Stuffing the Turkey

The drum beat is growing louder now that we may soon see the outcome of all those merger talks between American Airlines and US Airways.  As Ray Neidl of the Maxim Group wrote in a November 20 research note this morning:  “We believe a merger would definitely benefit the industry since it would promote further consolidation and enhanced pricing power for the carriers in general. However, we also believe that an AMR/US Airways merger, if it were to happen, would not be an easy endeavor to manage (as was Delta/Northwest merger, even with AMR union support). We believe that the benefits in market mass would not be as great as either the Delta/Northwest or UAL/Continental merger are proving to be.”

US Airways and others tout the benefits of synergy – relying mostly on the experience of recent mergers that may not apply in this case. Proponents are less likely, however, to spotlight dis-synergies. The fundamental question: What are the net synergies?

This question is particularly relevant in the case of a potential merger that creates an unstable labor situation.  I tried to address this before in the most-read blog in swelblog history:  US Airways and American and the Elephants in the Room.

The labor issues we’ve seen recently at several airlines offer a big window into the risks of brand and service degradation. But let’s focus just on pilots.  What’s most important to a pilot’s career, flying opportunities and pay? Seniority. What is for pilots at most risk in a merger?  Seniority.

We already know what can happen when pilots are unhappy . . . they uniquely have the means to affect the operation by something as minor as a slow taxi to the gate.  Look no further than American’s on-time performance in September and October. .

Difficulty in merging seniority lists is likely the rule, not the exception. Even MaCaskill-Bond, legislation designed to make the process fair for each side, does nothing to ensure a smooth integration. 

So imagine for a moment the seniority integration monster a merger between American and US Airways could create because there are not two but FOUR pilot groups involved: American’s pilots represented by the APA, US Airways pilots and former America West pilots both represented USAPA but working under separate contracts, and former TWA pilots who have never been very happy about their treatment when American acquired TWA’s assets in 2001.

By the time you involve management in that equation, it could be a 5-way or 6-way conversation..  We have seen enough cases of difficult outcomes with three parties at the table, let alone more.

Enter arbitration.

At US Airways, an arbitrated seniority award under ALPA merger policy resulted in the decertification of the union by a majority of US Airways pilots because some more junior America West pilots were placed ahead of them on the combined list. This happened in part because America West pilots had more certain career expectations than the original US Airways’ pilots whose carrier was in bankruptcy for a second time with little hope of surviving as a stand-alone carrier.

If an AA-US merger were to occur before American exits bankruptcy, the two pilot groups at US might successfully argue that AA is a failed carrier and that, as pilots for a successful carrier they deserve super-seniority consideration.  This scenario, known in the industry as the Failed Carrier Doctrine, has long played a role in combining seniority lists in mergers involving a profitable carrier and a bankrupt carrier

Former TWA pilots at AA won a recent court case arguing that ALPA did not meet its “duty of fair representation” in the AA-TWA integration. The APA was originally part of this litigation but was dismissed because the court found that APA did not yet represent the TWA pilots at the time the lists were merged.  Now, the TWA pilots working at AA may demand that wrong be undone as part of their support for a merger with US Airways.

Now consider this: If an integration list is created using a pilot’s date of hire (the most common method of determining seniority) then it is likely that many US Airways East pilots would be placed at the top of the new list. And you can be sure that would not be received well by the AA pilots or the former TWA pilots who could argue that the AA list should be adjusted to reflect their hire date at TWA.

Fences (an industry term for isolating respective operations from another) can fix some of the seniority concerns but also add complexity and unknown costs to the merged operation. At the end of the day, what usually makes pilots happy is a big check from the company.

Bottom line: A merger between American and US Airways would likely be the most difficult seniority integration in history. Some or all pilots will feel disenfranchised as a result because integration results in winners and losers - perceived or real.  Could the pilot unions work together to negotiate integration?  Maybe, but given the history of these pilot groups not without a lot of blood on ground.

Therefore the most likely path to integration is one in which every pilot at AA and US would put their future in the hands of an arbitrator with no guarantee of a positive outcome. There is plenty of precedent for the arbitrator to consider, but very little that indicates an outcome that would be acceptable to a majority of the combined pilot group.

Moreover, it could take years to work out the implementation of a new seniority list. During that time Delta and United would do everything possible to gain a competitive advantage. These carriers already have a first mover advantage over American and US Airways.  So put me in the C-Suite in Atlanta and Chicago and I’m cheering this proposed merger on with a megaphone because there is nothing but opportunity for Delta and United, not only from improved domestic market fundamentals but also from any fallout that occurs should the new American fail to produce.

No valuation of the merger is complete without consideration of this factor during what will be a critical transition period that could make or break the value equation.   And no shareholder should buy the optimistic prospectus from Doug Parker without taking into account this very real risk.

Is The Union Leadership at American Really Representing the Membership’s Best Interests?

Delta is cutting international capacity by 3-4 percent in the face of economic weakness.  In an effort to improve profitability, United has announced capacity cuts for 2013.  Federal Express just announced a 3-year plan to cut $1.7 billion in costs mainly in its Express unit as revenue suffers from high oil prices and the fact that customers have found cheaper alternatives.  The cost cuts will largely be accomplished through headcount reductions which work to eliminate fixed costs.

If FedEx is seriously evaluating headcount at a perpetually profitable business unit, then so should those who believe that American and US Airways together would not need to trim costs any more than has been done at each airline in restructuring.

This is why it is so puzzling to me that Laura Glading, president of the Association of Professional Flight Attendants at American, continues to beat the drum for a merger between American and US Airways.

My guess is that Glading negotiated some concessions for flight attendants in talks with American because she is convinced, or has been promised, that a deal with US Airways will come with some sort of snapbacks or other icing that benefit her members and, perhaps, her position in what would be a larger, more powerful union.

That theory, however, ignores the economic reality of consolidation in today’s domestic market which has proven time and again that airlines with the highest costs have a distinct competitve disadvantage. So Glading continues to view her world through rose-colored glasses, preaching the purported labor benefits of a merger that can’t hope to succeed without the strict cost discipline neither she nor Parker are willing to acknowledge.

Recently, Glading asked flight attendants at both airlines to petition AMR’s Board of Directors to pursue a merger. The petition reads:

Dear AMR Board of Directors,

American Airlines is no longer the brand it used to be. Instead, this once great airline is now at the mercy of a dwindling network and an inferior product. 

Fortunately, not all hope is lost. There is a way to right this ship. If American Airlines could merge with US Airways before this bankruptcy has run its course and the AA brand completely destroyed, we can all work together to get American Airlines back on top.

The US Airways merger plan is the best option to correct the problems AA faces. I encourage you to pursue the only path available that will lead American Airlines out of bankruptcy stronger than the day it entered: a merger with US Airways.

American Airlines + US Airways: Our Future Depends On It

One has to wonder exactly what Glading was promised to press so hard for a plan with such limited economic foundation.  If US Airways brings so much to the table, then why did the Delta employees band together to block Parker’s ardent overtures?  Why did United leave US Airways at the altar at the eleventh hour when a better partner emerged?  Yet at American, the unions’ leadership seems to believe that a marriage with US Airways is some sort of panacea that represents no pain/all gain for employees. 

Do investors see the proposed merger as American’s path to better labor relations?  Not if they’re looking at what’s going down at US Airways, where the union representing flight attendants called for a strike vote after flight attendants failed to ratify the second tentative agreement in six months. Clearly the expectations of the US flight attendants exceed the company’s ability to pay. And this comes after years of acrimonious relations between the airline and its two rival pilot groups which, 77 months after the fact, still prevent a smoothly merged operation between US Airways and first spouse American West.  If Parker’s team needs to promise more and more just to get ratified agreements with his own employees, imagine how expensive those labor deals become when you need a fast path toward a joint collective bargaining agreement and a single seniority list? 

What might the creditors at American think of the high price tag on labor peace likely necessary to get joint contracts between the two carriers?  And what toll will that price take on the combined company going forward?  Parker and Glading talk synergies, but both conveniently overlook the expensive path they’d need to travel to get there if, as I suspect is true, labor groups are being told they’ll be made whole – or better – as the reward for their support of a merger.

Flight attendants should think twice before they buy the line that synergies alone obviate the need for real-world cost reductions, particularly with one partner still operating in bankruptcy. A merger for the sake of a merger inside of bankruptcy is not going to make the creditors want less.

Union leaders must accept responsibility for helping to position the company to succeed before they can promise payoffs to employees, particularly in this competitive market. It is not up to management alone to promote fiscal discipline and constructive labor relations when success demands genuine efforts on both sides.

Ignoring the fact that creditors will want to maximize their claim in bankruptcy is a sure-fire way to ensure that the best interests of employees are not represented because there is nothing that can be negotiated that will improve the well-being of members.  Ignoring the reality of deteriorating revenue trends and the fact that other carriers are cutting capacity is to knowingly accept an overpromise on the synergies.

Facebook: Will American Friend US Airways?

Much has changed since I last posted. Summer came and went.  I played some golf and worked some projects. My mom had major surgery.  And the usual drama in the U.S airline industry continued, including breathless speculation about the potential marriage of US Airways and American. 

I was thinking about this watching the dizzying rise and fall of Facebook’s fortunes as part of its Initial Public Offering (IPO).  Based on the price performance of the stock, the IPO has been anything but a success.  Circa 2000, it was thought to be a sure bet for anyone lucky enough to garner those initial shares offered.  Instead shareholders sued Facebook CEO Mark Zuckerberg and a number of banks, alleging that crucial information was concealed ahead of the offering.  At the heart of the lawsuit, according to Reuters news service, was the fact that Facebook and its banks failed to reveal "a severe and pronounced reduction" in forecasts for the company’s revenue growth, as users increasingly access the site through mobile devices. Investors, it happens, were so enamored of the Facebook “story” that too few asked tough questions about the company’s revenues.

I wonder if something similar isn’t happening with the US Airways-American story.  Where are the tough questions?  Or are reporters so taken by the Doug Parker storyline they’ve failed to look behind the pretty wrapping paper.

Mind you, I have not “friended” anyone at the unions representing US Airways or American employees. Not that they would accept the request. But if I were a line employee at American I would be demanding that my elected union officials, at a minimum, be asking the tough questions.

For me, the first question is how many employees are really needed at a combined US Airways and American. In its attempt at a shotgun marriage with American’s union leadership, US Airways suggested that it could hang onto more jobs than American would in restructuring.  That math deserves a second look.  For example, on a pro forma basis a combined American – US Airways network would be 3-4% larger than United – Continental yet it would have nearly 18% more employees.  Granted the number of employees will be reduced under either carrier’s plans, but someone is not telling the whole truth nor is it just found in the outsourcing of jobs. 

Where are the tough questions about airport overlap? Remember that when US Airways was singing the virtues of its proposed merger with Delta it talked about cutting capacity (frequency) in a large number of markets.  Many of those markets would have been smaller communities like Jacksonville, NC.  Today, American and US Airways offer 50-seat or less service in 60 common markets.  Can we honestly believe that all of that service will be maintained?  I think not, particularly when Delta has taken leadership in beginning to wean its system of the inefficient smaller aircraft and adding more 70-seat platforms and B717s.

Criticism of American’s stand-alone plan by the likes of Jamie Baker at JP Morgan point to the fact that a large portion of the proposed revenue synergies will be driven by the Ft. Worth carrier addressing its deficiency in the 70-seat jet arena.  Others cite concern that American would be dependent on a share shift away from incumbent carriers where a renewed AA will compete. 

Given the current significant overlap of the Delta network and the combination of American and US Airways networks, can we really believe that the new combination will stimulate new demand in the US Southeast?  Or will it be a share shift from Delta?  I am betting on the latter and that is a tough synergy to count on as the Delta network has a significant head start and a commensurate first-mover advantage in building presence where it and SkyTeam will compete with oneworld.  And that doesn’t even take into the account the fact that the two networks would be fenced off from one another while the pilots sort out lingering seniority issues?

To underscore the issue of share shift, Baker in his March 2012 report on the proposed US Airways – American combination suggests that a combined Delta – American probably could not pass muster with regulators based on the overlap of the two networks.  Imagine, then, the overlap a combined American and US Airways would have with Delta -- overlap in mature markets that offer little opportunity for significant stimulation of new demand. In that case, any market share model would point to a share shift among existing operators within the city pairs being served.

Where are the tough questions about capacity? This week, United announced it was cutting capacity in the face of weakening economic signals. If US Airways were truthful about their revenue and capacity plans they too would be signaling that the overlap between American service and its own would require a capacity haircut.  And in that case, you have little choice but to idle employees or furlough them.  We know the US Airways plan is designed to appease American’s unions.  What we don’t know is whether US Airways was honest with American’s unions in making clear the unions’ own contracts undermine the carrier’s ability to best manage its network, whether it be a cost disadvantage or restrictive pilot scope clauses.

To give you some idea as to American’s scope disadvantage, in July of 2012 American operated 7,175 70-seat departures or 231 per day.  That sounds like a lot except when you take into consideration what the competition is operating.  Delta offered nearly 36,000 departures with aircraft between 51-76 seats and United offered 26,000.  Hell, US Airways with a tiny network operated 13,000. There is no doubt that the ability to offer two-class service in smaller markets, at the right time of the day, equates improved revenue.

I do not need to be sold on the virtues of consolidation despite the best efforts of US Airways’ public relations firm when they sent me Baker’s report. 

I appreciate that few city pair combinations are overlaps between US Airways and American.  Baker identifies 33 East Coast markets that could gain access to the oneworld network as a result of US Airways becoming a new member of the oneworld alliance.  They range in size from Hartford to Elmira, to Lynchburg to Greenville, NC.  Lovely cities all, but not likely to tip the balance of power to a new combination when compared to Delta and United.  And hopefully a judicious British Airways recognizes this as well. 

The real balance of power is about the West Coast and New York.  US Airways does still operate the Northeast Shuttle but it sorely lacks at New York JFK and Boston.  A much deeper relationship with jetBlue does more for American than does a messy merger with US Airways.   And I am not talking about a merger with jetBlue.  US Airways does not give American what it needs in the West either.  So if this becomes all about Lynchburg and Richmond then I think this is probably not the right deal no matter what Wall Street, Doug Parker and the chorus of reporters tell us. 

Are there alternatives that do not add capacity to the system? The naysayers claim American’s stand-alone plan will add capacity to the system to the tune of 20 percent.  But Delta is replacing 50-seat RJs and bringing on more 70-seat platforms and 717s, and no one is crying foul about what that might mean from a capacity point of view.

My bet is that United and Delta continue to poke at US Airways to keep up the fight for American.  Not because a merger will be a silver bullet to improve the industry but because they would love to compete for traffic and revenue as the two go through a complex integration.  With Non-Disclosure Agreements now in place, I can only expect that the due diligence will spur the tough questions this pairing deserves and yield real answers that might temper the enthusiasm of stakeholders who believe another merger will produce the same results that first movers United and Delta enjoyed.

I have heard from many who question my skepticism about this potential merger when I have been an ardent supporter of consolidation in the past.  My interest is, and always has been, in the economics.  Facebook may have a lot of “friends” but show investors the money.  Can the economics of a US Airways-American marriage create a carrier that can not only compete in the vicious US domestic market but also with the global networks?  I remain unconvinced.

US Airways And American And The Elephants In The Room

I want to talk about the elephant in the room.

Actually, it’s a whole herd of elephants in pink tutus with “Seniority Integration” and “Unintended Consequences” emblazoned in neon lettering across their posteriors. Yet, most media seem too distracted by sexy headlines and hoped for revenue synergy calculations an alleged US Airways – American Airlines tie-up might bring to even notice the elephants.

Maybe they’re right. The customer doesn’t care what uniform the pilot flying the plane wears or what that pilot’s career prospects look like. They just want that pilot to safely get them to where they’re going.

US Airways is a perfect example that ignoring the elephant can work with few external (i.e. passenger) repercussions: it hasn’t fully integrated pilots or flight attendants since merging with America West in 2005. After nearly seven years of flying separate-and-not-nearly-equal crews on two coasts, maybe US thinks the elephant is just a mouse. Heck, company president Scott Kirby said taking over American Airlines would actually solve US’s problem:

"It's ironic but the solution to that issue at US Airways I think it's probably because we're able to get this deal done. The area that people focus on the most is USAPA, our pilots' union. In this case there is a huge benefit for our pilots in getting the deal done.”

Kirby’s comments would also seem to hold true for flight attendants. He even pointed out merging work groups would be subject to the McCaskill-Bond legislation… created in part, by American’s 2001 takeover of TWA and the short-end of the deal those employees received.

And that’s where the elephants start trumpeting.

I’ll concede again that seniority integration doesn’t mean anything to the average customer. But it means everything to airline employees and, because of the very McCaskill-Bond law Kirby mentioned, even to those employees who don’t belong to a union. They, too, will be subject to the law and the vagaries of seniority integration.

If the Allied Pilots Association really believes seniority integration is, as its spokesperson Tom Hoban labeled it, a “faux concern,” then it’s ignoring its own recent past.  If I am an APA pilot and my union is calling seniority integration a faux concern, well I would be concerned.

If the Association of Professional Flight Attendants thinks it will join hands with US and its senior members will either cash out or staple US’s two groups to the bottom of the seniority list – like the APFA did to the TWA flight attendants – its remaining members will have plenty of time to regret that decision when they’re flying Richmond, VA to Greenville, SC via Charlotte for the third time that day.

REAPING WHAT THEY SOWED

The very group APFA leaders either think they will harmoniously bond with or take precedence over (and I’m betting it’s the latter more than the former) is the Association of Flight Attendants.  The AFA represents two distinct groups at US – the flight attendants from the “old” US Airways and former America West FAs – which have never worked under a joint contract. Kirby’s mention of McCaskill-Bond is especially pertinent in this potential combination of three different flight attendant groups, each with its own pay rates, work rules and benefits.

Why? Well, this is what the AFA says about McCaskill-Bond:

“In 2001, American Airlines purchased TWA. The TWA flight attendants, represented at the time by the lAM, were stapled to the bottom of the American Airline's flight attendant seniority list. The AA flight attendants are represented by the APFA. This was grossly unfair to the former TWA flight attendants. The TWA flight attendants fought back. They were unable to right the wrong that had been done to them. But they were able to, with the help of Congress, ensure that it will not happen again.”

Doesn’t sound like the AFA is ready to take a jump-seat to anyone, especially not a group that was “grossly unfair” to other flight attendants. No matter what promises US’s Doug Parker and Scott Kirby have made to the APFA and president Laura Glading. US flight attendants are going to have a say about what part of the pie they get. It’s also important to remember neither AFA group has approved a new contract with US – in fact, they overwhelmingly rejected the last tentative agreement two months ago.

Currently, the APFA has, in total, the best pay, benefits and work rules in the industry. (A decision on American’s 1113 motion in U.S. bankruptcy court could change that). US Airways are among the lowest compensated. Doug Parker will probably promise his own flight attendants they’ll move up to APFA pay, and with the reported “early out” incentive offered as part of the US-APFA deal (about 80 percent of APFA’s members would qualify under the union’s stated parameters including President Glading), would quickly dominate the seniority lists.

That’s probably not going to be enough for the US flight attendants. They’ll likely – and, perhaps, justly – demand the same early outs, guaranteed seniority and other incentives. McCaskill-Bond calls for arbitration, though US Airways says it is “hoping” for a negotiated settlement. This is the same group hasn’t been able to negotiate contracts with any of its current flight groups in seven years, yet “hopes” for agreements with three different unions all clamoring for top billing?

That doesn’t even take into consideration the lawsuits that will be generated when the remaining APFA members realize they’ve been sold out or either of the AFA groups feel they’ve been shorted.

Speaking of lawsuits, the APA knows a bit about seniority integration court battles. When American took over bankrupt TWA, the APA argued in the Supreme Court of the United States that its members deserved seniority over all Trans World pilots because TWA crews had limited to no future prospects and no reasonable “healthy carrier” would agree to merge if its employees didn’t take precedence. Some call this the “failed carrier doctrine” and it is still applicable with the McCaskill-Bond legislation. The APA won its case in front of the Supreme Court, so it shouldn’t be surprised if USAPA East & West use it against them.

Of course Kirby thinks merging will solve US’s current integration problems. The USAPA pilots are salivating over new planes, APA’s high pay rates and benefits and the chance at more international routes. They’ll happily staple APA to the bottom of the seniority list to get those perks.

Perhaps APA president David Bates really believes the former America West pilots will just give way to the APA’s claims on seniority. He met with USAPA pilots in Charlotte last month and touted the meeting as a beginning of negotiations to resolve the issue.

I don’t believe any “negotiations” are going to resolve this issue quickly or simply… and I see no way APA members come out of this scenario better in the long-term. Union solidarity only goes so far and US pilots have been waiting years for an opportunity like this.

More telling I thought was a quote in The Charlotte Observer from USAPA president Gary Hummell:

"My job, even though we are looking forward to a cooperative effort, is to protect USAPA pilots (and) to ensure our pilots get the best contract they can."

Even if that means it’s at the expense of the APA.  Even if this means making American out to be a failing carrier.

WHITHER TWU?

The Transport Workers Union International and many of the locals haven’t exactly rushed into the arms of US Airways. Unlike APFA, which has thrown itself at US like .... well I won't say it, or APA, with its “studious business” approach, TWU has seemingly shrugged its collective shoulders about the US “deal.”

That’s probably because the US agreement isn’t much different from the one AA recently offered TWU. The Mechanics and Related and Stores work groups rejected American’s proposal, but I doubt they’re holding their breath waiting for US Airways to save them.

The TWU is being realistic. Besides saving some jobs – which the M&R and Stores groups decided wasn’t enough reason to approve the AA offer – there’s not a lot US can do for TWU members. They’ve heard US’s promises of limited job protection and bringing more maintenance in-house, but a quick look at DOT numbers also shows US currently has one of highest percentages of outsourced maintenance in the industry. Hard to believe it would be more cost efficient for US to give that work to TWU.

Plus, the TWU successfully used the failed carrier doctrine against TWA as well. While its 24,000 members at American dwarf the number of ground workers at US, TWU leaders know their own arguments will be used against them in arbitration. The TWU has seen what has happened to ground workers at other failed airlines and, at this point, can only hope to minimize its losses.

TWU also lost a bitter and expensive battle against IAM to represent workers at US and, as any political junkie knows, unseating an incumbent is neither easy nor cheap.

WHAT’S IT ALL MEAN?

I’ve already admitted seniority battles might mean little to nothing to customers and operations. That’s possibly enough for Wall Street types who are bounding after this potential consolidation like dogs chase cars.

There are, though, real concerns for other financial stakeholders.  One complex integration should give them pause - but three battles should/will make them nauseous.

US has touted the synergies merging with American would immediately bring. What happens to those synergies if integrating pilots, flight attendants and ground workers drags on, or as I expect, become overly contentious and litigious?

US Airways’ own track record – now going on seven years - shows it cannot facilitate integrated contracts and is quick to suggest the reason is because of internal union squabbles. “Old” US flight attendants fly with “old” US pilots, segregated from their former-America West peers. If a similar situation develops with a devoured American workforce, those already questionable synergies become even more degraded. In other words, the risk and return calculation might be worth further consideration by AMR’s creditors.

There are also a couple of other elephants standing off in the corner that bear watching. First is US Airways own unions, specifically the AFA and the IAM. None of those three groups (remember, AFA represents two distinct flight attendant units at US) are very happy with Parker and Co. right now. Contract negotiations have dragged on with US holding the line on costs because of its structural revenue underperformance relative to the industry.

Yet the IAM and AFA saw Parker and Kirby promise the moon, stars and assorted planets to American’s union leaders. They have significant leverage, including asking the National Mediation Board for release. With an election quickly approaching, a Democratic White House might be hard put to ignore the treaties of two very influential labor organizations, both of which wield more power than American’s unions. Keep in mind, the current chairperson of the NMB is former AFA president Linda Puchala.

Then there are American’s non-union employees. The CWA is currently trying to organize American’s 10,000 agents and representatives, even though the CWA has publicly admitted the majority of those employees don’t want a union. Well, guess who represents US Airways passenger service representatives? That’s right, the CWA. (It also is partnered with the AFA). In a merger, American’s PSRs would get a union whether they wanted one or not, most likely without a vote and probably find themselves on the bottom of the seniority scale. Their – and the other non-union AA employees not happy about their new seniority “rank” – only recourse might be the courts.

The last elephant is more of a wooly mammoth: extinct, but vestiges still remain. That would be the group of employees the APA, APFA and TWU all made bones off of… the former TWA workers. This could be their last shot to right some wrongs and adding them into the mix exponentially increases the level of difficulty of integration.

"We have a chance for a fresh start here," Roger Graham, a spokesman for the former TWA flight attendants, told Ted Reed of TheStreet.com earlier this month.  At least there is one group of employees who might benefit from this proposed merger.

It’s hard to fathom why no one has really taken notice of the elephants. Maybe because they obscure Wall Street’s desire for a (very) short-term gain despite the longer-term implications. Maybe it’s because American’s unions are simply using US as leverage with no intent to expose their members to the possible risks of actually going through with the merger. Or maybe it’s because ignoring them makes it easier for Parker and Kirby to believe this deal is really as simple as they pretend.

Maybe the court and AMR’s creditors, blinded by pro forma financial reasoning that is, sadly, often divorced from airline industry reality and the notion of competitive response, will embrace the US proposal as the best value for their dollars.

If they do, they should beware that discounts to the pro forma estimate are called for because of the elephants in the room.

APFA, by not making a deal with the company in 1113, should be questioned by its members about its decision to put all of its eggs in the US basket under the failed leadership doctrine.

Finally, the TWA pilots reared their heads last week by filing suit against American Airlines and the Allied Pilots Association. 

Looks to me like -- game on.

Musings From the Last Five Weeks

US Airways - American

$130 here - million I mean.  $100 million there.  Couple hundred here and there.  A chunk of the company for you.  A less than desirable chunk for me.  Hey PBGC, what do you need so we can carry a pension liability on our balance sheet going forward? That’s not a problem since the “old” US Airways terminated its plans!  While we are at it, let’s keep 15,000 more employees than a similar-sized United (each carrier would generate approximately $37 billion in revenue) because, after all, the synergy generation will surely cover it.  It’s the new math - circa 2012.

In its quest to acquire American Airlines, US Airways sounds like a teenager with its first credit card, spending money it doesn’t have.  Paper wealth.  What cracks me up about this “plan” is the new math I mentioned. Critics pan AA’s goal of creating $1 billion in new revenue as bogus because, among other issues, it assumes no competitive response.  Does anyone really think United and Delta are going roll over and let US Airways improve its revenue generation at their expense? Not a chance.

UAL CEO Jeff Smisek said last month a US merger "net, net, that would be good for us." Will there be more competition on certain city pairs?  Yes.  But neither United nor Delta are afraid of competition much less the threat posed by the paper tiger US Airways/American combination.   Smisek and Delta’s Richard Anderson are smart. They know the synergy formula US has seduced some media and AA’s unions with is but a calculation at this point.  Even American’s own pilots admitted in bankruptcy court this week its faux “deal” with US doesn’t include cost assumptions or valuations.

In other words, US is spending money it has no idea whether it will actually have. It is one thing to have a term sheet and quite another to have written contractual language.  My bet is United and Delta see that the first mover advantages created by mergers have already been mined.  For AMR’s creditors – including the labor unions – there are a host of other issues with this proposed takeover.  It is my opinion that US’s new math adds up to the likelihood that they may need to visit out-of-court cost cutting exercises within a very short time to finish the job that they are choosing not to finish during the courting stage – particularly if exogenous shocks again plague the industry.

Showdown in Houston

Most readers of www.swelblog.com know I was asked by United to help study the findings of the Houston Airports System (HAS) report about Southwest flying internationally from Houston Hobby Airport.  HAS and its consultants originally claimed that 23 flights by SWA from Hobby would create in excess of 18,000 jobs and generate more than $1.6 billion in new economic activity for the City of Houston. 

Stratospheric numbers like those don’t pass the sniff test, yet Southwest executives Gary Kelly, Bob Montgomery and Ron Ricks reference the HAS findings as if they were they were gospel.  More on this later.

I believe the HAS study is seriously flawed and is based on what has become known as the “Southwest Effect.”  Problem is, the “Southwest Effect” is a largely a thing of the past.  It got its name from a study completed more than 20 years ago by the U.S. DOT when jet fuel was the equivalent of $30 per barrel.  The fundamental premise is lowering fares will create a disproportionate level of “new” demand in a market. 

Despite the fact Southwest has no experience in flying to international markets, the HAS study assumes traffic will increase 180 percent.  Relevant empirical data shows Southwest’s (135 city pair markets entered since 2006) entry into new markets over the past five years resulted in traffic stimulation of only 10 percent. The latest data shows fares in those markets have actually increased – not decreased.  The HAS study, at a minimum, grossly exaggerates the benefits of a Southwest entry into duplicative markets and is based on a host of unrealistic assumptions. Publicly available cost data shows international flying done by Southwest from HOU would lose more than $76 million per year.  Even Southwest is not flying markets that lose that kind of money despite its self-proclaimed benevolence toward the air travel consumer.

The economic stimulation predicted by the HAS study claims that prices will decrease 55 percent lower than United’s fares.  The truth is, what Southwest calls “stimulation,” is comprised mostly of the cannibalization of IAH traffic which adds nothing to the Houston economy.

The “Southwest Effect” does not drive benefits to local economies as it once did.  Even Gary Kelly agrees.  When pinned down by the Houston City Council on the number of jobs that would be created at Southwest from its limited entry to routes already served, Kelly admitted that total number (nationally) would be 700 and direct Southwest jobs created in Houston would be 50-100. Kelly went on to say that even these 50-100 jobs would be achieved only if Southwest flies the maximum number of flights in its projections several years after entry.  

Even with outrageous multipliers, the number of direct, indirect and induced job creation cannot even begin to approach 10,000 – let alone 18,000.  Not even by relying on the long-obsolete conclusions of a 20 year old study.

The United Pilots

The United pilots are at it again.  While the Delta Air Lines' pilots reached an agreement seven months early, the United pilots are busy building websites whining about outsourced jobs (their term, not mine) and the salaries of United Airlines’ executives. 

Labor leaders in the pilot ranks would have you believe this “outsourcing” (international code sharing and the use of regional flying within the network) is all about management abusing provisions of their collective bargaining agreements to enrich their shareholders. In fact, reducing costs through the relaxation of scope provisions has been labor’s “quid” in return for increases in compensation (or to give less in a concessionary contract) and benefits for 20+ years [the “quo.”]

Among many myths portrayed on the website, United ALPA (Air Line Pilots Association) claims that after the tragedy of September 11, 2001, the management of United Airlines launched a strategic plan to offshore and outsource jobs in an effort to cut costs.  Look no further than the unaffordable contract negotiated between United and its pilots in 2000.  The pilots significantly relaxed scope provisions in return for increased wages, work rules and benefits.  I rest my case.

First of all, the fundamental economics underlying the health of the U.S. airline industry began deteriorating during the second half of 2000.  September 11 ensured that there would be no return to prior industry conditions particularly on the revenue line.  The incursion of the low cost carriers and the use of the internet for airline ticket distribution were every bit as powerful forces as 9/11 in compelling the industry to restructure.  The operating models sought by the network carriers were to find cost savings much like the low-cost carriers – a sector that outsourced a significant portion of its maintenance.  The advent of the regional jet in the mid-1990s was the catalyst driving a reduction in pilot and other costs.  Pilots at all network carriers permitted extensive use of the regional jet well before September 11, 2001.

Perpetuating myths to a public that largely doesn’t care (pilots are much better compensated than the average passenger) is probably a disservice to United’s ALPA members.  Put energy into negotiations like the Delta pilots and you might actually get somewhere.  That requires leadership and telling the entitled pilots at the old United that things are not going to return to the days when the company negotiated contracts it couldn’t afford.  It is just not going to happen.

Concluding Thoughts

Delta Air Lines just continues to do things a little differently.  When it merged with Northwest, Delta made the pilots “buy in” to the concept that consolidation was inevitable and that it was in their best interests to participate.  Delta’s financial performance relative to the industry has been very good quarter after quarter.  Then it buys an oil refinery and negotiates a deal with pilots seven months before the amendable date.  Hell, most negotiations have just completed the uniform section at this point in the proceedings – maybe.

It is clear Delta’s largest unionized group understands industry realities.  That’s a rare thing these days when, too often, reality is sacrificed for political expedience.  Simply look at how much has been made in the media about American’s unions joining hands with US Airways.  That was the easy part.  Which union wouldn’t agree to give up less and suffer fewer job losses?  It sounds great to members and union leaders can knowingly smile and say, at the very least, they’re putting pressure on management.  But reality says they’re weakening their own position, opening themselves up to my favorite term – unintended consequences and simply ignoring the truth that US Airways would have to carry 15,000 more heads than United, while generating the same level of revenue.  That’s not reality; that’s fantasy.

There is little doubt industry consolidation has helped catapult financial results beyond what could have been imagined for the industry based on past performance.  In that reality, my guess is Delta just made it more expensive for US Airways - and United - yesterday by negotiating yet another joint collective bargaining agreement.  US Airways needs those lower labor rates because its network produces below industry unit revenues. So now US is in the position of not only promising American’s pilots increased pay, but having to actually pay its own pilots at Delta +.

But hey, what is a couple of hundred million here and a couple of hundred million there?  After all, the margins for the US airline industry are plentiful.  Right?

US Airways at the Masters: Trying to Win on Thursday?

For those readers who know me well, today marks the beginning of the end of the finest 30 days in sports television.  It starts with the NCAA tournament and culminates with what can often be the best two hours in sports – the back nine at the Master’s Tournament on Sunday. 

Even with the history and the azaleas to occupy my attention, on this tournament Thursday, my mind still wanders to the airline industry and I see similarities in golf, aviation and the games people play.

As is tradition at the Masters, past champions Nicklaus, Palmer and, this year, Gary Player (a.k.a  Delta, United and Southwest) ceremoniously hit the first tee shots to open the playing of 76th tournament at the venerable Augusta National Golf Club. Past champions (multiple winners) at the Masters Tournament enjoy notoriety and historical significance long past their years of playing.

A popular past champion still participating in the Masters Tournament is Ben Crenshaw (American Airlines).  Crenshaw is given little to no chance in this year’s tournament, but the sweet putting stroke possessed by the Texas gentleman keeps Crenshaw a fan (AAdvantage members) favorite. 

Some very good golfers have never attended the Champion’s Dinner. Greg Norman (er US Airways) for example.  Nobody in Masters’ history lost in more heartbreaking fashion than Norman in 1987 when Larry Mize chipped in on the second playoff hole to beat him; or when Norman beat himself in the final round that handed the green jacket to Nick Faldo in 1996.  Norman’s misery is akin to US Airways missing out on consolidation opportunities in 2001(United), 2008 (Delta) and then again in 2010 (United).  US Airways’ strategy to attempt a hostile takeover of Delta while in bankruptcy in 2008 reminds this golf fan of Norman’s collapse in ‘96.

Playing in this year’s field and given a real chance to win are world #1 Luke Donald (Alaska Airlines) and world #2 Rory McIlroy (jetBlue Airways).  The Europeans are also making a strong showing these days, like defending champion Charl Schwartzel and perennial contender Lee Westwood (British Airways and Iberia).

Bunkers, Birdies and Bogeys

Pressure tournaments like the Masters tend to spawn meltdowns even among the very best players. The young McIlroy, in fact, suffered through a sad Sunday in Augusta last year.  Just like airlines have their good years, bad years and critical moments. And just like golfers, the difference between success and spectacular failure in the airline industry depends on how you read the lie. It’s how you think your way around the course, avoiding bunkers like bad decisions, taking advantage of business opportunities (birdies) and minimizing the negatives (bogeys and others) like fuel spikes and bad strategic decisions.

That brings me to US Airways.  

US Airways pursuit of Flight Attendant Hearts and Minds

The Masters is an invitational tournament; you have to be invited by the “committee” [UCC] in order to play.  US Airways is trying to play to the court of public opinion to get an invite to this year’s event.  US Airways had one good round it hoped would help it win an invitation to play in the year’s first major. That was reaching a tentative agreement with its flight attendants.  Unfortunately for US Airways, it couldn’t finish. The flight attendants at the company overwhelmingly rejected that agreement despite the fact it offered significant pay increases.

The flight attendants said in a press release:  "Since the onset of negotiations, Flight Attendants have been steadfast and determined that an agreement must address the needs identified by the membership. Flight Attendants have subsidized the cost of the merger and rising fuel costs for the 'New US Airways.' Management must recognize that our sacrifices have directly contributed to the success of US Airways," said Deborah Volpe, AFA pre-merger America West President and Mark Gentile, AFA pre-merger US Airways acting President.”

It has been nearly seven years since the “Old US Airways” merged with America West and there is still no done deal with either its flight attendants or its internally troubled pilot group. 

And yet before round one has been completed in Augusta, US Airways has allegedly been courting the president of American Airlines flight attendant union, Laura Glading, who is also a member of the Unsecured Creditors Committee (UCC) in order to get that invitation to the year’s first major… a merger with American?

While it’s hard to know exactly who is chasing who in all of the US Airways merging/consolidating with American talk, Glading and the APFA have been anything but shy in their pursuit of an offer from Doug Parker and company. The APFA has boldly stated it thinks there is a better business plan than the one American is offering… mainly because AA’s will freeze pensions and trigger approximately 13,000 layoffs. (Notice no mention of the finer points; that AA’s plan might finally unshackle the company’s ability to compete with other network carriers who rehabilitated under bankruptcy.)

Someone – probably the APFA - has “leaked” stories to specific media about “suitors” talking to the UCC – even though as far as anyone knows the only UCC members actually listening are the unions themselves.

While both the APA and TWU (who are also part of the UCC) have reportedly had serious discussions with AA – and apparently those negotiations might have saved some TWU jobs – Glading has been stomping her feet and pouting about the unfairness of it all.  She’s on record as stating the UCC (or, at least, one particular UCC member) is open to seeing a “better” business plan, thus leading to the flirtation with US Airways.

“Better” to Glading apparently means giving up nothing and gaining everything. But what “better” will she glean from this dalliance with US Airways?  Not to change sports, but Vince Lombardi, the iconic former coach of the world champion Green Bay Packers said:  “the only place you will find success before work is in the dictionary”.  Do Glading and other leaders of American’s unions honestly think US Airways will not seek to make major changes to American’s archaic work rules and collective bargaining agreements? 

In the tentative agreement, the former America West flight attendants were granted a 22 percent increase and the former “Old US Airways” flight attendants were given an 11 percent increase to even out pay rates – finally, after seven years. What then would US Airways have to do in order to put three groups on par with one another? Would APFA members be willing to work more for less? And if so, why wouldn’t they just stay with their own company? Or entertain commercial opportunities that might not involve a seniority integration process?

Maintaining a Cost Advantage Is Critical for US Airways

US Airways suffers from a stage length adjusted unit revenue disadvantage versus its legacy carrier peers – even more than American. But it also enjoys a stage length adjusted unit cost advantage versus these rivals – much more than American. Despite the revenue generating deficiency of US Airways’ network, the Tempe-based airline is producing very good revenue results relative to the industry.

US Airways’ revenue disadvantage is offset by maintaining its cost advantage – and most of that advantage is very low labor costs relative to the industry. As a result, US Airways’ pre-tax margins are impressive given its structural deficiencies. The cost advantage the carrier enjoys cannot be overstated nor can the company hide behind the fact a significant portion of its profit performance can be found in lower labor costs. By contrast, United and Continental are only now beginning to navigate what it might cost to buy labor peace, particularly among the pilot groups. US Airways has not explored what labor peace would cost, probably because maintaining the status quo is more cost effective.  Or did the flight attendants say in their vote that what US Airways could afford was not sufficient to buy labor peace?

US Airways Touting Merger Synergies Before an Invitation is Granted

The most recent version of the US Airways – American merger story leaked to the press suggests the “synergies” of a combination would produce $1 billion in revenue and $500 million in cost savings.  The revenue synergy number stems from the idea other mergers have realized a three margin point improvement in revenue resulting from the combination.  JP Morgan’s Jamie Baker point to the fact American is weak in Albany, Buffalo, Greesnboro, and Richmond to name a few.  What a yawn. In today’s world why are Baker and US Airways not talking about Auckland, Buenos Aires (oh American is positioned there), Guangzhou or Rome?

The strongest example of American’s domestic weakness is that AA is the #4 carrier in the Eastern U.S. in terms of market share and #4 in the highly fragmented Western U.S.  So, the question remains, can AA truly address these structural weaknesses organically or does it need a merger partner?

Problem with adapting previous margin calculation to a US-AA merger is they don’t necessarily apply. Other mergers involved carriers with stronger domestic and – and more important – international networks. US Airways flies to mainly second-tier markets and has little international presence. That might seem like a good thing – each partner filling a need – but there is little synching between the two – but for this observer there is nothing that gets me excited from a network perspective. Domestic calculations are one thing – international are another.  If I were Delta or United, I would be applauding this possible combination because it adds little to what other combinations might add.  And what about the cost savings?  We don’t even know what American will look like once it goes through the full bankruptcy process.  Therefore how can we know what the cost savings will be?

It is just too early to tell because no one knows what AA will be when it gets through the restructuring process.  Stated differently, what if AA wins the ability to have unlimited code sharing in the U.S. domestic market as a result of a changed pilot scope agreement?  Then is US Airways the only choice?  After all, American’s CEO, Tom Horton, has stated publicly he is not averse to a merger, but will only consider such a strategy once the company completes the restructuring process.

US Airways is absolutely not the only option for American.  What about a fully integrated relationship with each Alaska and jetBlue?  These would certainly better address the weaknesses on the west coast and in New York, particularly at JFK – two aspects of American’s not-successful-to-date “cornerstone strategy”. 

The point is, there are options for American beyond US Airways and I might suggest there are better options than the Tempe-based airline – and they do not require a seniority integration process and potentially do not add seats to the capacity fragile U.S. domestic market.  Then again the restructuring needs to be completed in full before we can begin to evaluate options – something that US Airways wants to avoid.  For a company that constantly claims it does not need to merge, it seems to this observer to be incredibly desperate and fearful of not merging with its bigger counterpart.

Concluding Thoughts

As they say at the Masters, and any golf tournament for that matter, you can lose the tournament on Thursday but you cannot win it. It seems to me that US Airways is trying very hard to win the tournament on Thursday.  There is a lot of golf to play in the American Airlines’ bankruptcy case. And until the back nine begins on Sunday, the leaderboard promises to be crowded as American is an important asset to many – most notably employees, British Airways, JAL, the Dallas-Fort Worth Metroplex and Tulsa to name a few. 

If employee members of the Unsecured Creditors Committee are going to believe there is a free lunch (egg salad and pimento cheese sandwiches) with US Airways they are surely mistaken. Simply, if US Airways doesn’t fix many of the structural things wrong with American, then in a few years maybe the “New New US Airways” will have to file for bankruptcy and fix some of the obvious problems their desperate overpromise and sure to under-deliver approach to American’s unions will avoid in order to win the hearts and minds of employees to get a deal done.

Most of the naysayers regarding American’s stated stand-alone business plan have vested interests in the outcome of the game.  Wall Street has made the case that consolidation and strict capacity discipline absolutely need  to be adhered to if the industry is to be stable.  They cite American’s 20 percent stated growth as something to fear.  And it might be.  But what is the 20 percent American has mentioned?  Nobody knows.  What if it is the ability to generate 20 percent more city pairs to sell through code sharing alliances with Alaska and jetBlue that add no new capacity to the system?  Net effect equals zero.  Period. 

Then we have US Airways.  Too big to be small and too small to be big.  Like American, there is a case to be made that their route structure is being marginalized each and every day; therefore a merger is more important to its very success.  For US Airways it’s only shot at a green jacket is to buy one (remember Crenshaw has two and Norman has none) because over a career opportunities to win one have been missed. 

Angst breeds strange bed fellows.  Angst does not win an invite to the Masters Toonament.  And angst does not win an invite to membership.  Yesterday Dustin Johnson had to withdraw from the Masters because of health reasons.  For US Airways this sucks because the Masters does not have an alternate list.  It must earn its way into the 2013 event because angst will not get it into this year’s Masters Tournament.

More to come.

Swelbar Interview With Emirates' Open Sky Journal

It has been 46 days since I last posted a piece on swelblog.com.  That is not to say that I have not been writing.  I have - just not here. To be truthful, I am bored with most things U.S.  I cannot read anymore rehashes of the American Airlines case; or labor forever trying to create leverage where there is none; or who will be AA’s exit partner if there is one; or the United pilots thinking that it is totally incumbent on management to reach a deal amidst union in-fighting and an ignorance about competitive realities. 

But a topic that always has my interest is happenings in the Middle East region when it comes to aviation.  I was asked by the Emirates Airline Public Affairs group for an interview that was included in their February 2012 Open Sky journal release.  It is included below.

Doug Cameron, writing in today’s Wall Street Journal, talks of Emirates intentions to enter a 7^th U.S. point in the immediate future with more to come.  There is no better time for this inevitable next phase of competition to begin as SkyTeam’s European partners report weakening financial results; STAR carrier Lufthansa reports results are down but being buoyed by non-airline assets all the while partner Air Canada finds itself trying to simply hang on and remain relevant; and oneworld’s US partner American Airlines flounders in bankruptcy making it an opportune time for the Middle East juggernaut to begin the process of adding more of North America to its global route portfolio before the third global alliance is a more meaningful competitor.

I am excited to see new competition for the aligned U.S. and European competitors begin in earnest as it seems that employees and other stakeholders just do not take the threat of this obvious evolution as serious.  It is.  The U.S. carriers reported a paltry .3 point earnings margin in 2011 and that is before the new competition begins and ever increasing fuel prices are used to describe 2012.  The work is far from done.

1. Generally, what do you see as the major themes playing out next year in the airline industry?

The health of the global economy generally, and Europe specifically, will continue to dominate headlines in 2012.

The industry can’t just be viable; it must continue to recreate its business model into one that can be profitable on a sustainable basis.  The industry as a whole must find a way to earn at least its cost of capital in order that it can reinvest in itself.

Today’s dysfunctional governments, particularly across the Eurozone and the U.S., must find a way to function.  When it comes to aviation, policy makers must begin to think clearly about what laws, regulations, taxes and fees are necessary for the business to achieve overarching economic and social goals. Too many current governmental decisions claiming to be in the best interest of the consumer are fraught with unintended consequences.

The growth of the Middle East carriers (Emirates, Ethiad and Qatar) will remain a topic of conversation around the world.  Not surprisingly, the response to the Middle East carriers from some parts of the world has been protectionist. First the world wanted to open the skies. Now that the skies are largely open for some/most, the talk has turned to restricting access to markets from new, innovative and vibrant competition. I agree the new competition should not be allowed access to cheap capital that is not available to all. But to limit market access because of presumed subsidy, cheap fuel, little or no airport costs and whatever other excuse to limit the growth of Middle East carriers is just plain wrong.

Of course, the rhetoric over the EU Emissions Trading Scheme (ETS) and the proper policy to ensure that the industry is environmentally sustainable will be a news item throughout 2012 and beyond. 

The price and volatility in the price of oil remains an important theme, albeit much less so in 2012 than in 2008.  [here I may be wrong]  Commodity industries abhor volatile input prices.     

Consolidation will remain an important part of the global airline industry’s vernacular in 2012.  It’s proving to be a healthy tonic for improved profitability in North America, but there are not many logical combinations left in the U.S. unless we begin the process of considering cross-border financial transactions among airline companies.

2. What effect is the Eurozone crisis having on protectionism vs. liberal aviation policies in Europe?

I think it is less the Eurozone crisis and more the fear of new competition from Middle East domiciled carriers that’s triggered increasing calls for protectionism in many parts of the world.   From my perspective, short-term aviation protectionism stands in the way of a country’s long-term global relevance.  Moreover, it seems like a high price for governments to pay in order to coddle a nation’s flag carrier.

There has been considerable consolidation among Europe’s flag carriers over the past five years.  With the obvious buyers of remaining carriers, or stakes in those carriers, struggling financially, I expect fewer future intra-Europe financial transactions.  As a result, the financial resolve of the remaining carriers in Europe will be significantly challenged, especially without hope of a government bailout.  Those governments will be hard pressed to protect struggling flag carriers over the medium term.

Either way, I see Europe as a more protected zone in the coming years rather than embracing liberal policies promoting competition.  The contemporary Europe will likely be anti-airline, except where the industry is viewed as a tax revenue generator and deficit reducing business sector.  The consumer will lose, economies will lose and countries may even likely lose their coveted flag airlines.  Ultimately, the market will win, but not before artificial protectionist barriers are erected.  The good news for Middle East-based carriers is other opportunities for carrier growth are present in emerging markets in Africa, Southeast Asia, China and even mature markets like North America.

In many ways, the European market is going through a similar transition that the U.S industry has been painfully undergoing since the mid-1980s. That shakeout triggered massive change and until the Darwinian process fully plays out in Europe, liberal aviation policy thinking will probably not resume either.

3. Do you foresee any fallout, aero-politically, from the AMR bankruptcy filing?

I do not see any aero-political fallout from the AMR bankruptcy filing.  Rather, I see it as necessary for the Fort Worth, Texas airline to obviate its competitive weaknesses relative to other U.S. network carriers that used U.S. law to restructure their mature operations.

Internationally, American Airlines is oneworld’s one and only link in accessing the world’s largest aviation marketplace – the United States.  A loss of American weakens competition among the three global alliances in a significant way both across the Atlantic and the Pacific.  In my mind, a loss of American would be another reason for politicians to restore the protectionist chorus that would point to the dominant positions held by the remaining two global alliances – STAR and SkyTeam - all the while ignoring the new competition emerging in the Middle East.

Rather than fallout from AMR’s restructuring, I believe oneworld carriers British Airways and Iberia – through their immunized joint ventures with American - will be an important aspect of any plan of reorganization. That plan could very well renew the call for changing foreign ownership rules.  In fact, the continued growth and the competitive threat posed by the Middle East carriers for traffic flows that were once the sole domain of the global alliances is also a triggering event for change in the ownership laws.

4.  What effect do you see from the EU ETS on EU-US relations or otherwise? What will be the knock-on effect?

While this story is in its infancy, there is no question that the global industry must address environmental issues and be a leader in creating a sustainable business.  How to go about establishing the proper policy will be debated for years to come.  It seems odd that the EU would institute potentially billions of dollars of new fees on airlines when finances of the global airline industry and economies around the globe are in such a fragile state.  Less profitable airlines have less capital to invest in technology that will prove to be the best prescription for reducing the carbon footprint over the longer term.

I expect we will see business as usual “under protest” in the immediate term.  Will ICAO act?  Initially, US-EU relations will certainly be strained, but airlines attached at the hip through joint ventures will have to maintain the current course of business.  What is ironic is the European airlines are high-cost producers and just became higher cost producers.  If I was a lower-cost producer, I would be trying to figure out how to use this to my advantage and appeal to the customer through lower fares.  This knock-on effect may finally open the eyes of the EU and other governments that you cannot tax and fee the industry into oblivion.

5.  What is happening in the world of alliances and anti-trust immunities?

I am beginning to fundamentally question whether STAR and SkyTeam are growing/have grown too big in terms of number of carriers under the respective alliance umbrella.  After all, it is the top 5 carriers within each alliance that realize a significantly disproportionate share of the synergy benefits generated.  It is no coincidence these carriers enjoy an immunized relationship.  Moreover, if the primary synergies of an immunized alliance are revenue only, we must be nearing an end to the alliance lifeline where marginal revenues generated by a new member exceed the marginal cost of inclusion of that new member. 

Aviation networks have evolved from linear systems to hubs and spokes with a focus on building regional dominance; to connecting regional hubs creating national/continental networks; and then establishing connections between alliance partner gateways. The evolution of competition has been from city-pair to hub to gateway to network.  Each of these evolutionary steps has led to increased traffic through the stimulation of new local and connecting traffic.

Alliances were originally built to accomplish what no one airline could do itself – create ubiquitous networks ferrying passengers from one point in one world region to another point in another world region.  But are alliances truly ubiquitous?

Emirates is able to combine the use of new technology (the A380), with low labor costs, government policies designed to promote aviation and a unique geography allowing it to compete with global alliances. Should we really concern ourselves with flag carriers to the same extent today that we did 20 years ago or even 10 years ago? Alliances have already caused borders to blur and the colors in some flags to cloud. Emirates, Ethiad and Qatar are simply doing what the oneworld, Star and SkyTeam alliances have already done.

Just like low-cost airlines, the Gulf carriers will place enormous pressure on network incumbents to match prices. That will be a problem for some of those incumbents, whose high cost structures – particularly in Europe - make it difficult to reduce fares even when faced with new competition. Even if some of the carriers within the global alliances or the independents were to fail, the market has demonstrated time and again that, where competition is vulnerable, a new entrant will exploit that vulnerability. Where there are market opportunities, there will be a carrier to leverage that opportunity. And where there is insufficient capacity, capacity will find the insufficiency. Networks evolve because of competition.

I believe the next phase of evolution will do some of the same. The challenge from the three Gulf carriers to the three global alliances will accelerate the discussion about global mergers because the networks being built by Emirates, Ethiad and Qatar are truly ubiquitous. The Gulf airlines are each one carrier, while the alliances are a patchwork architecture designed to circumvent archaic bilateral rules.  Organic growth will again prove to be the right tonic for airline systems to be financially sustainable – because the benefits of cost synergies are not being realized today and must be realized if the full financial potential of carrier combinations is to be appreciated and the resulting benefits are enjoyed by the consumer.

Swelbar: Pondering More of American’s Bankruptcy “News”

So much speculation around what American Airlines might be upon exit from bankruptcy; so many scenario possibilities.  Some media and those with specific interests in the industry are moving pieces around the game board with talk of mergers and acquisitions. I’m willing to play, but with a caveat; no one should take all the recent posturing seriously – at least not yet. And it won’t be tomorrow, or next week, or even next month. More likely the serious gamesmanship will begin approximately 7-8 months from now as creditors evaluate and negotiate American’s proposed plan of reorganization.  Right now, AMR has no choice but to approach the upcoming Section 1110, 1113, 1114 and all other discussions as if it will emerge as a stand-alone entity. 

The world is much more comfortable with the bankruptcy process today than it was even a few years ago.  Lessons have been learned.  Hostile runs on companies in bankruptcy are probably not the answer if a potential suitor really wants to be successful in being a part of the ultimate entity that emerges – unless there is no other option as creditors get close to signing off on some other plan of reorganization.  American will tell stakeholders what IT thinks needs to be done to put the company on a viable path. 

American’s $4 Billion In Cash – It Is Not Quite What It Seems

I just have to get one thing off of my chest:  $4 billion in cash on November 29, 2011 was about to become something much less.  It is one of the reasons why American filed for bankruptcy protection before it was too late.  Can we stop talking about a cash-rich filing?

Reactions ranging from dumbstruck employees to PBGC Director Josh Gotbaum’s comments regarding AMR’s bankruptcy filing with over $4 billion in cash leave me smiling.  The fact is AMR’s $4 billion cash reserve would have depleted quickly had the company continued without bankruptcy – possibly to the point of corporate oblivion.  AMR’s Board of Directors had no choice but to file as the company likely had very little access to affordable credit markets since few of the company’s assets were unencumbered.

Since September 2001, airline companies have significantly increased their liquidity (unrestricted cash plus available credit) as a percent of trailing twelve month revenues from roughly 10 percent to 20+ percent.  In 2011, only American and US Airways held liquidity balances of less than 20 percent.  While American’s cash erosion will be mitigated in bankruptcy, it resembles only adequate operating liquidity not a pool from which to pay large fixed obligations.

With that $4 billion in cash, American faced a pension contribution of $100 million during the fourth quarter of 2011; and $560 million in 2012; maturities of long-term debt including sinking fund requirements were $1.1 billion during the fourth quarter of 2011; and $1.8 billion during 2012.  These obligations should be considered against the backdrop of an airline entity that was burning cash at the operating level and the fact nearly all of its assets were pledged as collateral.  While it is true that some $800 million in assets would have become unencumbered during 2012, the amount is certainly less than necessary to maintain sufficient liquidity and meet fixed obligations assuming American would need to collateralize any credit it would seek.

In fact, if AMR were to pay its obligations with its existing cash balance, it is highly likely that the company would have faced a liquidity squeeze at some point during 2012. And that’s assuming no fuel spikes or world events that might impact airline operations.  I think it can safely be deduced the company did what was prudent to preserve the enterprise. Moreover, employees in denial and a PBGC with its own vested interests should step back and reexamine whether the $4 billion is really $4 billion. 

I don’t think so. The case is clear that a $4 billion liquidity balance is on the low end of optimum for a $22 billion dollar revenue generating airline company whether in bankruptcy or not.

Last Friday’s Bloomberg “News” – A Combined US Airways and American

The cynic in me just loves to read airline news published late in the day on a Friday afternoon.   But that is precisely what we got from Bloomberg last week titled:  US Airways Said To Consider American Airlines Merger To Fill Revenue Gap.  There were no sources to the story, only the classic reference to “people familiar” with the Tempe-based airline’s current activity.  Neither US Airways nor American Airlines would comment.  You know how it goes.  [On the US Airways 4^th quarter earnings call Wednesday the company did confirm the hiring of the advisers to study the matter mentioned in the story]

It has been suggested by some that American needs to pare capacity along the lines of other U.S. airlines in the domestic arena because it hasn’t done enough to date.  US Airways is often used as the example of a company that has demonstrated stringent capacity discipline and now has significantly improved margin results.  Yet the article says American Airlines might have pared too much capacity – to the point where the Fort Worth carrier is no longer attractive to significant portions of the revenue rich corporate travel sector. Someone is right - I guess?

In some circles, both American and US Airways’ networks are referenced as sub-optimal.  My question then:  does sub-optimal plus sub-optimal equal optimal (at least when compared to United/Continental and Northwest/Delta)?  Probably not, but there is the possibility the whole could/would equal more than the sum of the parts and thus generate more revenue. That doesn’t necessarily mean it’s the best-case scenario because there are plenty of questions when considering an American - US Airways combination -- but one can consider such a combination. 

A merged American and US Airways would be the second-largest U.S. airline on paper, but US Airways got out of the mid-continent hub business when it left Pittsburgh. So, how would the Chicago hub fit in? Philadelphia might be the poor man’s JFK (absent sufficient slots at the New York airport), but could Philadelphia prove to be an acceptable surrogate Northeast U.S. gateway to oneworld as it battles STAR and SkyTeam for high yielding east coast traffic?  What happens to the jetBlue relationship forged by American that could certainly be expanded when expected scope relaxations are achieved?  If the carriers combined, is there really a need for both a Phoenix and a Dallas/Fort Worth hub?  I don’t think so.  If not, where would the headquarters be?   

If American’s exit were to include US Airways, would oneworld make US Airways a full partner in each the transatlantic and transpacific joint ventures?  I would think so because, if US Airways’ domestic system is so fertile as to fill a hole in American’s U.S. network as the media stories claim, then it must be every bit as powerful in filling oneworld’s intercontinental revenue deficiencies.  Assuming that, nearly overnight, oneworld would become a more vigorous competitor with SkyTeam and STAR for traffic flows that neither carrier could capture on their own.  There would be a shift of revenue share from STAR to oneworld in addition to new competition.  How might STAR react if there were an overnight shift of 15 points of revenue share to oneworld?  Might STAR – or United - move quickly to make US Airways a full joint venture partner? 

For airline nerds like me, thinking about mergers/acquisitions by only looking at a map is fun. As games are supposed to be.  But reality means there is much more to consider.

Like any other potential bidder, if US Airways were to emerge as a party to American’s exit, the Tempe-based carrier will have to win the hearts and minds of the employees, the PBGC, the rejected Section 1110 lien holders and the unsecured debt holders to name a few along with Boeing and Airbus.  The onus would be on US Airways to demonstrate its plan will ensure higher returns than a stand-alone plan by American or a plan submitted by other interested parties.

Labor will be a key target.  US Airways, or anyone else, will tell labor a combination can offer an option to the cuts AMR is all but certain to require.  While that sounds great, labor will have to weigh any alleged benefits against a certainty it will be forced into a seniority integration process.  And we all know how emotional seniority integration proceedings can be in the airline industry. 

US Airways and its pilots have not negotiated a new collective bargaining agreement because of a failed seniority integration process that started in 2005 and today flounders in litigation – an internal union issue and not the company’s.  Nonetheless, would that mean American Airlines’ pilots could not achieve raises/improvements from the company because the integration of US Airways and America West pilots is not complete?  What about the flight attendants?

The Section 1113 and 1114 process at American all but ensures those employees will take significant cuts in work rules and benefits as those are the areas where AA has the largest competitive exposure.  Even after those cuts, though, some AA employees (like pilots) will still likely make more than many peers at the current US Airways.  So, would the theoretical combined carrier ask AA employees to take less so US Airways employees can get more than they might?  How does that apply to work rules, benefits? There are those who would (and, in fact, are) dismiss these issues saying they can be dealt with later, but that’s short-sighted.

A Combined Delta Air Lines and American

I still cannot get beyond the regulatory hurdles this combination would face, let alone the fact that all of the issues discussed above would also apply.  But here are four things that immediately concern me:

1. There are significant overlapping routes that would need to be addressed by the U.S. regulatory agencies to the point the carve-outs necessary might look and feel like a breakup of American, similar to Delta’s past devouring of parts of Pan Am.
2. Given the current strains between the U.S. and the European Union, combined with the latter’s consternation over the existing alliance construct, I cannot imagine the EU having an appetite for seeing three global alliances reduced to two.
3. The concentration at New York JFK specifically and New York generally.
4. Given the Obama Administration’s expressions of regulatory angst and outright displeasure when #2 AT&T proposed combining with #3 T-Mobile, I find it unlikely that any of the respective agencies would embrace a similar proposition in the airline industry.

As they say in the South, “this dog don’t hunt”.  But let it be clear I respect Anderson, Hirst and the Delta team as they did push a merger with Northwest and the slot swap with US Airways through the regulatory process.  And that is no small feat.

Concluding Thoughts

At this point, three/four names are circulating as having an interest in a restructured American Airlines:  US Airways, Delta Air Lines, TPG Capital and, possibly, IAG.  Whether American emerges from bankruptcy alone or with a partner(s), the case is going to take many twists and turns – some daily.

In pure laboratory conditions where American could restructure without any outside influences, AA would emerge as a much lower cost entity and, therefore, pose competitive threats to other U.S. airlines. 

To mitigate American’s potential cost advantage, other airlines will be sure to muck up the process to ensure that American is not fully successful in achieving its stated result.  Delta is not necessarily just gaming US Airways to cough up more in a bid or vice versa, but as I’m fond of saying, it is the law of unintended – or in this case intended - consequences.  Both are trying to ensure American has to pay more.  The conditions for American will prove anything but pure.

Of course, the game changes if United moves to buy US Airways in order to prevent losing the 15 points of transatlantic revenue share it delivers to the STAR alliance.  I do not believe Delta has a chance unless the Unsecured Creditor Committee (UCC) recommends, and the bankruptcy court agrees, that the parts of American are worth more than the carrier as an ongoing enterprise.  In that scenario, Delta will try to secure as many of American’s assets as it can conceivably digest and still get regulatory approval.  

But there we go again, speculating.  In order of least employee/corporate disruption I rank today’s possibilities as follows:

1. American as a stand-alone
2. American and IAG/oneworld
3. American and TPG Capital
4. American and IAG/oneworld, TPG Capital
5. American and IAG/oneworld, TPG Capital and US Airways
6. American and US Airways
7. American and most anything Delta
8. Liquidation of Assets

The one thing I can positively guarantee, though, is there will be employee/corporate disruption and plenty more speculation to come. Let the games begin.

Swelbar: Just Thinking About A Few Things

Yesterday’s Wall Street Journal

Susan Carey, Gina Chon and Mike Spector report that Delta Air Lines and TPG Capital are separately evaluating potential bids for American Airlines’ parent, AMR.  This story, along with the myriad of others discussing a US Airways bid for the Fort Worth, TX carrier, is just a warm-up for the main event of AMR’s trip through court-assisted restructuring and the ultimate filing of a plan of reorganization acceptable to creditors.

Delta might seem like an odd suitor.  First, we have to accept the fact Richard Anderson’s Delta is not your father’s Delta.  He and his team are aggressive and understand American holds many assets and relationships that are valuable and thus important to Delta (and SkyTeam) like:  Chicago (where Delta has been adding select domestic flying), a relationship with British Airways, a relationship with JAL, a relationship with LATAM, more of New York (this is where regulators will really struggle along with the absolute size of the combination), a deep South America presence, more of Mexico, Miami (where Delta has been adding select domestic and international flying), and a way to defragment Los Angeles. It could also simply be an attempt to keep a restructured competitor from emerging.

Delta is reported to have performed an antitrust analysis that concluded - with certain carve outs - the massive combination could pass regulatory scrutiny.  While I can see such a combination would bolster Delta’s market positions in many areas including the middle and eastern regions of the U.S., across the Pacific and into burgeoning Latin America, there is also a lot of overlap between hubs.  If Detroit and Cincinnati competed before, imagine the hub competition – and redundant flying – with Chicago thrown into the mix.  Nonetheless, just on sheer size alone, I think an American-Delta combination would  prove hard for U.S. regulators to grasp and approve. Delta would also have a difficult task of selling such a merger to an already skeptical European Union.

Fort Worth-based TPG, on the other hand, likes to work with strategic partners according to the Journal.  TPG has strong ties to the current management team at US Airways.  Richard Schifter, TPG partner, served on US Airways Board of Directors.  Schifter is currently a director at Republic Holdings.  Schifter and another TPG partner, David Bonderman, have extensive ties to the airline industry stretching from Continental to Ryanair.  No one should be surprised a private equity concern like TPG Capital might have an interest in a restructured AMR.  For TPG, the strategic partnership possibilities are many and include US Airways, British Airways or any oneworld partner that fears the loss of its only meaningful access to the traffic rich U.S. market.

This Wall Street Journal story highlights something I think is very important; AMR is attractive to strategic buyers as well as a financial buyer like private equity.  Today, the list of names publicly discussed as interested in AMR is three.  That list will grow over the coming months. 

It is also highly likely that this story was leaked by a party to mask something else.  We will see. It is important to remember potential bidders will likely wait a few months until a lot of difficult decisions regarding network and fleet are largely complete. They’ll wait until contentious negotiations with labor are complete – probably including layoffs -  as any new owner will not want to get their fingernails dirty in that process. Potential bidders will also likely wait to see how creditors are treated in a debtor negotiated exit plan.

A question remains however:  will any bid attempt by a strategic or a financial buyer for AMR be friendly or hostile?  US Airways tried an unsuccessful hostile run for Delta. There are a myriad of possibilities here and all that is guaranteed is the debtor has the exclusive right to file a plan of reorganization until the court says otherwise.  That plan may include an offer from a strategic or a financial interest, but at this point, it is all conjecture providing an opportunity to opine.  That said the news reported yesterday officially begins AMR’s journey through bankruptcy.

LAN/TAM

If there is an airline company built with more innovation and creativity than LAN, then someone give me a call and let me know who it is.  Or was it just being in the right place at the right time?  Either way, LAN Airlines has quietly grown into one of the global elite carriers and has earnings and a market capitalization to match.

LAN is an airline I rarely mention, but have a deep admiration for.   Based in Santiago, Chile, LAN’s strategy of taking equity stakes and, in effect, becoming a surrogate flag carrier for a country in an economically struggling region where other airlines have failed, has been brilliant. The strategy has allowed the former Lan Chile to diversify its traffic base away from Chile-only and grow to become the de facto flag-carrier for other countries on the continent. LAN’s ability to take advantage of non-Chilean country bilaterals has produced growth opportunities where a reliance on Chile-only would have only led to diminishing returns.

The carrier began as Línea Aeropostal Santiago-Arica in 1929 before becoming Línea Aérea Nacional de Chile (Lan Chile) in 1932. The Chilean government privatized Línea Aérea Nacional de Chile in 1989, and the carrier absorbed Chile’s second carrier, Ladeco, in 1995. Today, the LAN umbrella covers LAN Chile; LAN Peru; LAN Dominicana; LAN Ecuador; LAN Argentina; LAN Cargo; and LAN Express, among others. Some said LAN refers to Latin American Network. Any way you cut it, LAN is a brand!

LAN was just given authority to complete its merger with Brazilian-based TAM and the combined entity will be LATAM.  To become a true South American airline powerhouse, LAN absolutely needed a significant stake in Brazil, which it now has.

One of the merger problems is each carrier is currently a member of a competing alliance.  LAN is a member of oneworld and TAM is a member of STAR.  If Brazil was essential for LAN, imagine just how important the emerging market is to each of the global alliances.  This story might take on the characteristics of the fight for JAL between SkyTeam and oneworld.  South America is yet another critical geographic area where oneworld is under attack.

American Eagle

Two months ago, most industry watchers were scratching their heads about the investment reasoning for American Eagle as parent AMR intended to spin it off.  High unit costs largely stemming from a very senior workforce, along with a fleet that was built around an archaic scope clause at mainline American Airlines, defined the carrier.  I am confident virtually every carrier comprising the regional industry had little to no fear that Eagle was going to steal any potential business. 

Now with bankruptcy and the freedoms to cut costs, American Eagle may look very different coming out of court-assisted restructuring.  Fleet alignment is sure to occur, and is happening, with any and all 37 and 44-seat aircraft immediately being taken out of service.  Certainly there are numerous out-of-market leases on aircraft controlled by the parent that can be reduced.  In fact, we may see a new market rate established for a 50-seat aircraft that takes into account a $120 per barrel jet fuel environment.  Labor rates and rules are sure to be reduced.  If the ground handling services Eagle offers were the crown jewel pre-bankruptcy, just imagine how much more attractive Eagle’s rates to other carriers will become after the restructuring.

Don’t let the point regarding a new ownership market rate that takes into account the high cost of jet fuel get lost.  While Eagle might be successful, it is likely that Pinnacle will not.  This factor is potentially significant.  If a new rate can be found through the bankruptcy process along with reduced labor rates, suddenly for American, a number of small markets served could be removed from the chopping block and remain a part of the reorganized American network.   

Whatever the size of Eagle when it emerges, it is going to be much leaner than the majority of its competitors.  My guess is SkyWest, Pinnacle, ExpressJet and others are watching this restructuring with bated breath because a new market rate for 50-seat flying, and other flying for that matter, will present itself in the coming months.  And a new competitor for future regional flying will emerge.

American Pilot Scope and Pilot Negotiations at United-Continental

As American and its pilots union attempted to negotiate a new agreement up until the time the company filed for bankruptcy protection, certain aspects of what was being discussed were leaking into the mainstream media.  The game changer being discussed was the new A319 fleet would be flown at rates and rules much lower to reflect the difficult economics of the domestic business and appropriately reflect the market/aircraft size. 

If this is indeed the road American travels down in its Section 1113 negotiations, there are significant and immediate ramifications for the negotiations taking place between United-Continental and its pilots.  As the UA-CO pilots spend more time taking on the company using safety as a hot-button, a new baseline is about to be established as to how pilots work and get paid.  If the UA-CO are hung up on nothing more than 50 seats, then I ask:  what about 115 seats? 

The United-Continental pilots’ strategy to exert a leverage point blew up in their face on November 29, 2011.  Where AA is going is in the right direction as it accomplishes multiple things that will benefit their business:  1) it is better able to match costs with the domestic revenue environment; and 2) it puts an end to the pilot scope discussion.  Regional partners will not be doing any 100 seat flying because, in this seat range, mainline pilots have a better ability to match the cost of flying done by the regionals.

Whether United-Continental pilots either figure it out (or not), the focus then shifts to Delta where scope is already a hot button issue.  In 2013, US Airways pilots are absolutely going to be forced to consider something similar to what the AA pilots are likely to agree to. 

Then you just have to wonder what Gary Kelly is really thinking.  The tables just may be turning.

How the Weeks Ahead Will Shape AMR In The Years To Come

The biggest story in the U.S. airline industry right now is, of course, American Airlines’ parent company seeking Chapter 11 bankruptcy protection. After a flurry of initial filings and some alterations at American Eagle, there hasn’t been a lot of movement from AMR.

The lack of news from it or the bankruptcy court probably has a lot of people - union leaders, media, employees, communities – wondering what is taking so long. That’s the first key to understanding this airline bankruptcy is different and why other airlines such as United, Delta and Southwest as well as the federal government and even regional carriers are keenly watching and waiting.

Unlike all the other airlines that have gone through Chapter 11, American doesn’t have a Debtor In Possession (DIP) lender breathing down its neck. That’s because the AMR board of directors made a strategic decision to file for bankruptcy with more than $4 billion in cash in the bank. That’s more cash than any airline that’s ever entered bankruptcy has had on hand and one of the highest totals in U.S. corporate history.

That gives AMR and American some flexibility to run its business during the initial period of exclusivity, protect its interests and, most importantly, time to ensure that its ultimate plan of reorganization (POR) is the very best it can be. While time is still of the essence to put forth a POR, it gives the debtor (AMR), time to look carefully at its network (mainline and regional partner), its labor contracts, its fleet and then make unhurried and potentially dramatic changes.

When United filed in December 2002, the DIP lenders and creditors demanded interim labor deals within 30 days, some even hammered out on Christmas Day. Delta and the Old US Airways faced similar pressures. As much as is possible in the bankruptcy process, American controls its own fate. It needs to use the time it has to get this right and make sure its labor costs and operations are where they need to be when it emerges. If it doesn’t, I don’t believe American in its current form gets a second chance.

A quick aside: This is usually when AA employees harrumph they gave millions in concessions to management in 2003 and that should balance what other airlines gained in bankruptcy court. I have the greatest respect for what American’s unionized employees tried to do back then, but it was apparent by 2006 those concessions weren’t enough. United, US Airways and Delta’s labor cost competitive advantage continues to pound American. The Airline Data Project (ADP) numbers show American’s employees get paid more, work less and have a range of benefits that are distant memories for peers at other airlines. That’s not an accusation; it’s simply the way the industry restructuring unfolded.

It’s also why all the other airlines, including venerated low-cost carrier Southwest Airlines, are nervously waiting to see what American looks like when it emerges from restructuring.  Following AMR’s Chapter 11 filing, Southwest CEO Gary Kelly posted an open letter to employees saying American, and the other major carries that went bankrupt, did so because of “high costs” and that “Great Customer Service cannot overcome high costs.”

I view Kelly’s letter as an important glimpse into what became American’s inevitable bankruptcy filing and what it means for the rest of the industry.

Kelly said he expected American to become leaner and warned, “If they do emerge from bankruptcy, as I believe they will, they will join the New United, New Delta, and New US Airways as giant, lower-cost airlines. They are, collectively, much more formidable competition than their predecessors. The term “Legacy Carrier” no longer will apply.”

In what had to be a stunning admission to most Southwest employees, Kelly also said, “We currently do not have a sufficient cost advantage to stimulate the market because our fares are much closer to our New Airline competitors.”  In effect, this is what I’ve been saying for years: the “Southwest Effect” is dying, if not dead.

If that’s the feeling in the executive suite at the most consistently profitable airline in aviation history, then I can only imagine how raw nerves must be at Delta, United and US Airways.

American’s filing is the airline industry’s version of “Freaky Friday” with role reversals that have long-term implications. Delta’s pilots are next up in negotiations and, like American did for the last several years, management will essentially be negotiating against itself. Remember, it was just within the last year plus that a significant number of Delta’s pilots began earning more than their colleagues at American… and that was with an infinitely more flexible scope clause that permits the higher pay at the mainline. Delta will be left negotiating improvements to the highest cost pilot contract in the industry knowing American will attempt to emerge from Chapter 11 with significantly improved scope and much lower costs. That’s essentially what American faced from Delta in 2007.

The recent NMB rulings upholding election results afford Delta only a temporary reprieve from unionization efforts. I can all but guarantee Delta will face additional organization campaigns, forcing it to, once again, spend millions to counter labor representation drives with no assurance it won’t be saddled with costly union contracts.

At the new United, the world’s largest airline might be facing world-class headaches. Integrating Continental pilots into the system is already shaping up to be a long, contentious fight, especially as many of Continental crew currently enjoy better pay rates than United peers. Continental flight attendants make considerably more per hour than their United counterparts. Those facts should not only make United’s future negotiations lively, but also mean it will likely have higher costs than a correctly restructured American.

It’s not just big brother that will garner all the scrutiny either. Eagle has already shed leases and announced potential layoffs. When AMR exits restructuring, the once-for-sale Eagle could look completely different and potentially pose real competition to SkyWest, Republic and the apparently spiraling-toward-Chapter-11 itself, Pinnacle Airlines. With American’s fleet purchase plans and a revamped Eagle, momentous change is potentially in the offing for regional airlines as well. I’ll have more on that at a later date.

As I outlined in my last post, American’s payroll is proportionately out of whack compared to its major competitors. A quick glance at the ADP numbers shows every carrier that’s gone into bankruptcy since 2002 has seen a double-digit reduction in workforce within one year of filing. That doesn’t include the nearly 25,000 jobs Delta shed in the four years prior to going into bankruptcy. Those statistics are small comfort to the employees at American who will likely lose jobs, but there is no disguising the pain this type of necessary transformation causes.

Layoffs will get the bulk of the media and general public’s attention, obscuring changes – scope, productivity, benefits – that will have more far-reaching effects. An American that comes out of Chapter 11 with significant changes in those areas potentially sends tsunami-sized ripples through the industry – particularly the flying within the U.S. domestic industry.

Yet the federal government, industry observers and, likely, the media, will spend considerably more time and hand-wringing on another hot button issue: pensions.

Pension Benefit Guaranty Corporation (PBGC) Director Josh Gotbaum has been very vocal about what he thinks AMR should do with its industry-leading pension plans. In short, he doesn’t want them to become PBGC’s problem. Gotbaum is also very quick to point out the additional burden AMR’s pensions could add to the $26 billion deficit the PBGC currently faces.

A couple of things strike me about the pension issue. Gotbaum has questioned American’s commitment to employees, which I find a bit wrongheaded since the airline spent eight years in a good faith effort to keep its pension obligations off the PBGC rolls. 

Gotbaum said American Airlines employees could lose one billion dollars in pension benefits if the airline terminates plans. That’s a bit misleading as all of the carrier’s employee pension plans are not created equally.

Like employees at the other bankrupt airlines, the majority of employees at American will most probably get their pension benefits in full. In 2012, the maximum PBGC payout is going to be more than $55,000 for those who retire at age 65. That’s more currently than the average American ground worker and flight attendant makes. The pensions really at risk will be those of the people who can most afford it – management and pilots. The bottom line is if American terminates its plans, the PBGC will do what it was designed to do: protect the investments of the working class.

AMR’s bankruptcy process will likely dominate the airline industry’s financial and economic headlines in 2012. What happens in the next few weeks and months as the new American (and Eagle) takes shape, though, will be felt by employees, competitors and taxpayers for years to come.

More to come.

If History Is A Lesson – American’s Labor Cuts Will Be Large

There is much anticipation regarding when American will file its petitions for labor relief under Sections 1113 and 1114 of the US Bankruptcy Code.  The clock is ticking in terms of the airline’s ability to get its network and costs in line generally and its labor costs specifically.  This needs to be done without undue rancor and in time to implement a workable plan. 

Further, the bankruptcy road has many unknown twists and turns as experienced by US Airways (not one filing but two), United (a three year stay and multiple approaches for concessions from labor) and Delta (an unsolicited offer to buy the company from US Airways).  American will face surprises along the way as well.

Let’s consider some facts.   Today United/Continental fly 39 percent more ASMs than American, yet its payroll is only 17 percent higher.  Delta flies 27 percent more ASMs than American, yet its payroll is only 7 percent higher.  US Airways is 53 percent smaller than American in terms of ASMs but its payroll is nearly 1/3 the size of American’s.  Any way you consider it, American pays significantly more for labor to fly its schedule than its network carrier peers.

I concluded a recent blog noting that American’s problems are bigger than any check labor could write outside of bankruptcy, but that employees will pay a much higher cost inside bankruptcy.   And that’s a painful situation that might have been avoided if all of the employee groups had the will and found a way to negotiate cost savings the airline requires to survive and prosper.

As APA President Dave Bates told The Wall Street Journal, "Sometimes in life it's easier to have something imposed upon a person than have them agree to it voluntarily." 

UNITED

The same story played out at United in 2002 and, sure enough, the toll on employees was much higher in bankruptcy than what the company originally sought in direct negotiations. Early that year, the company proposed a package of concessions totaling $9 billion over six years – or $1.5 billion per year.  The unions went back and forth for months and ultimately proposed a give of $5.8 billion over 5.5 years as a package they said employees could live with.  But as with the American negotiations, deadlines kept slipping as the unions sought more time to ratify the agreements. 

United, losing millions of dollars a day at a time the carrier was trying desperately to win a loan guarantee from the Air Transportation Stabilization Board (ATSB).  As it was, the ATSB was about the only potential source of capital then available to a company hemorrhaging cash and seemingly unable to control its labor and other costs.

As the clock ticked, the unions finally agreed to the $5.8 billion package, only to have the International Association of Machinists and Aerospace Workers (IAMAW) vote the deal down.  With the ATSB loan imperiled as a result, United filed for court protection 11 days later, on December 9, 2002.

US AIRWAYS

Four months earlier, inside of court protection, US Airways in its first filing asked for $950 million in labor relief per year on a total labor bill of $4 billion.  This was US Airways’ first bite at the labor apple as the company quickly emerged from bankruptcy number one and filed again in 2004 where a subsequent $800 million in concessions were granted.  By the time US Airways emerged from its second bankruptcy and was being merged with America West, the company was half its size in terms of employees and its payroll was 58 percent smaller.

DELTA

On September 14, 2005 Delta Air Lines filed for bankruptcy reorganization.  In the year before Delta’s filing, its payroll was $5.8 billion and it employed nearly 58,000 employees (down from 71,000 in 2000).  Through the bankruptcy stay, Delta shed nearly $2 billion in payroll and reduced the number of employees by an additional 11,000.

WHAT IS THE LESSON FOR AMERICAN?

First, the bankruptcy court proved to be a more effective means to achieving the cost savings than any airline is able to accomplish through traditional collective bargaining.  Remember, United asked for $1.5 billion per year from its labor groups prior to bankruptcy and the unions would agree to about two-thirds of that. Under Section 1113, United asked for, and received, $2.4 billion dollars of an annual labor cost savings over 6 years – for a total of $14 billion in concessions.  And this would only be United’s first of three bites at the labor apple.

The second bite occurred in early 2004 when United filed for relief from paying contractual retiree medical benefits under Section 1114 of the US Bankruptcy Code.  The third bite came in late 2004, with fuel prices beginning their march to $147 per barrel and clear recognition that the company had not cut enough while in bankruptcy, United went back and asked for an additional $725 million per year that would include the employees’ defined benefit pension plans.  These two additional bites at the labor apple cause American to stand out as having benefit packages significantly more rich than the industry and productivity constraints dictated by terms in the existing collective bargaining agreements more onerous.

According to the MIT Airline Data Project, if American’s contract with its pilots union allowed it to match the productivity of Continental’s pilot workforce, American would need 800 fewer pilots to fly its current schedule.  That amounts to $400 million in costs mostly attributable to a labor contract that puts artificially low limits on the amount to hours an American pilot can fly.

If American were to achieve the same flight attendant productivity as Delta, it would require 1,500 fewer flight attendants than it now carries to fly the schedule.

And had American relied even partly as much on outsourcing as does every one of its competitors, American’s maintenance operation, represented by the TWU, would be a fraction of its current size. American today outsources only 24 percent of its maintenance and related work, compared to an average of 40 percent outsourcing among all other carriers.  When United began its restructuring, it outsourced 17% of its maintenance.  By 2007, that had grown to 46 percent.  So it’s not unreasonable to expect something similar when all is said and done in American’s trip through the restructuring process, particularly as its maintenance-heavy Super 80 fleet is retired.

According to AMR, American’s labor cost disadvantage versus the industry now tops $800 million a year.  One of the he main questions outstanding is where the airline cuts, resizes and reconfigures its network to get to a place that it can compete and earn sustained profits.

That plan could, and probably should, contemplate significant outsourcing in the aircraft and traffic servicing department, particularly “under the wing” work in small stations with limited flight activity.

And as the airline rethinks its overall fleet and flight schedule under the watchful eye of its creditors, every position from the flight crews to ground workers to airport agents will be examined to determine how many employees will be necessary to support a resized operation.

How much power do the unions have to “protect” these jobs? If history is any guide, very little. Ultimately, the bankruptcy court will determine the viability of the company’s operating plan based on its ability to balance costs and revenues and return a profit. And if that means fewer jobs, then that’s the reality the court will consider.

This is an admittedly harsh portrait, particularly in light of the $1.8 billion in concessions granted in 2003 by American’s unions – alongside another $2+ billion in non-labor cost reductions that affected employees across the company. 

I have no direct knowledge of what American will ultimately ask of its employees or the other elements of its restructuring plan. But I don’t believe the ask will be light, or easy, and that is more a factor of the economics of the industry and the competitive marketplace than anything American could have done through other means.

Airlines and Airports: Two Different 2012 (and Beyond) Stories

The links between the economy and the airline industry are well documented.  It used to be that when the U.S. sneezed, Europe caught a cold.  The interdependencies between the two economies are clear.  The question today is which side of the Atlantic is most prone to a bad economic cold?

Today’s economic indicators and the relative performance of the airline industry are a bit perplexing.  Real GDP remains below 2007 levels.  Household incomes are at 1996 levels.  Consumer confidence is an oxymoron as it recently hit the lowest non-recession reading in its history.  While manufacturing activity showed strength in the early half of 2011, it is now close to levels suggesting contraction of the sector might be around the corner.

Despite the negative signals surrounding the economic indicators we tend to rely upon for direction of U.S. airline revenues, the industry is performing admirably - albeit still not covering its weighted average cost of capital.  Maybe even incredibly given the economic headwinds it faces.  At the heart of the industry’s performance are the positive results being realized from consolidation and a religious adherence to capacity discipline.

An example of the industry’s improved financial performance can be found by comparing financial results in 2008 and expected results in 2011.  The U.S. airline industry yearns for its earnings to be relatively stable like those of corporate America; steady with minor ebbs and flows based on economic cycles. 

Instead, the airline industry follows a boom and bust pattern – mostly bust.  Look at 2008 and, as oil ran to $147 per barrel, the industry lost 17 cents on each dollar of revenue.  In 2011, the industry is paying more for oil on average than in 2008, yet is expected to earn one penny for each dollar of revenue.  This is a remarkable result particularly given the negative economic underpinnings, the price of crude oil and the price to refine a barrel of crude into jet fuel.  Ancillary fees have helped most airlines, but are still secondary to consolidation and capacity discipline.  

Truth is, without the high oil price trigger, it is unlikely the industry would have had the will or the necessary pressure to cut capacity.  The U.S. airline industry has too often expanded too much during the up cycles and kept unprofitable capacity in place in the down cycles - all in the name of market share.  The industry’s obsession with market share arguably created an airport system too big to be sustained as well.  Today, 97 percent of domestic demand can be found at 40 percent of the commercial air service airports comprising the system.

That brings us to the airport side of the equation that, arguably, has more capacity than is necessary to satisfy profitable demand.   Why should the infrastructure for a consolidating industry not consolidate itself around the strongest airport markets serving any number of regions within the U.S. air transportation grid?  Are all of the airport markets enveloped by larger airport market catchment areas necessary? 

Over the past three decades, aircraft technologies, airline marketing strategies, and one could even say, airport strategies (think Los Angeles with five airports serving one metropolitan area) have all been designed in some way to fragment markets.  Some argue this creates “healthy” competition, but I think it actually is destructive. Look at it this way, current fuel prices caused airlines to cut capacity and, in some cases, retrench in certain markets. Those same fuel prices – which are probably never returning to previous levels – are why examining what airport capacity can be removed from the system without disenfranchising significant amounts of the population is necessary.

2012 begins a period in which the U.S. air service map begins to redraw itself.  There is no way the government will do the right thing and study the nuances of airline service and determine whether one airport is more profitable, or more ”essential,” than another. Politics will not allow it.  The market, though, is already at work determining the survivors.  This is not a process that will happen in one year; I believe the 2012–2020 period will be a shakeout of profitable and unprofitable airport markets. 

Some will say a smaller regional airline network and fewer markets served will have a negative impact on overall demand.  I disagree.  True demand will find its way into the air transportation system even if the highway serves as the first access point.  Think back to the days when iconic airline names were lost and hubs were closed.  Are those hubs like Atlanta and New York smaller today?  No.  Is St. Louis?  Yes, because it does not have the same economic vitality as an Atlanta.  In most markets new capacity quickly replaced capacity lost.  Along the same lines, small market capacity will find its way to larger regional markets within a reasonable drive.

On the other hand, there are a significant number of markets that realized less traffic in 2010 than in 1990.  There are a number of factors why, including the location within the catchment area of a competing low-cost carriers and the fact jet service was replaced with regional carrier service.  This trend will continue as long as the price of jet fuel remains at the equivalent of $120 per barrel.  Don’t forget, Delta announced it was looking to pull out of 24 markets mid-2010.  They won’t be alone in 2012 – 2020 period.

Airport markets with relatively strong local economics and demographics will survive the war of attrition.  Markets with three or more choices of a larger regional airport with a more diverse menu of services within a 2 hour drive may find it hard to keep service.  A look at any airport map shows there is too much duplication of service in the Northeast, Upper Midwest and parts of the Southeast.

The regional airport of tomorrow will offer a mix of networks, low-cost carriers, as well as some “traditional” regional service.  It will not be dependent on the 50 seat jet.  It will also have competition from carriers representing each of the three global alliances.  It may have service from a carrier like Allegiant, but if its traffic makeup is comprised of a majority of ultra-low cost service, it is unlikely to be the airport of choice within a region.

Most airlines are expected to report a profit in 2012 because they have consolidated and adhered to capacity constraints.  But there is still more to do.  Today’s industry only cares about profitable flying, not flying for the sake of pretending to be something for everyone. The regional airport of tomorrow, though, will need to be everything to everyone. 

My outlook is not all doom and gloom.  I see it as the next phase of restructuring being undertaken by an industry badly in need of a fix.  The industry is inextricably tied to its infrastructure and what has become a necessity for airlines might soon become reality for airports.  That is to regionalize, the airport vernacular for consolidate.