May 5 Disclosure Could Raise Cost To Put 737 MAX Debacle Behind Boeing

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Peter CohanContributor

Will Boeing — whose shares are down nearly 3% in pre-market trading — lurch even lower?

Up until a Sunday disclosure, its investors were estimating that Boeing would have to pay to fix technical problems with the 737 MAX — the aircraft in which 346 people perished in crashes in October 2018 (Lion Air) and March 2019 (Ethiopian Airlines), lose revenue while the aircraft is grounded, and compensate airlines for their lost revenue until regulators let the 737 MAX fly again.

But on May 5, Boeing disclosed in a statement that it knew months before the Lion Air crash that a cockpit alert wasn’t working the way the company had told buyers. Moreover, Boeing did not share its findings with airlines or the FAA until after the Lion Air crash.

A corporate governance expert I interviewed says this could add to how much Boeing will pay to put the debacle behind it, but he’s not sure how much. (I have no financial interest in the securities mentioned in this post).

Before the news, analysts estimated that lawsuits and delayed 737 MAX deliveries could cost Boeing in the billions. Boeing could lose $1 billion a month in revenue until the aircraft start shipping again, pay another $1 billion a month to compensate airlines and leasing companies for lost revenue, and fork over $500 million to fix the software, according to Canaccord Genuity.  Meanwhile, Cowen estimated that Boeing’s free cash flow would fall $5 billion below its January 2019 guidance as a result of the 737 MAX debacle.

Lawyers could use Boeing’s Sunday announcement to raise that cost. In a May 6 interview, Richard Aboulafia, Vice President, Analysis at Teal Group, said “This issue doesn’t cost the company anything from a technical standpoint in developing a fix, But I’m certain lawyers will use it against them in which ever lawsuits develop.”

In describing its delay in sharing information about the non-working AOA Disagree software, Boeing argued that it was protected by its standard process. According to Boeing’s statement

In 2017, within several months after beginning 737 MAX deliveries, engineers at Boeing identified that the 737 MAX display system software did not correctly meet the AOA Disagree alert requirements…When the discrepancy between the requirements and the software was identified, Boeing followed its standard process for determining the appropriate resolution of such issues. That review, which involved multiple company subject matter experts, determined that the absence of the AOA Disagree alert did not adversely impact airplane safety or operation (italics mine).

Boeing plans to make a working version of the AOA Disagree alert available to airlines as “a standard, standalone feature before the MAX returns to service.”

AOA Disagree — which worked on the older versions of the 737 — is intended to “alert pilots that signals from the airplane’s two angle of attack vanes sent conflicting data about the relation of the plane’s nose to the oncoming air stream,” according to Bloomberg.

Boeing’s disclosure adds a new element to the potential cost to shareholders of the 737 MAX debacle. Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, said in a May 6 interview from Cambridge, England, “Boeing faces three costs: tort — and potentially punitive damages — due to the deaths from the two crashes; contractual damages due to its airline customers’ loss of business while the 737 MAX is grounded; and reputational damage.”

That reputational damage means airlines could buy from Airbus instead of Boeing — something that is already happening. For example, as the Wall Street Journal reported, China is “taking the lead in grounding the Boeing 737 MAX [and] buying 300 planes from rival Airbus [a considerable lost opportunity since the 737 MAX retails for $106 million apiece according to Statista].”

Elson speculates that Boeing made its disclosure on May 5 “after an internal investigation of the matter and determined that the information would eventually come out and was material to the stock price. Some will raise questions about why Boeing did not disclose this sooner.”

While investors may have previously assumed that Boeing would pay for the tort, contractual, and reputational damages, Boeing’s May 5 disclosure raises the question of punitive damages — which Elson said in theory could go even higher than “treble damages” — or three times the tort damages. As he said, “Does it open potential liability to Boeing? Absolutely. How far does it go? I don’t know.”

The answer could depend — in part — on where Boeing’s actions sit on a scale from “oops” to “intentional recklessness,” he said. There are four forms of negligence — and the worse the negligence the higher the punitive damages. As Elson said, “Negligence is when a reasonable person would do it differently; gross negligence is more extreme; recklessness is a drunk person getting behind the wheel of a car: and intentional is the cigarette company litigation — [which was settled in 1998 for $246 billion over 25 years, according to NPR].”

Boeing’s main defense, according to Bloomberg, is that AOA data aren’t a “safety feature because an alert about faulty readings don’t form a central part of a pilot’s classic flight display.”

Elson sees this as Boeing’s effort to argue that it was doing what a reasonable person would have done. As he said, “Whether Boeing was negligent will come down to whether it is seen as acting as a reasonable person. And that could be the subject of a long and involved trial. There is also the question of whether Boeing misrepresented the situation to regulators. It’s a very complicated story.”

Perhaps Elson is not alone in asking about the latter question. According to the Journal. “Senior FAA and airline officials increasingly are raising questions about how transparent the Chicago aerospace giant has been regarding problems with the cockpit warnings.”

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