader. FCF model The model estimates Airbus free cash flows associated with the potential implementation of A3XX project in 2001-2020. All calculations are performed in US dollars, net present value is calculated as of December 31, 2000. Given the uncertainty of model assumptions and the long-term nature of the model itself, additional sensitivity analysis was performed in respect of (a) operating margins, (b) discount rate, (c) inflation rate, (d) aircraft sales, (e) investment expenditure, and (f) sale price. Key assumptions Sales & production †¢ Sale price: $216m as of 2006, rising afterwards at the inflation rate. Although some of the first contracts are expected to be executed with a significant discount, this is not factored into the model due to low data availability. Operating margin: 15%, learning curve effect was ignored due to insufficient data (assuming lower margin in early years and higher margin at later stages — averaging at 15% over the forecasted period). †¢ Sales ramp-up: based on the assumptions used in Lehman Brothers equity research reports (25% of ‘steady state’ capacity in 1st year, 75% in the second year). †¢ Production capacity: 53 aircraft annually in â₠¬Ëœsteady state’ (based on a total sales estimate of 730-750 aircraft in 2001-2020). Pre-payments: although a fraction of the sale price is usually paid in advance, this factor was ignored due to insufficient data (all costs and payments are assumed to occur in the year when aircraft is delivered). -1- Airbus A3XX case study, Group E10 Funding & investments †¢ Funding: $11. 9b of quasi-equity, debt is not used in the project. †¢ Launch costs: $11. 0b for research & development, $1. 0 for capital expenditures, $1. 0b for additional working capital (as per Dresdner Kleinwort report). †¢ Additional capital expenditures: assumed at zero after the investment stage (20012008) is over †¢ Discount rate: 11. % as cost of equity (CAPM = 6. 0% risk-free rate + 0. 84 commercial aviation beta * 6% market risk premium). †¢ Depreciation: straight line over 10 years, starts immediately after corresponding capital expenditures are performed. †¢ R&D expenses are n ot capitalised. Other †¢ Inflation: constant at 2. 0%. †¢ Tax rate: 38. 0% (standard French rate). †¢ Terminal value: growing perpetuity where growth is set at the rate of inflation. †¢ Boeing’s response to A3XX launch is not explicitly modelled (assuming this factor is already taken into account through unit sales and margins). Although the market demonstrates considerable cyclicality, this factor was ignored for the sake of simplicity. Modelling results Net present value of the A3XX project is estimated at $528m, consisting of ($1,447m) NPV of 2001-2020 cash flows and $1,975m of terminal value. The break-even number of planes after the investment stage (in 2009 and beyond) is estimated at 48 per year. In this case the NPV of growing perpetuity is expected at $4,702m (annual inflows of $1,061 growing at 2% with 11% discount rate), while the NPV of cash flows in 2001-2009 is estimated at ($4,552). Sensitivity analysis The following tables present bi-dimensional sensitivity analysis of the resulting NPV for model variables that have significant predictability issues and / or likely to cause huge changes in the resulting NPV: -2- Airbus A3XX case study, Group E10 Project launch considerations Implementation of the A3XX project definitely has a very high risk profile. Although the resulting NPV figure is positive under the base scenario, sensitivity analysis indicates that returns on this project are extremely sensitive to the underlying model assumptions (e. g. a drop in operating margin by just 2 percentage points results in negative NPV). Therefore, there is a high risk of negative returns on this project. The project’s profitability may also be undermined by external market factors. The most crucial ones being (a) the response of Boeing to A3XX project launch, (b) growth rate of the VLA market. However, this project is strategically important for Airbus. Over the last several decades, since the introduction of Boeing 747 the share of VLA segment has expanded significantly. Additionally, analysts estimate VLA manufacturing has the highest operating margins — that is commonly used to subsidise production of smaller aircraft. However Airbus is not present in this segment at this time. Therefore, despite a very high-risk profile of the project, Airbus has good reasons to proceed with this industrial launch. It it difficult to estimate the number of firm orders Airbus needs to have before committing to the project. The financial model suggests it needs to sell 300+ aircraft before cumulative non-discounted project cash flow becomes positive. However, taking into account the fact that airlines do not place orders with delivery time exceeding 5-6 years, it is highly unlikely that Airbus secures orders for 300+ planes before project launch. A significant amount of orders (e. g. 50+) is likely to be enough to test Airbus demand forecasts. Potential Boeing response Although Boeing’s estimations of the VLA market are not so optimistic as Airbus’, it should definitely take some actions to defend its dominant position on this market. Boeing is unlikely to undertake a similar development project (i. e. develop a new plane for the VLA segment), since it would be a lose-lose strategy for both companies given limited size of this market segment. Therefore, the most obvious decision for Boeing would be to invest in the ‘stretch’ version of its 747 model. This is likely to take significant amount of orders away from Airbus while keeping the investment costs low. In case Airbus decides not to go ahead with its A3XX project, Boeing has no incentive to incur any investment costs whatsoever, since it already has established presence in the VLA segment with its 747 aircraft. -3- Airbus A3XX case study, Group E10 Financial projections (in US$ mln) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Revenue Operating pro? t R&D expenses Depreciation EBIT Taxes EBIAT – – – – – 2,808 421 -880 -100 -559 212 -771 8,813 11,910 12,149 12,392 12,640 12,892 13,150 13,413 13,681 13,955 14,234 14,519 14,809 15,105 1,322 -660 -100 562 -214 775 1,787 -440 -100 1,247 -474 1,720 1,822 -100 1,722 -654 2,377 1,859 -100 1,759 -668 2,427 1,896 -100 1,796 -682 2,478 1,934 -75 1,859 -706 2,565 1,973 -40 1,933 -734 2,667 2,012 -5 2,007 -763 2,770 2,052 2,052 -780 2,832 2,093 2,093 -795 2,889 2,135 2,135 -811 2,946 2,178 2,178 -828 3,005 2,221 2,221 -844 3,066 2,266 2,266 -861 3,127 1,100 -2,200 -2,200 -2,200 -1,320 -25 -60 -95 -100 -1,100 -2,225 -2,260 -2,295 -1,420 418 846 859 872 540 -1,518 -3,071 -3,119 -3,167 -1,960 R&D expenses Capital expenditure Net working capital Operating pro? t Taxes Free cash ? ow Discounted FCF -1,100 -2,200 -2,200 -2,200 -1,320 418 -250 -150 846 -350 -300 859 -350 -300 872 -50 -200 540 -880 -50 421 212 -296 -158 -660 1,322 -214 448 21 6 -440 1,787 -474 873 379 1,822 -654 1,168 457 ,859 -668 1,190 419 1,896 -682 1,213 385 1,934 -706 1,227 351 1,973 -734 1,238 319 2,012 -763 1,249 290 2,052 -780 1,272 266 2,093 -795 1,298 244 2,135 -811 1,324 225 2,178 -828 1,350 206 2,221 -844 1,377 190 2,266 -861 1,405 174 -682 -1,755 -1,991 -1,978 -1,030 -614 -1,424 -1,456 -1,303 -611 Aircraft sale price Aircraft sold 216 13 220 40 225 53 229 53 234 53 238 53 243 53 248 53 253 53 258 53 263 53 269 53 274 53 279 53 285 53 -4-