« 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.

Comments

[Holly Hegeman]

Just about right. Not a lot to disagree with here. It's going to be a long slog. Any number of things can happen between now and when American finally exits bankruptcy protection.

[DesertGhost]

I tend to agree with Holly. Overall, not much to quibble with. But on a couple of minor points I will.

I'm only an observer of the airline scene, not an expert in any sense of the term. I am a transportation geek of sorts, but an outsider seeing the industry as a fan and possible investor (although I subscribe to the Jim Cramer / Robert Crandall school of airline investing at this point). To me, it's quite telling that Warren Buffett lost a bundle on "old" US Airways (U) stock, but has now taken the BNSF railroad private. I follow railroads, also. I used to follow them a lot more. They're boringly profitable now and that makes them less interesting than the airlines. I'm old enough to remember when the railroads were going through the same turmoil of mergers and bankruptcies (Penn Central, Erie Lackawana, Rock Island, Milwaukee Road, etc.) the airlines are now. The parallels are quite remarkable, but that's really not surprising.

First quibble: Pittsburgh. Pittsburgh is not in the "Midwest." It's way, way too far east. Indianapolis and Detroit roughly mark the eastern border of the Midwest as I see it. Chicago is in the Midwest. St. Louis is in the Midwest. Now if you see the world from Boston or New York where the prevailing view holds that the country's western border is the Hudson River ... After all, ESPN stands for "Eastern Seaboard Programming Network' ... then Pittsburgh is out west, I guess. Of course, growing up in the "real" Midwest, Minnesota, Wisconsin and the Chicagoland area skews my view slightly. Living in Phoenix for the last 35 years skews it even further.

Second quibble: Phoenix as redundant. As I've mentioned before, I live in Phoenix so take my words with a grain of salt. I'm old enough that I remember Hughes Airwest fondly even though I think the yellow and purple livery was awful, but I digress ... When I flew out here in 1976, the non-stop choices I had from Chicago were TWA and American. United didn't serve Phoenix in those days. I vividly remember when America West started and have friends who work there. Southwest started service to Phoenix just before America West launched. America West / US Airways has been serving Phoenix a long time and has built up a following here. Contrary to what you read on some airline forums, Southwest does not dominate Phoenix. In fact, Doug Parker mentioned Phoenix as a city where US has a competitive advantage in the latest earnings call (how much of an advantage I'm not sure, but, again, I digress...). There are many north-south flights to Mexico and Canada from here that I doubt would disappear if US and AMR merge. PHX is not nearly as redundant with DFW as it is with LAX. PHX is 370 miles from LAX (a roughly six hour drive on I-10; in fact, many who live in the western suburbs of Phoenix refer to living in east L.A.). It's 868 miles to DFW.

One other point (not a quibble): In US's earnings call, both Scott Kirby and Doug Parker spoke of the importance of having a competitive advantage. The comments were to the effect that it isn't as important to have size, per se, as it is to have a competitive advantage in your important cities. Alaska appears to be a classic example of this. I have to wonder if that's not some of AMR's problem. AMR has little to no competitive advantage in New York, Chicago or Los Angeles, three of its "cornerstone" markets, at least by the numbers as I understand them. I really wonder if US might think twice about pursuing AMR given these comments (I think it ultimately will, by the way). It's also quite possible that a "decent" presence (or a profitable niche) in cities like New York, Chicago and Los Angeles is enough, given their size and importance.

In any event, the airline industry is far from boring. If the history of the freight railroads is prologue, I think there will be more consolidation and that the US / AMR tie up is the most logical among the legacies for many reasons I won't go into here. Part of my rationale is that the railroads ultimately merged very much in line with their past alliances and relationships (i.e. what was New York Central is now aligned with CSX, which grew out of the Chesapeake and Ohio, the Pennsylvania with Norfolk Southern, which grew out of the Norfolk and Western, the Hill and Harriman lines have merged into what are now BNSF and Union Pacific, respectively). Both US Airways and American have a history with British Airways. The parallel isn't perfect, of course, and I readily admit that living in Phoenix colors my perspective.

In any event, it should be an interesting ride; far more interesting than the boring, profitable railroads.

Just my 2 cents worth - and you got it for nothing. You get what you pay for, huh?

[James A. Grobbin]

William,
88 seats, huh? How convenient. Just make sure AMR explains to the judge that the seats are all economy seats and limited to a handful of aircraft (taking precedence into consideration). No first class or economy plus/comfort/ for all those flights operated on behalf of America West/America West Express/U.S. Airways/U.S. Airways Express/(now add the other myriad of airlines authorized by the government to add their code to these flights).

I'm quite sure American will gain a competitive advantage in the marketplace by selling non-premium products to premium customers in limited quantity. But, of course, you know and I know they're asking for so much more.

I know you like to think of all this stuff as entertainment . . . a big, fun game as you eat your popcorn and pontificate. I, quite frankly, have had enough.

James A. Grobbin

[Private Jet Hire Direct]

I wonder if it was a small company such as ourselves or an individual whether there would be such help and leniency shown to American Airlines?