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Sunday, February 14, 1993 - Page updated at 12:00 AM

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Down Draft -- Troubles Make Future Unclear For Mcdonnell Douglas, But Company Says It's Here To Stay

Wall Street Journal: Dow Jones & Co. Inc.

The news on the global aviation front is growing grimmer. Carriers are slashing routes, airplane orders and jobs. Aircraft and engine manufacturers are cutting production and idling workers. Even the largest of the old-standby leasing companies, which in tough times usually bridge the financing gap between buyer and seller, is tottering.

The bleak news inevitably raises questions about the staying power of the weakest manufacturer of commercial jetliners, McDonnell Douglas Corp.

Its venerable Douglas Aircraft Co. division has been losing orders month after month to The Boeing Co. and Europe's Airbus Industrie consortium. Last year, in fact, it managed to pick up only a single net order for its flagship MD-11. But beyond the current order book lies a plethora of other problems for McDonnell Douglas:

-- The collapse last year of its deal to get as much as $2 billion in Taiwanese investments.

-- Delay after delay in plans to offer new models to fill in its product line, and a general unwillingness to plan the new-generation airliners that entail the greatest development expense.

-- The failure to match the financial enticements of its wealthy rivals in the sale of aircraft in an increasingly competitive market.

-- The prospect that its original plan, to cut production and hold it at low levels until worldwide orders turn up again, could be ruined by an extended recession in the airline business.

McDonnell Douglas says emphatically that it is in the airliner business for the long haul. "I recognize the perception out there is we're going out of the business," says Chairman John McDonnell. But he declares: "We're not in the process of going out of the business. We're in the process of constructing the business in a way that we can stay in in the longer term."

Yet industry observers note that Lockheed Corp., just months before pulling out of the jetliner business in late 1981, was giving public assurances similar to McDonnell's.

Doubts about McDonnell Douglas' staying power might seem strange at a time when the company's airliner unit remains profitable, except that some of the reasons for the profitability aren't encouraging: production based on a backlog of aircraft orders taken years ago, cuts in current spending on development of new jetliners and substantial layoffs, among other cost-shaving measures. The future of operations in Long Beach, Calif., the nexus of Douglas Aircraft facilities, looks dim.

Earlier this month, for instance, the unit lost a hard-fought contest for one of the year's biggest orders - one it should have had a good chance to win - from United Parcel Service of America Inc. The package hauler elected to buy 30 Boeing jets valued at $2.4 billion, instead of MD-11s. Two months ago, Douglas was nearly shut out of a huge $4.6 billion order by leasing giant International Lease Finance Corp., a Beverly Hills, Calif., unit of American International Group Inc.

While Boeing and Airbus logged an estimated 270 orders last year, even after accounting for numerous order deferrals and cancellations from recession-struck carriers, harder-hit Douglas ended 1992 with only 36 orders - the lone MD-11 and 35 smaller twinjets.

With its order book and backlog drying up, the Douglas unit has feverishly chopped 21,000 jobs in the past three years, and it plans to cut as many as 5,000 more jobs from the work force this year. It also sharply has scaled back efforts, once described as crucial, to fill gaping holes in its product line with a long-range 430-seat MD-12 jumbo jet and a smaller 100-seat plane.

Such moves raise a special kind of problem with customers. "Not only do they have to convince the airlines that their hardware is good," says Steven UdvarHazy, president of International Lease, but they also must convince them that the company "has a long-term commitment to commercial aviation and will stand behind the product - and that is sometimes tougher."

Making the commercial business look even more problematic is the fact that St. Louis-based McDonnell Douglas' other businesses seem to be stabilizing. As maker of the F-15 and F/A-18 fighters, among other warplanes, the company remains the nation's largest contractor in the consolidating defense industry.

Douglas Aircraft, founded in California more than 70 years ago, was a leader in the jetliner industry through the 1970s, thanks to its venerable DC-8s, DC-9s and DC-10s. The years since its 1967 merger with McDonnell Aircraft Co., known mainly for its production of fighters, have been marked by a repeated failure of the St. Louis managers to run Douglas' West Coast operation efficiently. It wasn't long after the merger that Douglas quit investing in new aircraft types.

McDonnell Douglas settled instead for upgrading the three-engine DC-10 into the MD-11, and for souping up the DC-9 to produce the MD-80 derivative, and a larger MD-90 cousin now entering production. Another jet on the drawing board, a 100-seat MD-95 airliner that Douglas Aircraft planned to co-produce with China, has been placed "on hold," says Robert Hood Jr., president of Douglas Aircraft.

Boeing and Airbus, meanwhile, have expanded aggressively into new jet models. Boeing and the four partners in Airbus, acting independently, recently unveiled a plan to join in studying development of a 600-seat superjumbo jet.

And the new Boeing and Airbus products have attracted the world's airlines, even as the carriers have had to make hard decisions about slowing down delivery schedules and canceling excessive orders. When McDonnell Douglas balked at a financial restructuring proposal for Irish aircraft leasing company GPA Group PLC, for instance, its objections didn't derail the lessor's advancing plans. That's because of the 250 large jetliners GPA has on order, only 27 are McDonnell Douglas planes.

To lead the marketing push for its commercial jets, McDonnell Douglas has made an unusual choice. For what is arguably the commercial aircraft industry's toughest job, it selected David Hinson, the 59-year-old former chairman of failed Midway Airlines. His outlook is glowingly positive.

"Let's look at the facts," he says, "not wishful thinking." Hinson says Douglas' sturdy jets invite less concern as fleets age than do planes of any other manufacturer. Older MD-11s are steadily increasing in value because of their usefulness to airlines, he adds, and not a single one of the 518 DC-10 and successor MD-11 jets is grounded today, despite the financial pressure on carriers. Narrow-body DC-9s and MD-80s, meanwhile, have the highest rating, "period," he says - when it comes to being mechanically ready for takeoff.

"Douglas probably builds airplanes better than anybody else, and always has," he says.

His enthusiasm for McDonnell Douglas products is evident in the field, as Hinson trots the globe in search of business. Last June, for instance, he flew a small team of Douglas executives, including a celebrity marketer in the larger corporation, former astronaut Pete Conrad, on a costly flight from Zurich to Saudi Arabia in an MD-11 borrowed from Swissair. There the team extolled the jet's virtues before more than 50 officials who have influence over the state-owned Saudia airline. After a full day of briefings, they were still fielding queries at 1 a.m. from a high-level ministry official who dropped by on short notice.

Adnan Dabbar, executive vice president of the prosperous Saudi airline, was somewhat impressed. "I think McDonnell Douglas management at this time is perhaps a bit more aggressive than previously," he says. But, he warns, "competition is fierce."

Indeed, for all the tenacity of the McDonnell Douglas sales team, an MD-11 sale to Saudi Arabia would be a surprise. Perhaps the only big order on the horizon this year, the Saudi contract for as many as 60 jets valued at about $5 billion is widely expected to go to either Boeing or Airbus, or be split between the two.

Competitors say Hinson's arguments are hardly what it takes to sell airplanes in these harsh, competitive times.

Robert Baker, executive vice president of AMR Corp.'s American Airlines, says Douglas is right in its current program of slashing costs and seeking financial partners. "Those who can get their fixed costs down have a chance as the volume slides away, which it is inevitably going to do," he says. American is a longtime buyer of Douglas jets.

But Baker worries that Douglas is cutting too deeply into the ranks of experienced personnel, and will suffer in the long run for delaying airplane development. "At some point, in theory, it gets to where you can't build an airplane," he says. And without building jets for the future, "you may survive the first round of bombs, but not be able to breathe when you come out the other side."

McDonnell Douglas did set its sights last year on one new model: a superjumbo MD-12 to be built in Taiwan with the benefit of that country's investment. But plans for early development of the double-decker MD-12 fell through not long after the Taiwan deal itself failed, reflecting concerns about the exposure of any equity investment from the Asian nation.

McDonnell Douglas is still engaged in an effort to get an outside investment partner. Some industry people say the company has asked its Italian parts supplier, Alenia, to buy a minority slice of Douglas Aircraft and help it meet the $1 billion cost of developing a stretched MD-11, instead of the bigger, more expensive MD-12. Longtime supplier Mitsui of Japan and some Taiwan interests are said to be other targeted minority investors. An Alenia spokesman says such an investment isn't being contemplated.

McDonnell says he believes the perception that his company may abandon the jetliner business "will be significantly changed once the initial partner comes on board." He declines to discuss specific potential deals.

The chairman still hopes Douglas will one day resume a leading role in the jetliner industry. Perhaps, he suggests, it may even oust Airbus from the No. 2 slot, behind Boeing - a goal it had hoped to reach with a multibillion-dollar Taiwan investment. Privately, Airbus managers guffaw at the notion.

Nonetheless, despite all the bumpy flying recently, the MD-80 and MD-11 product lines both are making money as Douglas delivers planes ordered several years ago. Hood, Douglas president, notes the division has been profitable overall for nine consecutive quarters, and predicts ever-better results ahead as costs drop with the shrinking payroll.

But to date, only 173 firm orders for the MD-11 have been taken in its seven years on the market, and 76 of those have already been delivered. And McDonnell Douglas recently reported 1992 operating earnings of $151 million for the Douglas unit, off 48 percent from the prior year. By the end of 1994, the production rate for MD-11s - currently at 42 planes a year - is expected to be halved, with MD-80 output falling even more sharply.

Tassos Philippakos, aerospace credit analyst for Moody's Investors Service Inc., says weak cash flows keep Douglas from offering sorely needed customer financing, such as valuable loan guarantees or favorable leases that keep aircraft debt off the books for financially pressed airlines. "They do not have the financial flexibility to be a strong participant in this market," he says. Boeing increased customer financing by $1.2 billion last year alone.

Indeed, perhaps the darkest aspect of losing the UPS order was that the package carrier required little in the way of easy terms, leases or financial backing - something that should have provided McDonnell Douglas with a level playing field in its duel with Boeing.

Herbert Lanese, McDonnell Douglas' chief financial officer, personally wooed the president of UPS's airline, Dick Oehme. Though Lanese was optimistic before the UPS decision, he now reasons that UPS simply needed a smaller jet, and found it in Boeing's new cargo version of the 767. UPS says it made the most prudent long-term fleet decision.

Lanese is widely perceived inside McDonnell Douglas as being reluctant to give away the store through financial incentives for customers. Some managers, in fact, suspect he wants to wind down the remaining jetliner production and quietly end it entirely, squeezing out the highest possible profit along the way. That perception has led to some friction with the sales crew at Douglas, people there say.

"I have no secret agenda," Lanese says. "But you have people in the company, as you do in life, who want to take the easy path." He maintains that the only deals Douglas makes are those that promise solid profits in advance. "I am absolutely the least understanding guy you'll ever meet about selling products at a loss," he says.

At McDonnell Douglas, the falloff in commercial jet orders is taking place against a backdrop of corporate reorganization that has streamlined its defense and aerospace businesses. The company's cost-cutting efforts follow five years in which $5 billion drained from the company - $3 billion to build up inventory for programs such as the MD-11, and $2 billion more for growth on fixed-price contracts such as its loss-plagued C-17 military-transport program.

Asset sales and $1 billion in new debt have helped pay the bills, with a 20 percent companywide cut in employment making up the rest. Another 8,700 jobs, 10 percent of the total McDonnell Douglas work force, are to be cut in the year ahead.

Perhaps the most dramatic evidence of a defense-side turnaround is in the division that makes fighters, Apache helicopters and Tomahawk missiles.

Ignoring the C-17, which the company vows will be profitable this year, operating profits for military aircraft in that division rose 46 percent last year, and there was a series of big contract wins. John Capellupo, executive vice president for the division, says plant costs dropped about 5 percent last year, and expenses for overhead and labor not directly involved in production plunged by more than 20 percent.

So the world's airlines and industry analysts are asking: Mightn't the parent company be justified in shuttering the airliner business - or just wringing it for the money to be made on ever-dropping production - and sticking to its guns in the defense business?

Lanese swears he stands fully behind the boss' plan to stay in the jetliner game. But the financial officer says that as McDonnell Douglas rebounds, "if you can't carry your own weight, we don't need you. . . . The rest of the company should not have to make up for the poor performance of Douglas Aircraft."

Reprinted with permission of The Wall Street Journal, copyright 1993 Dow Jones & Co. Inc. All rights reserved.

Copyright (c) 1993 Seattle Times Company, All Rights Reserved.

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