Every time the real appreciates against the dollar, the financial pages of the Brazilian media speculate about a new round of macro-prudential pressures from the government. And at some point, the debate about the benefits of currency manipulation focuses on the Brazilian aircraft-maker Embraer.
It’s an unusual Brazilian company, developing and manufacturing technologically advanced engineering and exporting to the rest of the world. Proponents of currency manipulation advance their cause as a defence of Embraer’s global competitiveness.
However, in reality Embraer is not the poster company for artificially maintaining a low real-dollar exchange rate it is championed to be. True, the company is affected by the valuation but it is not as exposed as many other manufacturers. The company’s accounting currency is dollars, and its sales and revenues are largely in dollars. It does have exposure to real-based costs, at about 20%, but in the last year its domestic sales were 14% and those revenues are booked in reais, so the currency mismatch is small.
"If there is an appreciation, then that hurts our domestic costs but we have the natural hedge of domestic sales," says the company’s CFO, Paulo Penido Marques, who joined the aircraft manufacturer in July. "We buy some protection for some of the balance of the exposure, about 40% to 50%. The rest is under 10% of net sales and we can run this risk. It’s small but it would be costly to buy protection at a decent price."
Penido’s attention is elsewhere. The company’s $1 billion stand-by credit facility expires in the third quarter of 2012 and Penido is planning to have the replacement signed by the second quarter. He is assessing the impact of Basle III on bank capital requirements on the cost and the liquidity of loans but does not foresee an issue with securing favourable terms.
"We split the credit facility into a local and an international tranche," he says. "We will probably reduce the international part to $500 million, and because of the health and quality of the local bank market, we will create a stand-by facility of around R$1 billion [$585 million].
"We do not intend to use these facilities but if there is a global crisis and we would need liquidity at home and abroad, [having both facilities] makes us more hedged in this respect."
Does he have an idea of the cost of the new capital allocation regulations? "We are tapping the water to see where the prices are. It’s too early to say for sure but the first indications are that the price will be similar or a little bit lower. That’s what we have heard from the top seven international banks and top four domestic banks. So the carrying cost and the structuring cost might be a little lower but it’s still to be negotiated."
Penido adds that despite market speculation that the European banks might withdraw capital from Latin America, he says they are still available – as are the US banks.
And then there is the possibility of conducting a new international bond to take advantage of the low-yield environment. Embraer has no need for credit and has a net cash position on its books, but it is expecting a large capital expenditure exercise aimed at enhancing the technology in its leading commercial aircraft series.
The company employs 17,000 people, and 3,500 are engineers dedicated full time to research and development. The project will be big but Penido says no fixed cost has been determined, as the company is negotiating supplier agreements.
However, the possibility of pre-funding that capex commitment in the current market is continually assessed – although a liability management exercise has been ruled out. "We talk to the banks all the time, every week," he says. "We analyse if we can do a liability management exercise to reduce the cost of funding of our two outstanding bonds, but there is a structuring cost when you do the buyback – and possibly a tax cost as well if we buy the outstanding bonds at a discount. So we will carry the outstanding deals to maturity."
Penido does, however, admit the probable cost of 10-year financing for the company in the current market is "attractive". As well as the capex programme, the company is building a plant in the US and is completing another in Portugal.
"We will need some financing and so that’s one exercise every CFO should do," he says. "Should I anticipate and secure money at a good price and so pay the carrying cost as a type of insurance? It’s the type of exercise we discuss all the time."
Is he tempted to pre-fund in the current market? "Yes, it is tempting. If I will need it, why don’t I take it and relax? There could be a crisis and financing might not be available. But at the same time a board member or a shareholder might ask why have you [printed a bond] now when you don’t need it now – there is a cost."
Having been a banker at Citi and JPMorgan, one thing Penido is clear on is that the bookrunner inflation seen in recent fixed-income deals won’t feature in any Embraer transaction. "I have seen deals with five [bookrunners]," he says. "It’s a nightmare. Deals can be arranged with four or five but it’s far from ideal.
"All the banks are professional but there is always a leader, and the others are taking a fee and having their names stamped on the tombstones. [Having many banks involved] makes it more difficult to arrange a roadshow – there are conflicts over large investors."
He also believes a blend of local and international banks would be best. "The large Brazilian banks have developed their branches in New York and facilities in London, and they have developed aggressive and efficient distribution forces, even in Asia," says Penido. "But I would say the international banks [still] tend to have better distribution."
Embraer tries to minimize its post-sales financing liabilities and only extends financing to a select number of clients. Its accumulated liabilities are reported to be under $100 million but when residual value guarantees and other guarantees are included, this rises to $1.22 billion, as of September 30.
In 2009, the company posted a loss of $103 million in relation to the bankruptcy of US airline Mesa, and the impact of the Chapter 11 bankruptcy situation at American Airlines has not yet been determined, but Penido is comfortable with any potential liabilities.
"Our outstanding guarantees in relation to American Airlines never go to 100% – they go to a certain percentage and that is still under negotiation," he says. "American was financed by BNDES and we counter-guaranteed part of the risk that BNDES took. Depending on [what American Airlines agrees with BNDES], we might have to recognize some loss. We are speaking to the appraisers about the values of the planes. If we have to pay something, I will take the plane back and sell it."
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| Paulo Penido Marques, Embraer |
BNDES finances about 20% of the manufacturer’s sales. It’s a large proportion but much less than, for example, US Exim Bank’s support of Boeing’s sales. "I expect [the proportion of sales supported by] BNDES to grow while respecting the internal limits they have and the way they do business," says Penido. "It’s a good business for them, it’s good for us and it’s good for the country. That’s the role of the development bank – it’s a win-win-win. BNDES is very professional and has a very good relationship with us. It’s very important to us."
Beyond commercial aviation, the company has been successful in diversifying its revenue streams into business jets and its military business. The aim is to have all three businesses generating roughly one-third of revenues. Competition in all sectors is fierce, the business-jet market in particular is growing below target, but the military business is ahead of revenue expectations and just completed its first sales into the US – albeit the legitimacy of that order is being challenged by the losing US bidder, Hawker Beechcraft.
The same is true for its geographical revenues, with the manufacturer targeting emerging-markets growth and customer segments – the company has been aggressively marketing to aircraft-leasing companies with some notable success.
Another legal hitch came when the company revealed in November’s third-quarter results that it was being investigated by the SEC. The company was criticized in some quarters for the way it announced the news: listing on page nine of the report, which was released on a Brazilian national holiday, under the heading Other Events. The company’s stock fell 5% when the market reopened, but Penido accentuates the positives to a company that has a generally good reputation for transparent governance.
"This is something that happens more and more with businesses that operate all over the world," he says. "We have internal controls and follow all the rules and regulations. But this investigation has been a good experience. We have to take the positive side. I am learning a lot. It’s good – we are questioning our controls but at this point we can’t quantify in terms of timing or impact – or if there will be an impact."
