Considering the Concept of "Rent Sharing"

Maybe the best answer to US airline industry woes is the same path followed in the early 1990’s when iconic names like Pan Am and Eastern liquidated.

I understand Continental’s thinking, I think. They have many attributes that are viewed in previous consolidation periods as positives: youngish fleet; decent, if not good, labor relations; hubs/gateways in markets with strong underlying local demand; hubs/gateways in markets that have interest not only to those in the US but around the globe; and a respected management team that has not only devised a plan but has acted on it. But they still have a fragile balance sheet just like the rest of the US industry.

Kevin Crissey at UBS writes this morning on Continental’s attitude toward consolidation: “We believe CAL mgmt view consolidation as beneficial over the long run but much less so in the short run as labor would take a big cut of the synergies. With fuel and demand draining life from the sector, mgmt appears to be focusing on CAL's survival and likely views a merger as increasing bankruptcy risk”. Continuing to beat that fuel issue to death, my only question is what is the short-term and what is the long-term for the US industry? Is the short-term six months or is it two years?

Mr. Crissey was right to raise the labor situation and the negative impact on any short-term synergies that might be gained from the overall deal. In last week’s congressional hearings on the Delta-Northwest hearings, I believe that Dr. Clifford Winston of the Brookings Institute referred to the topic as “rent sharing”. The negative synergies in "rent sharing" between labor and the deal in the case of Continental and United are somewhere in the $300 – 400 million range, or double those in the Northwest – Delta case.

But rates of pay are only half of the story. Continental’s pilots are more productive than United’s pilots per month based on publically available data in 2006. If that were to be the case, the Airline Data Project estimates that the increase in productivity to Continental levels would mean that 460 fewer United pilots would be needed. While final 2007 numbers will not be available for another six weeks, rate and productivity calculations underscore just one of many difficulties faced in estimating the offset of overall network synergies by the “rent sharing” calculation between management and labor.

On both the compensation and productivity calculations included in the Airline Data Project, please read the footnote that suggests problems with the US Airways and America West calculations for 2006. Further, and based on the calculations there should be no secret as to the difficulties American has in considering whether to play in this round of consolidation or not. The math for them is particularly difficult.

So maybe we just will not be able to get there. Bankruptcy is less an option unless it is a liquidating bankruptcy like we saw most recently with American and TWA where American purchased the assets of TWA. The few combinations left to consider do little to address the immediate need to minimize exposure to the US domestic market unless the opponents to change recognize that the current structure is simply not healthy. US Airways has too many eggs in the US domestic market basket. Hell, everyone has too many eggs in that basket.

Maybe we should start thinking about consolidation as the world thinks about our marketplace and engage in a consolidation of North America and bring Air Canada and Mexico fully into the conversation. This idea would address the US centric mindset that seems to dominate the conversations among the naysayers.

Talk about a bad time to be a CEO in the airline industry. Someone has to get their fingernails dirty. To be sure, private equity would not want to touch the issues left for the industry to work through. Last night, United said in a statement following the Continental Board’s decision: "Ensuring you have the right partner is everything,"

As the late Johnny Cochran might have said: If it doesn’t fit, you must attrit. And in the long run the survivors will benefit.