NEWS ANALYSIS : Financing Dilemma May Prevent Takeoff of MD-12

McDonnell Douglas appears caught in a “Catch-22” dilemma, in which its prospective Taiwanese partners have declined to finance the new MD-12 jetliner project, and international air carriers are reluctant to order the aircraft when McDonnell cannot afford its development, experts said Monday.

“It makes the deal truly non-viable,” said John Harbison, director of the aerospace practice at the consulting firm Booz Allen & Hamilton.

Taiwan Aerospace, a consortium of government and private investors, backed off from a preliminary agreement made last November, in which it planned to buy up to 40% of McDonnell’s commercial aircraft business for $2 billion.

Instead, Taiwanese investors want to arrange financing for an order of 20 jets, which they would help lease, and make only a minor equity investment in McDonnell. The Taiwan group, however, would link that help to McDonnell’s success at winning other airline orders for the MD-12.

But airlines are unlikely to commit to making a launch order for the MD-12 before McDonnell can arrange financing for the project, Harbison said. “It reflects a lack of understanding about how this business works,” he added.

“I can see where it is a ‘Catch-22’ for McDonnell,” said Don Scales, director of the aerospace practice at the consulting firm Arthur D. Little & Co.

Scales said Taiwan’s waffling on its agreement has “hurt the MD-12’s future in getting it off the ground,” but he doubts that it will necessarily kill the program.

The MD-12, a four-engine jet carrying more than 500 passengers, is considered crucial to offsetting McDonnell’s continued loss of market share to Boeing and Airbus Industrie. Taiwan is seeking to link up with the U.S. aircraft builder to boost its fledgling aerospace industry.

Separately, McDonnell received more bad news Tuesday when the credit rating firm Standard & Poors said it was revising its assessment of the firm’s financial condition.

S&P; said it was maintaining McDonnell’s triple-B rating on its senior debt, which has been downgraded four times in the past few years, and maintaining the firm’s A-3 commercial paper rating. But it revised its so-called watch on those ratings to developing from positive, meaning that a change could be coming.

“It now appears less likely that McDonnell Douglas will receive a substantial cash infusion from a potential partner,” S&P; said. “At the current stage of negotiations, Taiwan Aerospace is suggesting alternatives to a meaningful equity infusion.”

Without a final agreement that provides a cash infusion to McDonnell, the firm’s ratings could be lowered, S&P; said.

The problems associated with coordinating a Taiwan deal and obtaining orders from airlines are compounded by weakness in the commercial aircraft market, Harbison and Scales noted.

“This is the worst possible time to launch an aircraft, because we have just come off a major buying cycle,” Harbison said. Several airlines that placed too many orders during the last buying cycle are canceling some orders, he added.

Jack Modzelewski, an aerospace analyst at PaineWebber, said the precipitous decline in McDonnell shares, from a high of $80.50 to $44.50 when the stock market closed Tuesday, has further hurt prospects for a Taiwan deal and for the MD-12 program.

At the current stock price, Modzelewski noted, McDonnell has a market value of $1.7 billion--significantly less than Taiwan was to pay under its original agreement for 40% of McDonnell’s commercial business alone.

“They can’t get orders for the MD-12 until they get financing, and they can’t get financing until they get orders,” he said. “It is a circular loop they can’t get out of. The odds that this airplane will ever get launched are very low, under 20%.”

Even Taiwan’s flag carrier gave a negative reaction to the revised proposal from Taiwan Aerospace.

The Chinese-language Economic Daily News quoted an official at China Airlines as saying the airline had no plans to consider using the MD-12. Chen En-chin, a special assistant at China Airlines, would not comment on the report.

“The date for deciding to use the MD-12 is still far away,” Chen said.

Special correspondent Bruce Einhorn in Taiwan contributed to this story.