Can Boeing Afford to Cancel Garuda’s $4.9 Billion Order?

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In October 2015, Indonesian flag carrier Garuda Airlines placed an order with Boeing Co. (NYSE: BA) for 50 new 737 MAX 8s. The order came almost two years before Boeing had even delivered the first plane to a customer.

On Friday, Garuda said it had sent a letter to Boeing asking to cancel the order. Only one of the planes has been delivered so far.

In a statement published in The New York Times, Garuda spokesman Ikhsan Rosan said that filling the order “does not benefit Garuda. Our passengers, psychologically, they don’t trust flying with Max anymore. They often asked during booking what type of aircraft they would be flying on.”

The proposed cancellation comes after two 737 MAX 8s crashed in a five-month period, killing 346 passengers and crew. The crash in October involved another Indonesian airline, Lion Air, while the crash earlier this month was 737 MAX 8 flown by Ethiopian Airlines. In both cases, a faulty anti-stall system in the aircraft is suspected of being responsible.

How Boeing reacts to this cancellation request could have long-term consequences for the company. To escape from a firm order such as Garuda’s, the airline has to show that the aircraft has a flaw so serious that it shouldn’t be flying. If the anti-stall system is indeed responsible for the two fatal crashes, and if, as promised, Boeing has an acceptable fix for the issue, Garuda may not be able to cancel the order.

When Garuda placed the firm order, it also put down a deposit that could have totaled around $1 billion or more. Boeing is unlikely to return that money.

If Boeing does allow Garuda to cancel, what kind of impact will that have on the company’s other 4,600 order backlog? Does Boeing try to move these customers to a different airplane? If so, which one? The 787 is too much airplane, and Boeing currently has nothing smaller to offer.

Boeing has reached no decision on a new middle-of-the-market aircraft (the so-called NMA or 797), a concept it has been considering for at least three years now. Airbus’s acquisition of the Bombardier CS100/CS300 program (the A220 family, as Airbus has now designated it) has pushed Boeing into a deal with Brazil’s Embraer that may eventually have a smaller jet, but that is still some years away, probably 2024 or 2025 for first delivery.

If Boeing takes a hard line with Garuda, the aircraft maker runs the risk of facing more cancellation requests, all of which Boeing would have to deny, and leading to a likely blizzard of lawsuits over whether the 737 MAX is too dangerous to fly. More passengers may “psychologically” refuse to fly on the planes, putting Boeing in an even tighter public relations bind.

From an airline’s point of view, canceling an order for the 737 MAX leaves it with just one current alternative, the Airbus A320neo. Chinese aircraft maker Comac is building its first competitor to the Boeing-Airbus duopoly, the C919, but that plane did not make its first flight until last May and won’t be available for delivery before sometime in 2021. We’ve already noted that China’s quick ban on 737 flights following the Ethiopian Airlines crash may have been meant to buy some time for Comac to deliver the C919.

The queue for a new A320 is even longer than the one for the 737, and if an airline does succeed in canceling its order with Boeing, it then has to take a place at the end of a long line for the Airbus jet. Boeing is well aware of this and will certainly use it as leverage to hold on to existing orders.

So what does Boeing do about Garuda’s desire to cancel its order? Stall. The company can politely reject Garuda’s cancellation saying that it wants to wait until all the investigations are completed and until its fix for the anti-stall system has been implemented and pilots have been trained on it. Once the fix has been made and at least some regulators allow the plane to fly again, Boeing can (it hopes) point to a successful repair and reject the idea that the 737 MAX is inherently an unsafe plane.

By then (at most about six months from now is our guess), the 737 crashes will be out of the headlines and Boeing can give reluctant airlines a larger discount to maintain their orders for the 737 MAX.

The worst case for Boeing might be that the cause of the crashes is found to be something either in addition to or other than the anti-stall system. That would keep the 737s on the ground longer and increase the hit to Boeing’s cash flow.

The company is in a tough spot and has pinned its hopes for a quick resolution on a software fix and a new flight manual. That may not be enough.

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