:: January 2016 Letter ::
To understand the aerospace industry, you should follow at least 100 companies. But to understand the world today, you just need to follow one aerospace company. You can see most of the horrible headlines that we’ve come to associate with late 2015 and the first month of 2016 reflected in France’s Dassault. And since they own Chateau Dassault, you can do your “research” while drinking good wine, deducting each bottle as a business expense.
For analysts and students of global affairs, Dassault is an almost impossibly convenient combination of two unique units. The military side is unique in that it’s the only independent fighter manufacturer that builds solely high-end fighters (the Rafale is a relatively heavy and expensive twinjet; the last single-engine mid-price Mirage was delivered in 2007). The civil side, Falcon Jet, is unique in that it’s the world’s only business jet company that builds solely high-end models ($30 million and up).
Historically, the company’s FalconJet unit was a minority part of the corporation, while the majority came from fighters. But since the 1990s, global wealth creation and France’s shrinking role in world defense (exports, domestic procurement and military operations) had upended Dassault’s business mix. By 1995, the company was routinely delivering more Falcons than fighters, which seldom happened during the Cold War. By the late 1990s, Dassault offered company swag with pictures of a large Falcon and a small Mirage, saying “Every Falcon Jet has a little brother in the military.” Condescending, but accurate.
However, 2015 saw the relationship between these two units reversed again. Last year, just 55 FalconJets were delivered, about ten fewer than most forecasters expected (me included), 11 fewer than 2014, and the lowest number since 2005. Sales dropped by 72% from 2014, to just 25 Falcons. This means that for the first time since the 1990s the company sold more fighters than business jets. The company sold its first 48 Rafale export planes after three decades of failed sales campaigns. The Falcon backlog fell by 30 planes to 91. The Rafale backlog is now 83 aircraft. Compare this near 1:1 ratio to the backlog in late 2014: 121 Falcons and just 43 Rafales, or a 3:1 Civil-to-Military ratio.
Dassault’s Falcon misfortunes are completely understandable. Their strongest markets have been resource-rich countries (the Mideast, Russia, Brazil, etc.). In 2015, resource prices, particularly for oil, collapsed. This helped clobber economies and markets. Brazil’s economy contracted by 3.7%; Russia’s by 3.8%. China’s growth engine sputtered, and President Xi’s anti-corruption campaign destroyed any remaining hope of a business jet sales resurgence there. Somehow, the first two weeks of this year saw world stock markets fall by over $3 trillion, and equities prices have always been linked to business jet demand. Capital flows to emerging markets turned viciously negative last year (about $750 billion in the red). According to the IMF, oil exporter countries’ current accounts went from a ~$600 billion surplus a few years ago to almost nothing in 2015.
Heavy defense spending by oil exporters contributed to this red ink. Despite the oil revenue downturn, they continue to spend heavily on defense. Conflicts in Yemen, Syria, Libya, and against ISIS, domestic procurement requirements, and of course propping up poor allies with defense equipment are big requirements. They aren’t cutting back, despite the economic headwinds. Dassault benefited from all of this. Egypt, strangely enough, became the first non-French Rafale operator, because their oil-rich (but cash-hemorrhaging) Gulf allies paid for them.
Dassault benefited last year because of another unique aspect of their military business: they’re the only non-US Western fighter prime that has solely domestic content. Buy a Gripen and your engine is from the US. Buy a Eurofighter and you’re buying a plane built by four nations. Buy a JF-17 and you’re a loser. But if you buy a Rafale, all of its systems are French. Looking at history, there’s no risk of France cutting you off from spares and support if they think you’re too brutal. And given France’s active Mideast foreign policy and military presence, the country makes a good strategic partner. Tilting towards France also makes sense if a country wants to send a message to the US about the Iran deal, US actions during the short-lived Arab Spring, or if they just want to hedge their bets.
This year should see Dassault’s businesses continue to reflect all of these global trends, to an even greater degree. Expect either or both the India and UAE Rafale deals to be signed, adding 36-96 more export sales to the order book. Expect Falcon sales this year to remain weak.
The entire A&D sector will likely follow Dassault’s pattern in 2016. Boeing’s fourth quarter 2015 results announcement was a tough experience for all concerned, thanks to the company’s jetliner rate cut. Pure defense companies should do better. And largely commercial companies, particularly Bombardier, will not have an easy year at all.
And to recap the world’s dystopian hellscape in 2016 so far (as reflected in Dassault’s results): The global economy is on shaky ground, and resource-rich countries are being drained of cash while sectarianism and turf squabbles lead to vicious proxy fights and open warfare. Several US presidential candidates have proposed solving the problem with carpet bombing. Perhaps February will be better. And if not, well, have another bottle of delicious tax-deductible Grand Cru Classé.
This month’s Teal aircraft binder reports include the World Aircraft Overview, the Fighter Overview, Gripen, S-92, MiG-29, and AW101. Let’s hope for eleven less chaotic months.
Yours, ‘Til All A&D Companies Have Vineyards,
© Richard Aboulafia 1997-2006, All rights reserved.