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Today I’m going to write about the way Boeing does accounting, and how the corporation has been hiding its costs.
But first, newsletter housekeeping. This will be the last BIG issue of 2019. If you haven’t gotten ahold of my book Goliath: The Hundred Year War Between Monopoly Power and Democracy, you should. It’s a good Christmas gift for people interested in politics and/or business. Reception so far has been interesting, with something of a polarizing dispute between people who think monopoly isn’t very important and those who do. But surprisingly this fight doesn’t line up neatly between the right and the left.
The reason why is what I think venture investor Ross Baird noted in his review for the book in Impact Alpha. Addressing the problem of monopoly doesn’t come from the left or right, but from a business reformist ideology.
Second, before I go to Boeing, I have to address impeachment. My view is that whether Trump is removed is besides the point. The question Democrats have to answer is whether they are impeaching Donald Trump for being a uniquely bad guy they don’t like, or whether they are impeaching an entire system of power that placed him in office. I gave a talk last month at Lafayette college on this question, comparing the impeachment of Donald Trump with the impeachment of Treasury Secretary Andrew Mellon in 1932. You can watch it here. This argument is drawn from the research I did on Goliath. We’ve been here before, and we should know our history.
The Coming Boeing Collapse
One of the weirder aspects of the Boeing scandals is that the corporation has had significant operational difficulties for 20 years, and yet the stock has done quite well. Even before the 737 Max, the company was bleeding cost overruns. As Maureen Tkacik wrote in the New Republic, the 787 Dreamliner, was budgeted to cost $7 billion for development, but ultimately cost between $30-50 billion (which was both development and manufacturing). That’s a lot of money! Where are the losses?
One hint comes in this headline of a Wall Street Journal story from 2016, before the 737 Max scandals started: “Boeing’s Unique Accounting Method Helps Improve Profit Picture.” Unique is doing a LOT of rhetorical work in this headline. Here’s the nut paragraph:
Boeing is one of the few companies that uses a technique called program accounting. Rather than booking the huge costs of building the advanced 787 or other aircraft as it pays the bills, Boeing—with the blessing of its auditors and regulators and in line with accounting rules—defers those costs, spreading them out over the number of planes it expects to sell years into the future. That allows the company to include anticipated future profits in its current earnings. The idea is to give investors a read on the health of the company’s long-term investments.
In other words, Boeing’s accounting is not about presenting an accurate presentation of losses and profits, but about hiding risk. Obama’s Securities and Exchange Commission in 2016 was apparently investigating, but in keeping with tradition, they didn’t do anything to enforce rules against the powerful, and in all likelihood Trump has continued this bipartisan approach.
Boeing has significant development costs associated with the 737 Max, which is inherently the case for all large complex aircraft systems. The problem is that accounting for these costs have been pushed into the future based on anticipated sales, which is risky but manageable IF you can build safe aircraft airliners want to buy. But unfortunately for Boeing and anyone who wants a good aerospace industry, that was a big if. And now that the risk has turned into catastrophe, the accounting probably doesn’t make sense. There are large losses to write off, or hide somewhere. (UPDATE: Here’s Boeing’s correspondence with the SEC re: the 737 Max).
And this is where Boeing’s leadership comes in. In July, I wrote one of the first pieces analyzing the destructive corporate structure of Boeing, looking back at the merger with McDonnell Douglas and the financialization of a once great aerospace company. One very serious problem with Boeing is that its leadership has not shown itself capable of making safe aircraft. What it is good at doing is harvesting cash through short-term activities and political influence, which you would expect considering that our public policy framework encourages such activity. Just look at the Board of Directors, these are business and political leaders who excel at monopolization and financial manipulation. (I don’t say this to judge - hate the game, not the player. But it is what it is. I put the administration they served under in parentheses, so you’ll know it’s a bipartisan board.)
Amgen CEO Robert A. Bradway
Duke Energy CEO Lynn J. Good
Former CEO of Continental Airlines Lawrence W. Kellner
Former South Carolina Governor and UN Ambassador Nikki R. Haley (Trump)
Former Ambassador to Japan Caroline B. Kennedy (Obama)
Former United States Trade Representative Susan C. Schwab (Bush)
Former CEO of Allstate and AIG Edward M. Liddy
Former CEO of Aetna Ronald A. Williams
Blackstone Senior Partner and former CEO of Nielsen’s, David L. Calhoun
Blackstone Executive Advisor and former CEO of Nortel Mike S. Zafirovski
Former CEO of Medtronic Arthur D. Collins Jr
Former Admiral and consultant Edmund P. Giambastiani Jr.
Boeing CEO Dennis A. Muilenburg
Admiral and Former Chief of Naval Operations John M. Richardson
Blackstone is one of the more important private equity firms, and private equity is a vector for financializing corporations. Boeing has not one but two Blackstone people on its board, including the new Chairman of the corporation, David Calhoun, who was placed there to put a check on Muilenburg. As a veteran of General Electric and Caterpillar, Calhoun is experienced in dealing with corporate crises.
People who have worked with him describe him as an intelligent, pragmatic and disciplined leader with little patience for managers who don’t meet their goals. They also say he can be opinionated and at times brash, but skeptical when probing management.
I could be wrong, but “skeptical when probing management'“ strikes me as code for knowing when accounting is fraudulent. And this gets to the real problem, which is not large hidden losses, but cash flow burn. Because while you can hide losses indefinitely, you can’t hide a cash crunch. And Boeing’s cash flow in the wake of the 737 Max scandal has turned negative. Analysts are noticing, with Moody’s cutting the corporation’s debt rating. As we know, ratings agencies are largely corrupt lagging indicators of problems, so the conventional wisdom on the corporation’s financial position is shifting.
So far in 2019, Boeing operations have burned through about $226 million. The company has spent another $1.4 billion maintaining plants and equipment. That sums to so-called free cash flow of negative $1.6 billion for the year.
The biggest use of cash by far is the MAX inventory build. About 275 planes have been built and parked. Inventories have consumed nearly $10 billion in cash in 2019. Of course, Boeing hopes that reverses when the MAX is allowed to fly again.
Its cash flow is hurting. The company’s debt has increased pretty dramatically in the past few years, both actual on the books debt and I suspect delayed payments to suppliers. But there’s also this, which suggests more problems to come.
Boeing also said on its conference call some customers have stopped making advanced payments. That was a new revelation. Essentially, customers put down deposits when buying a jet. As the delivery date approaches, customer payments come due. Don’t forget, the current backlog of MAX orders stretches out years. Of course, the vast majority of cash comes in when the plane is finished, but suspension of payments is another—albeit small—cash headwind and one that could indicate strain with customers.
I’m not a financial analyst and I haven’t gone through the numbers in detail, but I’m going to go out on a limb and assert that this is not good news.
Let’s go back to the leadership of the corporation. The board of Boeing is a group of people who know how to cut corners on safety, which means they also know how to play financial games to increase cash flow, dividends, and buybacks. Again, hate the game, not the player, but even so, this is about hiding risk. If you hide your risk, and you have liquidity problems and a lot of debt, it’s a recipe for a bank-run like collapse a la Enron. Calhoun probably knows all about these kinds of problems, both how to cover them up with special deals for customers to paper over cash flow problems, or how to profit if the whole enterprise ends up in bankruptcy after the legal asset-stripping has taken place.
And this is where investigations should start. I’ve been waiting for the House Transportation Committee investigation of Boeing to produce something useful. So far, it consists of Peter Defazio writing polite letters to Boeing and the Federal Aviation Administration asking for documents they won’t give him. Congress can be a hard place to get things done, but Defazio needs to get more aggressive.
As I wrote in July, the basic problem is that we have financial engineers instead of actual engineers in charge of our aircraft industry. The whole board should be removed, their compensation clawed back, and the Department of Justice or state attorneys general or foreign justice officials indict every relevant executive. The right policy path is to break up the corporation into a civilian and military division, or potentially find a way to create multiple competitors. With a new leadership team in place and a competitive aerospace industry, Boeing could fix the 737 Max and begin planning great aircraft again.
But the place to start is very simple. The House Transportation Committee should hire forensic auditors to go over Boeing’s accounting, line by line and in excruciating detail. Because we have to know, where are the losses hidden? A massive group of airliners, governments, and defense players have an interest in making sure Boeing survives. It is genuinely Too Big to Fail. But we’re going to find out eventually where the losses are, because current Boeing executives and board members know how to do many things. But building safe civilian planes that airlines want to buy isn’t one of them. And it’s really hard to hide airplanes falling from the sky.
Thanks for reading. And if you liked this essay, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you want to really understand the secret history of monopoly power, buy my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.