THE BOEING & MCDONNELL DOUGLAS MERGER

For Dr. David Loomis Illinois State University

By Steve Rolinitis Illinois State University

April 17, 1997 Normal, Illinois

TABLE OF CONTENTS

BACKGROUND.............................................................................................................1 Boeing History.....................................................................................................1 McDonnell Douglas History.................................................................................1 MERGERS......................................................................................................................2 Increase Efficiency...............................................................................................2 Do Not Increases Efficiency.................................................................................3 THE BOEING & MCDONNELL DOUGLAS MERGER................................................3 Boeings View......................................................................................................3 McDonnell Douglass View..................................................................................4 The Deal..............................................................................................................5 Effects of Merger.................................................................................................7 CONCLUSION...............................................................................................................9 BIBLIOGRAPHY..........................................................................................................11

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The Boeing & McDonnell Douglas Merger

BACKGROUND The aerospace industry in which Boeing and McDonnell Douglas compete is one of fierce competition and severe cyclical swings. A record number of mergers and acquisitions have occurred over the past two years, largely due to the competition, volatility, and various other determinants. More than 10,000 mergers have taken place this past year alone, including over $660 billion changing hands. This merger in particular is the largest defense deal in history and the 10th largest United States merger overall (Cole, A6). Therefore, the effects of such a deal are expected to hit both the U.S. and world markets heavily. Boeings History The Boeing Company was founded by William E. Boeing in 1916. Their first airplane, the B&W took its first flight on June 29, 1916. It was a wood, wire, and cloth two-seater seaplane with a cruise speed of 67 mph. Boeings first jetliner, the 707, was build to carry up to 181 passengers and cruise at 528 mph. Its first flight took place on December 20, 1957. Boeing is the number one aerospace company in the country, and maintains a customer profile of 80% commercial and 20% defense. McDonnell Douglass History McDonnell Aircraft Corporation was founded by James S. McDonnell, Jr., in 1

1939. The Douglas Aircraft Company was founded by Donald Wills Douglas in 1920. The two companies came together in a 1967 merger creating the McDonnell Douglas Company. The Douglas Cloudster, was the first airplane to carry a useful load exceeding its own weight and first flew on February 24, 1921. The company then moved on to the Douglas World Cruiser which completed its first around-the-world flight on September 28, 1924. The first entirely McDonnell-designed aircraft, the XP-67, flew on January 6, 1944. McDonnell Douglas maintains a customer profile of 28% commercial and 72% defense.

MERGERS The purpose of most mergers, like that of companies, is to increase profitability. There are three primary ways for the purchasing firms to gain control of the other firm. The first method is to approach the management, negotiate the terms of the offer, and have the management recommend that the shareholders accept the offer. Second, to make an offer directly to the shareholders of the firm to purchase their shares at a stipulated price. The last method is to convince the shareholders to vote you into control because you would run the firm more efficiently. Increases Efficiency Mergers that increase efficiency are desirable for both the companies involved and the society. One way that efficiencies occur are when firms reduce duplication due to the merger. Another possibility for efficiencies to occur are due to synergies. Firms may 2

benefit from economies of scope where it is less costly for one firm to perform two activities than for two specialized firms to perform them separately. A final possible way that efficiencies occur is when a badly managed firm is taken over by a better management group. Do Not Increase Efficiency Some mergers reduce both efficiency and/or profitability, but are still favorable to conduct. Taxes are one example. If one company is making positive economic profits while the other company is losing money, the end result would be less or no taxes for the combined firm. Another example is when firms are going to exploit the short-term gains even if there are long-run losses. The final example of when firms merge even though there may not be increased efficiencies is when firms acquire additional market power by merging. This gives the new firm the ability to set price profitably above competitive levels, but is also carefully monitored by the governments anti-trust department.

THE BOEING & MCDONNELL DOUGLAS MERGER Meetings and talks about making this merger a reality began three years ago between these two stellar companies. At the time, neither one could agree on the underlying decision of setting a fair price. Although, time brought forth many changes for each company, and started the wheels turning. Boeings View Boeing has gone through periods of high demand making airplanes for WW II, to a 3

depressed commercial market where they were forced to cut employment by two-thirds, to the period where they are now. There were two enormous factors that impacted Boeings current condition: deep cuts were being made in defense spending and solid growth was expected on the commercial side largely due to growth in air travel in the worlds emerging markets. Obviously this heavily favored Boeing because of their 80% commercial and 20% defense outlay. Although these factors heavily favored Boeings make-up, Boeing was still concerned with the severe cyclical swings that the commercial market faces. At the level where Boeing competes, its not enough to dominate the U.S. market anymore. You need to match-up overseas too---in Boeings case mainly Airbus Industrie, the European consortium (Whitford, 96). McDonnell Douglass View McDonnell Douglas was seeing things from a much different perspective than that of Boeing. A fundamental problem was quickly growing to place McDonnell Douglas in a very bad position. McDonnell Douglas made two-thirds of its revenues and almost all of its earnings from defense products, but defense spending was drastically shrinking. This was a very bad sign for McDonnell Douglas because this was not a trend likely to change with wars based more on information and intelligence. At the same time the defense market was shrinking, the commercial market was expanding worldwide. The problem here was that Douglas Aircraft was steadily losing market share to Boeing and Airbus. McDonnell Douglas faced a series of rapid-fire blows to both the civilian and military sides of the company to cast a large amount of doubt on the prospects of the 4

company (Bryant, D14). First, their ValuJet order came into question after the crash of Flight 592. After this incident, the company failed to interest any other buyers in the MD95. Next, in October, the company scrapped the plans to develop a big new long-range jetliner, the MD-XX, because of prohibitive costs. This was the first time that McDonnell Douglas had ever abandoned the top of the airliner market. In November, the Department of Defense eliminated them from contention for a contract to build the Joint Strike Fighter combat aircraft to serve all branches of the United States military . The company regarded this project as a key to the companys future as a military plane maker since the contract is potentially worth $750 billion or more. McDonnell Douglas was beat out of contention by Boeing and Lockheed Martin. Later in November, one of McDonnell Douglass best customers, American Airlines, made a statement that they will place all new airline orders with Boeing. The final straw occurred at the beginning of December when McDonnell Douglas made a deal with Boeing to develop widebody commercial jets jointly. The question left for McDonnell Douglas management was will we buy or be bought (Whitford, 98). The Deal The primary problem with completing the deal in the past was the decision about the price. Both sides agreed that things would have to change before they could go any further, and those changes did occur. By the end of 1996, Boeings orders for new aircraft were up, the backlog was rising, and more than 12,000 laid-off workers were called back to work (Bryant, 98). On the other hand, McDonnell Douglas was heading in 5

the opposite direction with their dying commercial side, and the setbacks on the military side. McDonnell Douglas was in a critical stage where they were seriously considering the purchase of the defense divisions from either General Motors, Texas Instruments, or both. That is when CEO of Boeing, Phil Condit, called McDonnell Douglass CEO, Harry Stonecipher, to meet about a possible merger. In less than one hour, the two CEOs sketched out a rough agreement. Under terms of the contract, McDonnell Douglas shareholders will receive 65 shares of Boeing common stock for each 100 shares of McDonnell Douglas common stock. The deal is estimated to be worth approximately $13.3 billion, but the transaction is subject to approval by the shareholders of both companies and certain regulatory agencies. The merged company will have approximately 200,000 employee which includes the recent Boeing merger of Rockwell aerospace and defense units. It will operate with estimated 1997 revenues in excess of $48 billion, making it the largest integrated aerospace company in the world. The company will retain the formal name of The Boeing Company, and will remain to be headquartered in Seattle. The company will operate in three major locations: St. Louis, MO, Southern California, and the Puget Sound area of Washington State. Phil Condit will be Chairman and Chief Executive Officer, and Harry Stonecipher will be President and Chief Operating Officer of the merged company. Two-thirds of the new board will be drawn from the current Boeing board, while one-third of the new board will be drawn from the current McDonnell Douglas board. 6

Effects of Merger The effects of the merger are going to encompass several different aspects of the industry. First, the merger is going to affect Boeing and McDonnell Douglas directly. The Boeing company is now going to enjoy many new efficiencies due to the addition of McDonnell Douglas. A synergistic affect of combining the two companies is the first efficiency improvement. By adding McDonnell Douglas, Boeing solidifies itself as the number one commercial airline company and jumps to the number one position in defense since that was the strength of the McDonnell Douglas Company. The McDonnell Douglas addition enhances Boeings commercial lines while drastically improving their defense expertise. On the cost side, they synergies include facilities rationalization, research and development, business systems, and material purchasing. The merged Boeing Company believes the potential cost reductions could reach as much as $1 billion a year (Ricks, A4). The second way that this merger increases efficiency is by it filling the gaps of both companies while at the same time eliminating duplication and redundancies. Many of the gaps that are being filled include the facilities and manufacturing capacity to fill the Boeing backorders. To many competitors, this merger means that they will have to contend with a titan of production capacity and research might (Murray, A10). The management of the Boeing Company will also improve with the addition of the highly skilled McDonnell Douglas employees. In these ways, the new improved Boeing Company is going to be much more efficient.

The mammoth size of the firm is going to be one area to watch for in-efficiency because of the massive number of workers and facilities. The merger basically brought the number one commercial airplane company together with one of the best defense companies to form a colossal giant in the aerospace industry. The flow of communication will be a key to the companys success. The second way to look at the merger is how it affects the other competitors. In the defense industry, the merger places the Boeing Company in the number one position pitted against the number two defense company of Lockheed-Martin. The primary difference is that Lockheed Martin has moved heavily into electronics, while Boeing must now try to build that business from within (Cole, A6). The merged Boeing does have several advantages too though. For instance, Seattle-based Boeing and McDonnell Douglas of St. Louis together command more than 60% of the world market for large commercial jetliners (Cole, A1). In the commercial airline industry, Boeings in the number one position again against Airbus Industrie, the European consortium. Boeings merger is placing even more pressure on Airbus Industrie to get their four partner companies to turn their now loose consortium into a centralized company in order to boost efficiency. Most companies arent worried about the massive new company that is now overwhelming in size to all of the others. A way to handle the change to less companies is similar to Chinas preference of splitting up contracts to even out the competition which would now help or favor Airbus (Faison, D2). Customers thinking similar to China will 8

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also split up their orders between companies to keep competition fierce, and prevent a monopoly or powerful duopoly from forming. A similar worry-free feeling stirs because of feelings about McDonnell Douglas. Many of the customers agree that McDonnell Douglas was no longer a threat, and hasnt been a threat for a long time (Murray, A10). This sudden merger decision between Boeing and McDonnell Douglas has placed the remaining defense/aerospace companies in a bind. Mergers are expected between Northrop Grumman and either General Motors defense unit, Texas Instruments defense unit, or possibly even both. No-matter what the combination, it will not stack up against the power and experience that the new Boeing company will possess. Many officials like the merger activity in this industry because they feel that it is easier and less expensive to keep a couple of strong powerful companies going that can handle anything, than several small companies that are only specialized.

CONCLUSION The Boeing - McDonnell Douglas merger is definitely one that makes a very loud statement. It combines two companies who were both leaders in their respective specialties, and simultaneously capitalized on utilizing eachothers strengths to develop a company that will stand out as the best world-wide. Within the one short hour that the decision was made, one of the greatest aerospace companies of the world was created. The many efficiencies that occur because of this merger are a definite sign of why this merger is a good event for the company and the industry. The effects of this merger on 9

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Boeings competitors shows an example of what shear power and dominance this company already possesses. Boeing is proving to all that it plans on leading others into the future rather than following on the coattails of others. The Boeing - McDonnell Douglas merger is one that was driven by global forces, consolidation, changing economics of the defense industry, and many other variables. It was truly a strategic merger.

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BIBLIOGRAPHY

Bryant, Adam. Boeing offering $13 billion to buy McDonnell Douglas, last U.S. commercial rival: aerospace giant moves to expand its status into military field. New York Times. Dec. 16, 1996: pp. A1+. -----. Many airlines not worried by Boeing-McDonnell deal: U.S. to consider mergers competitive effect. Dec. 19, 1996: pp. D2. Cole, Jeff. Boeing plan to acquire McDonnell Douglas bolsters consolidation. Wall Street Journal. Dec. 16, 1996: pp. A1+. -----. Boeings challenge: absorbing McDonnell. Wall Street Journal. Dec. 17, 1996: pp. A3-A4. Faison, Seth. New U.S. muscle may send China to Europeans instead. New York Times. Dec. 17, 1996: pp. D2. Kutler, Jon B. Worthy behemoth: the bigger Boeing. New York Times. Dec. 22, 1996: pp. 14. Murray, Shailikagh. Boeing deal faces headwind from EU as commercial airline sales stir worry. Wall Street Journal. Dec. 19, 1996: pp. A10. Perloff, Jeffrey and Klaas Veld. Modern Industrial Organization. Second Edition. Harper Collins College Publishers. 1994. Ricks, Thomas and Andy Pasztor. Deal would test Pentagon policies about competition. Wall Street Journal. Dec. 17, 1996: pp. A3-A4. Sterngold, James. A swift transformation. New York Times. Dec. 16, 1996: pp. A1. Tagliabue, John. Feeling pressure, Airbus hopes to respond. New York Times. Dec. 17, 1996: pp. D2. Whitford, David. Sale of the Century. Fortune. February 17, 1996: pp. 92-100.

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