Performance Measurement
Asset Utilization
Revenue generation by each employee is perceived to be better for Boeing at $595,501.86, which may be due to a better employee retention policy. This was concurred by Boeing’s annual report where it revealed that the management has good relations with its employees since 38% are represented by unions (Boeing, 2016, p.20) with Lockheed at 18% (Lockheed, 2016, p.18). Due to the better employee retention, Boeing was able to generate a higher amount of sales based on its investor’s capital or equity at 15.02 but Lockheed was not lagging far behind at 14.90. The potential reason for this is that Lockheed’s security and aerospace products are primarily designed for its core customer, which is the US Government (Lockheed, 2016, p.11) while Boeing expanded its operations to include the manufacture of commercial airplanes (Boeing, 2016, p.17).
However despite the higher revenue value Boeing management has a lower sales to fixed assets ratio of 7.96 when compare to 8.40 for Lockheed. The potential reason for this is that Boeing is using a new fastener automation technology, which is currently being implemented in the 777 model (Boeing, 2016, p.5) resulting to a slower optimization of its fixed assets. The additional benefit is that the goodwill to assets is lower for Boeing at 5% when compared to 28% for Lockheed. This means that Boeing’s non-current assets are primarily tangible assets (Boeing, 2016, p.51) while Lockheed has a higher value for their intangibles (Lockheed, 2016, p.77), which results to a higher non-current asset value when the goodwill and intangibles are removed.
An additional reason for the better revenues is that the days’ working capital of Boeing is higher at 68 days when compared to 17 days for Lockheed. This means that Boeing has a higher operating fund since it is considered to be the market leader in its commercial airplane segment due to the fact that the current airplane order accounts for 7 years of production (Boeing, 2016, p.5). The generated revenue is perceived to be better for Boeing as concurred by the investment turnover of 1.02 against the 0.94 for Lockheed. This implies that Boeing management is better at managing and controlling its equity and debt since it was able to generate higher revenues. But the interest expense to debt at 3% for both companies revealed that Boeing is using its equities better than Lockheed resulting to a higher investment turnover.
Operating Performance
The gross profit margin is higher for Boeing at 15% when compared to 11% for Lockheed, which means that Boeing is better at controlling its production costs. However, Boeing is also incurring higher operating costs since its net profit margin was only 5% when compared to the 8% for Lockheed. A close examination of the annual report revealed that the reason for this was the higher taxation expense paid by Boeing at $1,979m (Boeing, 2016, p.49) when compared to $1,418m by Lockheed (Lockheed, 2016, p.75).
However, when production and operating costs are considered Boeing has a higher profitability per person of $46,115.24 when compared to $43,142.86 for Lockheed. This means that Boeing has a better control on its operating costs despite the fact that the cash flow return on assets was the same at 10% for both companies. The potential reason for this is that Boeing may have recently upgraded some of its production facilities as concurred by the slow maximization of its newly implemented fastener automation technology (Boeing, 2016, p.5).
Another reason for the better profitability is that Boeing is focused on remaining liquid since its cash to current liabilities is at 24% when compared to only 8% for Lockheed. The potential reason for which is that its commercial aircraft segment requires a higher working capital due to the high number of aircraft orders (Boeing, 2016, p.5). But this assumption was countered by only a slight increase in the expense coverage days of 85 days for Boeing with 81 days for Lockheed. This means that Boeing management is maximizing the use of its working capital and cash equivalents in order to improve its profitability.
Liquidity
The current ratio is higher at 1.35 for Boeing than the 1.15 for Lockheed, which meant that Boeing is concentrating on remaining liquid. The reason for which is that the quick ratio revealed that most of Boeing’s current assets are tied up in its inventories with 0.41 when compared to Lockheed at 0.65. This assumption was concurred by the lower inventory to sales ratio of Boeing at 2.03 against the 9.30 for Lockheed. This implied that Boeing’s production period is longer than its competitor as concurred by the inventory turnover of 1.74 against 8.27 for Lockheed. The primary reason for which is that Boeing is manufacturing commercial aircrafts, which may take a longer time than Lockheed’s security and aerospace products. This is despite the fact that Boeing managed to deliver 762 commercial aircrafts in 2015 but its airplane orders increased by an additional 768 (Boeing, 2016, p.5).
The higher working capital requirement of Boeing worsened its accounts payable turnover at 7.60 when compared to 20.78 for Lockheed. This means that Boeing is paying off its creditors at a longer period when compared to Lockheed resulting to a decreased perception by Boeing creditors. The reason for which is that Boeing’s working capital is significantly invested in its inventories as concurred by the inventory to sales ratio and the inventory turnover.
Capital Structure and Solvency
The debt to equity ratio is better for Boeing at 13.76 when compared to Lockheed at 14.86, which meant that Boeing is a lesser investment risk as perceived by its shareholders. The reason for which is that despite the higher working capital requirement, Boeing is still able to control its dependence on debt. This assumption was concurred by the times interest earned at 27.07 for Boeing and 12.27 for Lockheed. The ratio implies that Boeing’s profits are more than enough to pay off its current interest expense when compared to Lockheed. In case revenues for Lockheed declines, they may be unable to pay off their interest expense and result to potential financial distress or bankruptcy.
Return on Inventory
Boeing has a lower earnings per share of $7.52 when compared to the $11.62 for its competitor due primarily to the higher outstanding number of shares at 686.90 million (Boeing, 2016, p.84). This may imply that investors perceive Lockheed’s management as having the better management approach. But the price-earnings ratio countered this assumption since Boeing’s value at 19.23 is higher than the 18.69 for Lockheed. This means that the investors believe that future operations of Boeing will generate better profits than those of Lockheed.
Management Report
Competitor Performances and Problems
The higher debt ratio for Lockheed is perceived to be a cause for concern for its investors since it is perceived to be a higher investment risk. This was concurred by the increase in the total debt value from $6,142 million in 2014 to $15,261 million in 2015 despite a minimal decrease in the stockholder’s equity value (Lockheed, 2016, p.2). The reason for the higher dependence on debt was due to the acquisition of Sikorsky Aircraft Corporation at $9 billion, which is a manufacturer of military and commercial helicopters (Lockheed, 2016, p.37). Despite the perceived improvement in future revenues due to the acquisition, the company is highly dependent on its core customer, which is the US Government (Lockheed, 2016, p.38). The US Government is perceived to be facing continuing economic and fiscal challenges resulting to potential payment uncertainties, which is especially problematic with Lockheed’s current high debt levels (Lockheed, 2016, p.38).
Boeing on the other hand is generating revenues at $96,114 million (Boeing, 2016, p.49), which is more than twice the revenues of Lockheed at $46,132 million (Lockheed, 2016, p.75). The reason for which is that Boeing management is controlling its debt levels resulting to a lower interest expense of $275 million (Boeing, 2016, p.49) when compared to Lockheed at $443 million (Lockheed, 2016, p.75). The difference in the generated revenues was also reflected in Boeing’s total asset value at $94,408 million (Boeing, 2016, p.51) when compared to only $49,128 million for Lockheed (Lockheed, 2016, p.77). The reason for which is that Boeing is also competing in the commercial aircraft industry and is seen as a global market leader (Boeing, 2016, p.4). Its popularity is perceived in such a way that its recent aircraft orders will result in a production period of around 7 years (Boeing, 2016, p.5).
Payment for Lockheed Acquisition
The main problem is how Boeing will pay for the acquisition of Lockheed due to the fact that its market capitalization is only slightly lower at $72.37 billion (Yahoo, 2016) when compared to $84.79 billion by Boeing (Yahoo, 2016a). If Lockheed’s stockholder’s equity at book value was used, Boeing can easily pay off the acquisition by increasing its borrowings. The problem with a purely debt payment is that Boeing shareholders will perceive the company to be a higher investment risk. The recommendation is to use a combination of debt and equity financing to minimize the possibility that Boeing will also incur financial distress.
The reason for which is that the examination of Boeing’s stockholder’s equity revealed that the company has acquired $29,568 million in treasury shares by 2015 (Boeing, 2016, p.51). If the treasury shares are reissued and added to the retained earnings then Boeing has a total potential fund of around $68,324 million. This total value for Boeing makes it feasible to make use of both debt and equity financing for the acquisition of Lockheed. In case the currently held treasury shares and increase in debt is not enough, then Boeing has the option to fully issue all of its common stock, of which 187.74 million shares are still unissued (Boeing, 2016, p.113), which is worth at $24,988.04 million based on the last closing price of the stock at $133.10 on 9 June 2016 (Yahoo, 2016a).
Acquisition Price Determination
The total market capitalization for Lockheed of $72.37 billion (Yahoo, 2016) is perceived to be a best case scenario since Boeing needs to take into consideration that Lockheed incurred a debt of $15,261 million in 2015 (Lockheed, 2016, p.2). This will decrease the value of Lockheed’s purchase price especially when taking into consideration that most of the company’s non-current assets are primarily composed of goodwill and intangible assets (Lockheed, 2016, p.77) due to the impression of an overvalued stock.
The fair value of Lockheed stock based on the price-to-book value of 4.39 (NYU, 2016) is at $43.82, which is significantly lower than the market value at December 31, 2015 of $217.15 (Yahoo, 2016). This means that Lockheed’s market value is considered to be overstated and that the value of the stock will eventually go down to its true value. When another financial formula was used, the fair value of $206.65 using the price-to-sale value of the industry at 1.39 (NYU, 2016a) is perceived to be also lower than the December 31, 2015 market value of Lockheed. The financial ratio formulas revealed that the true value of Lockheed stock is actually lower than its trading value, which means that the purchase price of Lockheed will need to decline from its current market capitalization.
Optimal Capital Structure Use
The first step is to make use of retained earnings and the initial equity, which is suggested by Chen and Chen (2010, p.1) to be the safest when taking into consideration the pecking-order theory. The reason for this is that it is considered to be an internal financing approach since the treasury shares had already been issued and will only be reissued to maximize Boeing’s previously generated profits, which was held in the treasury share section of the equity.
The next step is to make use of external debt, which is in the form of additional unsecured debt securities (Boeing, 2016, p.100). The problem with this form of debt is due to the different interest rates being used for the unsecured debt, which is between 7.25 to 8.75% while ranging from 6.98% to 7.38% for non-recourse debt and notes (Boeing, 2016, p.100). But the value of using the debt with the high interest rates are only minimal when compared to the lower interest rates of 0.95% to 4.88% for the accumulated unsecured debt of $5,075 million (Boeing, 2016, p.100). This means that Boeing is taking advantage of its company strengths to acquire unsecured debt with lower interest rates.
The reason for the higher dependence on debt financing is that the after-tax cost of debt is computed to be at 6.33%, which is lower than the cost of common equity of 10.82% when the CAPM model was used. The resulting effect of which is that Boeing’s current WACC is at 8.08% but this will decrease to only 6.66% when the percentage of debt increases to 93% of total assets. Despite the perceived lower WACC due to a higher debt level Boeing must take care not to exceed or incur too much debt since it will need to take into account of the future payments of interest costs, which is currently the main problem of Lockheed.
Growth Plan
The core strength of Lockheed is that it is primarily manufacturing defense, space and security products, which has a reliable customer the US Government. The value of the acquisition to Boeing is that it can make use of the proprietary technology of Lockheed to be used for the other operating segments. The resulting effect is that it will minimize research and development costs for both companies due to cost efficiencies of a downstream supply chain. The opportunity for Boeing is that it not only acquires Lockheed’s proprietary technology but it also decreases the number of competitors in the space and security industry. This is especially significant since both companies are operating within the US and thus primarily offering their products and services to the US Government. Boeing can therefore increase the sales price of its defense and space products resulting to potentially higher profits.
Conclusion
The main benefit of Boeing purchasing Lockheed as a subsidiary is the acquisition of proprietary technologies in the defense and security industry. The additional benefit is that the number of competitors will decrease resulting to a higher sales price and better profitability. The main problem will be the purchase price, which will be reduced by the Lockheed’s significantly high debt values as well as its goodwill and intangibles. This was further worsened by the fact that the computed fair value was significantly lower than the inflated market value at December 31, 2015. The benefit of the lower purchase price means that Boeing can significantly pay off the purchase price by initially using internal financing in the form of retained earnings and treasury shares. In case this was not enough, Boeing can incur additional external debt financing but will need to make use of the equity financing as a last resort. The reason for which is that Boeing’s use of equity financing can be perceived by its investors as a potential sign of financial distress.
References
Arseneau, D. M., Rappoport, D. E., and Vardoulakis, A. (2015). Secondary market liquidity and the optimal capital structure. Finance and Economics Discussion Series, p.1-68. Retrieved from http://www.federalreserve.gov/econresdata/feds/2015/files/2015031pap.pdf
Berk, J., DeMarzo, P., & Harford, J. (2012). Fundamentals of corporate finance (2nd ed.). Boston: Prentice Hall.
Boeing Company. (2016). The Boeing Company 2015 annual report. Boeing Company. Retrieved from http://investors.boeing.com/investors/financial-reports/default.aspx
Chen, L. J. and Chen. S. Y. (2010). How the pecking-order theory explain capital structure. JIMS Journal, 1-9. Retrieved from http://www.jimsjournal.org/10%20Li-Ju%20Chenpdf.pdf
Lockheed Martin. (2016). 2015 annual report. Lockheed Martin. Retrieved from http://www.lockheedmartin.com/us/news/annual-reports.html
NYU. (2016). Price and value to Book Ratio by Sector (US). NYU. Retrieved from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/pbvdata.html
NYU. (2016a). Revenue Multiples by Sector (US). NYU. Retrieved from http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/psdata.html
Reuters. (2016). Boeing Co (BA.N). Reuters. Retrieved from http://www.reuters.com/finance/stocks/overview?symbol=BA.N
St Louis Fed. (2016). 20-Year Treasury Constant Maturity Rate (GS20). St Louis Fed. Retrieved from http://research.stlouisfed.org/fred2/series/GS20/
Yahoo Finance. (2016). Lockheed Martin Corporation (LMT). Yahoo Finance. Retrieved from https://au.finance.yahoo.com/q?s=LMT&ql=0
Yahoo Finance. (2016a). The Boeing Company (BA). Yahoo Finance. Retrieved from https://au.finance.yahoo.com/q/hp?s=BA&a=00&b=2&c=1962&d=00&e=16&f=2016&g=d
Y-Chart. (2016). Boeing (BA). YCharts, Inc. Retrieved from https://ycharts.com/companies/BA/key_stats
