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Report Questions Boeing Tanker Deal

Analysts say company faces a big charge if the Pentagon nixes the tanker refueling deal.
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is betting on a big $23.5 billion deal to build refueling tankers for the Pentagon, but after another government report recommended canceling the company's contract, analysts say the company faces a big charge.

A report from the Defense Science Board said that the Air Force does not have a "compelling material or financial reason" to buy and lease 100 air refueling tankers from Boeing. The report, which has not been released yet, but was shown to members of Congress Wednesday night, comes a month after the Pentagon's inspector general recommended against the Boeing tanker deal, saying it overcharged the government by $4.5 billion.

While the Air Force says it needs more tankers to refurbish its corroding, aging fleet, the DSB report, like the one from the inspector general, argued that alternatives should be re-examined. If the Defense Department adheres to the recommendation of the DSB's report and its own internal analysis, then Banc of America Securities analyst Robert Stallard said the tanker program could be delayed for another 18 months.

With Boeing telling investors that its better-than-expected fiscal 2004 forecast, announced on April 28, included the tanker deal, Stallard said the company is likely to take a hefty charge sometime this year. (Banc of America Securities does, and seeks to do, business with companies covered in its research reports.)

Shares of Boeing were off 32 cents, or 0.7%, to $43.26.

"We think it now very unlikely that the tanker deal will be signed this year, and that Boeing may have to take a charge in the region of $150 million," said Stallard, in a note to investors.

Even if signed, the 767 tanker deal could also be more costly and less profitable for Boeing.

Alan Mulally, Boeing's head of commercial aircraft, recently told reporters that it will have to consider eliminating the passenger version of the 767 in the next few months. If the passenger 767 is cancelled before the contract gets signed, Stallard said Boeing could face higher costs to build the tankers, which are based on the 767 airframe -- and may get less to build them, based on the two negative analyses from the Pentagon.

The delay or cancellation of the tanker deal would put a speed bump in Boeing's plan to win back the trust of Wall Street, investors and the government, in wake of the scandal over improperly influencing government contracts. In April, Darleen Druyun, a former Boeing vice president, pleaded guilty to a federal conspiracy charge as part of a government investigation into Boeing's tanker deal with the Air Force.

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In November, Boeing fired former CFO Michael Sears and Druyun for unethical behavior, leading to the resignation of CEO Phil Condit and an outcry on Capitol Hill. According to Boeing, Sears violated company policy by discussing job offers with Druyun when she was still a procurement officer for the Air Force, overseeing billions of dollars in Boeing contracts.

In recent weeks, Boeing has done everything it can to revive its image.

On April 28, the company beat Wall Street's first-quarter earnings expectations by 21 cents a share, while boosting guidance for both 2004 and 2005. The following week, Boeing attempted to engender more goodwill by

boosting its quarterly dividend by 3 cents and resuming a share buyback plan that had been shelved since the World Trade Center attack.

The effort appears to be working somewhat. Since it released earnings, Boeing's stock has been relatively unchanged while its fellow blue-chips have fallen 4%.

But with rival Airbus, a unit of


, clamoring the Pentagon to reopen the bidding process on the tanker contract and winning tanker deals with both the United Kingdom and Australia, odds that Boeing's bet will pay off are getting longer.

Even before the DSB report came out, analysts felt Boeing was making a bold move, including the tanker deal in its forecasts. "Boeing commercial margin guidance also assumes receipt of the 767 tanker program this year, which may happen but seems aggressive," said George Shapiro, analyst at Smith Barney, in a note. "We doubt it will happen before the election."

Ultimately, Boeing's tanker deal could fall by the wayside, which would hurt shares, but the company is so massive that the contract is merely one poker in a much larger fire. With Boeing shares trading at 18.6 times 2005 earnings -- higher than the average defense multiple of 15.6 times 2005 earnings -- if the stock is overly punished, Banc of America's Stallard would be looking to buy.

"Whilst this is clearly not good news, it needs to be put in perspective," said Stallard. "Even without the tanker, Boeing has a lot of products and opportunities. ... We would be looking to buy on any tanker-related weakness."