Boeing's Cheap Play Could Cost It $700 Million
Jun 16th 2013 11:15AM
Updated Jun 16th 2013 4:30PM
The KC-46 tanker that Boeing is building for the United States Air Force is on track for a major design review in July. Considering that Boeing is looking at absorbing an estimated $700 million in cost overruns thanks to the fixed-price nature of the contract, the fact that the project is on schedule is a welcome sign. Here's what you need to know.
When aggressive bidding bites back
Bidding for the U.S. Air Force tanker contract was fierce, to say the least, and defense heavyweights such as Northrop Grumman , and European Aeronautical Defense and Space , submitted bids. In fact, when Boeing's initial win was rescinded because of shenanigans -- people even went to jail -- a bid from Northrop/EADS won the second go-around. However, Boeing wasn't willing to give up that easily and lobbied to have the award overturned. It worked, and Boeing won the third and final round.
The reason Boeing's bid beat out EADS in the final round was that it came in 1% below EADS. Boeing admitted that its bid was "aggressive." More pointedly, in 2011, James Bell, who was then Boeing's chief financial officer, said, "We have always bid this contract thinking this, on the development phase, would be a very low profitability or breakeven."
Well, breakeven didn't happen, and now Boeing is on the hook for anything over the agreed-upon development-stage price of $4.9 billion. And while Boeing estimates that cost to be around $5.2 billion, the Air Force estimated it to be closer to $5.6 billion.
High-flying profits in the future?
Even though Boeing is looking at a pretty expensive cost overrun right now, potential future profits will more than offset the cost. The initial KC-46 tanker contract win was worth $35 billion for the purchase of 179 tankers. That worth has since climbed to an estimated $52 billion, and some analysts estimate that with future parts and maintenance, it could climb to $100 billion.
In any event, the crash of the U.S. Air Force KC-135 tanker in early May highlights the need for updated tankers, as the current fleet is more than 50 years old.
What to look out for
The new tankers aren't scheduled to come online until 2028, and there's a lot that could go wrong between now and then. The good news is that the tanker is based on Boeing's commercial 767, and not the troubled 787 Dreamliner, so perhaps it won't face too many issues going forward. More importantly, if Boeing keeps the tanker on track, this is definitely something that could prove positive for Boeing's stock. But right now, that's still a big "if," and investors would do well to continue closely monitoring Boeing's progress.
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