07.19.2009 « Let’s Just Get It Out There: Would You Loan To a (Union) Labor Intensive (Airline) Industry? »
In a post two weeks ago, a reader asked: “… are [you] just forgetting one thing about the "usury" that is the interest rate charged to United on what is in theory a very secured loan? The Obama administration pretty much threw out of the window centuries of legal precedent and destroyed the notion of secured credit with the Chrysler bankruptcy. Collateral is useless if you are not able to collect it in the event of a bankruptcy because someone in power favors the unions, and so the natural result is for all companies, across all industries, to pay higher interest rates (the law of unintended consequences is a pain in the ass, isn't it?). Frankly, 12.75% is a bargain for unsecured credit in a company with the creditworthiness of United.”
A Great Point
Similar questions were asked in recent months as Chrysler and General Motors teetered toward bankruptcy. In Chrysler’s case, the United Auto Workers ended up owning 55 percent of the company in a retiree trust following the automaker’s 42 day-stay in bankruptcy. Italian automaker Fiat ended up with 20 percent of Chrysler -- a stake that could grow to 35 percent under certain conditions [didn't the US Government insist on this foreign owner as part of the plan of reorganization?], while the United States and Canadian governments own the rest.
Was that deal fair to those who had loaned money to Chrysler thinking that their loan was secure?
In the final chapter of GM’s emergence from bankruptcy, the US government put $50 billion into the restructuring. In return, the US government got a 60.8 percent share of the new company, while the governments of Canada and Ontario hold 11.7 percent and a UAW retiree health trust holds 17.5 percent.
Was that deal fair to GM’s capital providers that thought their loan was secure?
What is wrong with this picture? How about the fact that secured debt is being relegated to Third World status to pay yesterday’s unsecured obligations before tomorrow’s capital providers and new shareholders get paid?
A similar story may be playing out in the airline industry, where unions are crying foul, demanding a return on the “investment” they made in concessions during restructuring in recent years.
And while several major carriers are already in negotiations with unions grappling with contracts that impose legacy costs and job protections that constrain their ability to compete, Teamsters President James Hoffa is marching on Continental, trying to convince the airline’s fleet service workers the Teamsters can offer them job security in an industry in the midst of a major competitive shakeout.
Will We Ever Understand?
Before long, the leaders of the major US airline unions will need to come to terms with the very financial realities faced by the US auto industry: a tapped out balance sheet isn’t going to provide much juice. For unions, the “unsecured debt” comes in the form of a two-tiered workforce in which younger or less-experienced members stagnate – unable to advance in the ranks – to protect the inflated wages, and generous benefits and working conditions bestowed upon senior employees at mainline carriers. Like all good Ponzi schemes, it works for awhile. But the bill is soon to come due. Airplane seating configurations have been downsized to the maximum extent and are now increasing. Furthermore, it is clear that the industry is not finished calibrating the right balance between mainline and regional flying, a necessary task for airlines that can only serve unprofitable routes for so long.
“Obamanomics” has been at play in the US airline industry since deregulation – manifest in the belief that the industry can continually borrow from tomorrow to pay for yesterday. First the “trunk” airlines bought up regional carriers – an easy decision given the better economics of flying smaller planes to smaller markets and in the process consolidating duplicated capacity that helped build regional dominance. Along the way, a pattern of cyclical bargaining played out, abetted by the Railway Labor Act which permits contract negotiations to continue for months and years.
Time and again, airlines would make unions “whole” for past concessions necessary in downturns, perpetuating an imbalance in which airline labor costs rose higher and higher – above the industry’s ability to bring in revenues to pay for them. As small jet technology improved, a new regional air industry took hold, creating a labor arbitrage game that made it all but impossible for legacy carriers to compete with labor costs too high to serve many markets. Finally, the lower-cost “upstarts” played their own arbitrage – taking advantage of their lower costs and workforce seniority to keep their costs down, and put yet more pressure on the legacy carriers.
We are soon approaching Judgment Day for airlines and their awkward and delicate relationship with the airline unions. In the airline industry, the “virtuous circle” that rewards success with more success has had a break in it for some time.
Something Different
I believe that we should be looking at this period of labor negotiations as an opportunity to find a better model. Employee morale is low, and that presents a real barrier to industry success in transforming today’s labor construct. But rather than trying to resurrect airline economics and models that are no longer relevant to the modern industry, labor should be working with airline management to find a way to rewrite legacy provisions that aren’t sustainable and won’t serve the long-term interests of their members.
Management Is At Fault
I’m tough on unions here, but you won’t find me congratulating management for labor's entitlement mindset created by decades of ill-conceived capacity growth. In the early 1990’s, American’s Bob Crandall began to close hubs at Nashville, San Jose and Raleigh/Durham, noting the important economic concept of fully allocated cost versus marginal cost of growth. In doing so, he acknowledged the error of his ways based on American’s growth during the 1985 – 1991 period in which growth was funded largely by lower marginal labor costs.
The recession of 1991 gave American and others pause. But it did not stop the growth. When the recession ebbed, that economic lesson was quickly forgotten and the industry continued to add capacity into early 2001.
By my calculation, until we get back to 1991 capacity levels, we’ve got another five years of shrinkage ahead.
Spreadsheet Analysis
It is a hard fact that, in its current construct, this industry only works for labor when it’s growing. Few airlines will be fortunate enough to avoid more labor trouble to come as they try to balance new industry economics against the expectations and demands of organized labor. It’s already messy at American, United, US Airways and Continental. Delta will only buy so much labor peace following its largely-successful integration of the Northwest operations, and Air Tran will be a new test now that its pilots have joined ALPA.
If I had money to invest, I would be staying far away from this industry unless a construct is put in place that will begin to allow airlines to manage the workforce with needed flexibility to match the direction of the business cycle.
Obama has promised airline labor that releases from mediation will be forthcoming – thus making the possibility of strikes a reality. Adding labor instability to today’s mix of economic, commodity and competitive instability should make any lender nervous. Then again, capital is already nervous about lending to this legacy industry as evidenced in the recent terms and conditions demanded for capital provided. What will labor instability, aided by this administration's promises to labor, add to the terms and conditions necessary to borrow scarce capital?
In any industry, there is no need for either labor or management if there is no capital.
Reader Comments (3)
You are absolutely correct. There is no way this industry will ever be healthy again unless things change. That the unions want to be made whole is bordering on ludicrous. A new model is needed. A model that that maximizes revenues while keeping costs in line. While management has been known to behave badly from time to time, I believe that it will be largely be labor's unsustainable demands that lead this industry down the tubes.
I'd have to agree. The acronym FUBAR is sadly appropriate for this industry. Labor costs that were once supported by the pricing power of the legacy airlines are now totally unsustainable as those legacy carriers fight the "upstarts" like JetBlue and Virgin America. New planes, low labor costs, no pensions; how could an AA, Continental or United hope to compete with that? On top of that the young carriers generally offer a better soft product at a better price.
While this has been unfolding at an increasingly rapid rate in the last decade or so, unions have taken pay cuts (whether voluntary or court-ordered) and focused their efforts on "restoring" their previous pay. That totally misses the point: their employers simply cannot stay competitive while paying at those previous wage scales. That's exactly what drove them to bankruptcy in the first place, so it would be foolishness to go down that road again.
Hi Bill,
Thanks for following up on my point, and sorry for the delay. Although I know enough about this industry to not invest in it (with one exception - if I ever become insanely rich for some reason I might start an airline but just with play money, for the kicks) I believe that the investing community is still not fed up with this industry. Sure, capital for now might be scarce but I believe it is true that,as they say, "a fool is born every day". It might take a while (and in the meantime some airlines might not make - *wink United wink*) but eventually the money will start trickling in, even despite the consistent destruction of value. The industry that best applies microeconomics (demand-driven pricing) is also the one that more seems to defy its basic principles.
Another thing, though, is that now that financial institutions are in the hands of the government they might have no choice but to lend/waive breached covenants to airlines...