Why investors are giving the thumbs down to Bombardier’s deal to sell its rail business

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Bombardier Inc.’s share price sank almost 10 per cent on Tuesday after the company announced a deal with France’s Alstom SA that will transform the Montreal-based aerospace and transportation giant into a significantly leaner company, but more exposed to economic uncertainties.

Bombardier agreed to sell its rail business, known as Bombardier Transportation, to Alstom for €7.5-billion (US$8.2-billion), including debt.

The deal, announced on Monday and expected to close in the first half of 2021 if it passes regulatory scrutiny, will cut Bombardier’s net debt in half to about US$2.5-billion after other pending asset sales are included.

But it will also further reduce Bombardier’s once-expansive business lines – spanning commercial aircraft to trains and streetcars – to the production of private business jets under the brand names Learjet, Challenger and Global Express. This division generated revenue of US$7-billion last year.

Earlier this month, Bombardier announced it is selling its remaining stake in the A220 program to Airbus for US$591-million, meaning that Bombardier will shed its commercial aviation business, along with the heavy financial commitments that go with it.

Although Bombardier’s share price initially jumped when markets opened on Tuesday amid mostly upbeat reaction from analysts, the gains quickly evaporated as global stock markets fell over concerns about the impact of the coronavirus, also known as COVID-19.

In Tuesday trading, Bombardier’s share price fell 16 cents, or 9.7 per cent, to close at $1.49.

“We view the sale of BT to Alstom as maybe the best solution available for Bombardier as it addresses the main issue facing the company: It has too much debt despite its strong product portfolio,” Kevin Chiang, an analyst at CIBC World Markets, said in a note.

Mr. Chiang has an “outperformer” recommendation on the stock, and expects that the share price will rise to $2 within the next 12 months.

Steven Hansen, an analyst at Raymond James, raised his target price on the stock to $2.75 from $1.75. He also upgraded his recommendation to “outperform” from “market perform” previously.

Mr. Hansen said Bombardier’s deal with Alstom is “a transformative deal poised to deleverage its balance sheet and reposition Bombardier into a nimble, pure-play business jet enterprise.”

However, investors face a couple of challenging obstacles here.

Despite management’s efforts in recent years to alleviate concerns over Bombardier’s high debt load and limited cash resources – it sold a controlling stake in its C Series commercial aircraft program, now called the A220, to Airbus in 2017 – the stock has failed to perform well over the longer term amid missed financial objectives.

Though the share price nearly doubled over nine months after the Airbus deal was announced in October, 2017, the price fell nearly 80 per cent between July, 2018, and January, 2020, giving the stock a bad reputation that may be hard to shake.

Analysts noted that even with lower net debt, Bombardier’s debt load is still relatively high, and it will be competing against better capitalized peers in the business jet market.

What’s more, Bombardier’s new focus on private business jets will expose the company far more to the ups and downs of the global economy at a time when the economic cycle is aging, and the spread of COVID-19 is weighing on some stocks.

Apple Inc. warned on Monday evening that its revenue in the current quarter will be lower than expected, owing to iPhone production setbacks and limited demand in China, where COVID-19 has spread rapidly.

The news rattled the S&P 500, which fell 0.3 per cent.

Nonetheless, Bombardier may be focusing on business jets at a time when the market for these smaller airplanes is already down, but could improve from low levels.

“The bizjet industry is at or near its trough in terms of annual aircraft deliveries and Bombardier’s backlog is quite strong, so cyclicality should not be a major concern at current levels,” Konark Gupta, an analyst at Bank of Nova Scotia, said in a note.

The analyst expects Bombardier’s business jet division will be valued at about eight times estimated EBITDA (or earnings before interest, taxes, depreciation and amortization), which is cheaper than some competitors. Textron Inc., which makes the Cessna line of business jets, trades at nine times estimated EBITDA, and General Dynamics Corp., which makes Gulfstream aircraft, trades at 11.5 times estimated EBITDA.