Re-merger of Boeing and Spirit AeroSystems pits quality control against value creation

Why do entrepreneurs form new companies? Nobel Prize-winning economist Ronald Coase contemplated this question in his groundbreaking work. He concluded that assessments on transaction, monitoring and agency costs would compel managers to either produce internally or outsource to another company. Such calculations have changed in recent weeks at Boeing.

On Friday, the struggling jet maker confirmed it was considering reacquiring Spirit AeroSystems. Kansas-based Spirit manufactures jet parts and was a part of Boeing until its 2005 divestiture to private equity. Yet today, 70 per cent of revenue in its largest division comes from Boeing. The 737 Max programme is particularly crucial to Spirit. 

Both Boeing and Spirit have been at the centre of a firestorm after a door plug on a Boeing 737 Max plane blew out mid-flight in January. A reintegration might please regulators, which might in turn please Boeing investors. For Spirit, it would spell the end of a strange, two-decade journey.

Spirit depends on Boeing. Boeing also depends on Spirit. Integration between the two is understandably tight. Spirit’s chief executive told investors recently that visitors to Spirit’s plant would not be able to tell if a particular employee worked at one company or the other. Every few years, the two sides have struck a “memorandum of agreement” that governs their economic relationship. 

Spirit depends on Boeing to be at the top of its production and delivery game. This has not been the case when it comes to the 737 Max and 787 Dreamliner programmes. The most recent deal, struck last autumn, came amid a liquidity crunch. Spirit generated negative free cash flow of almost $1bn in the past two years.

Spirit’s shares, post-deal rumours, have bumped up more than $30 each. However, that level is not far from its 2007 public market debut at $26. The company’s enterprise value is now $7bn, with a net debt balance of $3bn and more than $300mn of annual interest expense.

Boeing sold off what would become Spirit to focus on plane design and final assembly, both higher margin areas that investors would value. Even after a fall in recent years, Boeing shares have far outperformed those of Spirit.

An acquisition would strain Boeing’s liquidity and efficiency measures. Yet for long-term regulatory and political reasons, component manufacturing might be most optimal when performed in-house.