Hell Yes, Going It Alone Remains an Option

In Washington, D.C., Congressman Oberstar says “hell no” before hearings are held on significant issues important to the US airline industry. In Atlanta, Delta Air Lines is reminding us that there is some probability that “no” to a deal just might be the right answer at this time after the company and its board carefully review possible merger combinations.

Russell Grantham, in this morning’s Atlanta Journal-Constitution offers a clear line of sight to the issues Delta views as critical tenets of any combination. Delta’s #2 executive, Ed Bastian, is quoted in the story as saying that “any merger must meet three major goals. He said Delta won't agree to a deal unless the proposed merger: creates a global network that "fills holes" in Delta's operations; avoids burdening the combined airlines with excessive debt; and treats employees fairly and assures them of job and seniority protections”.

We seem to be hung up on the political clock. Yes it is ticking. But with vigilant focus on satisfying certain labor issues, is the time on the clock of critical importance? Personally, I would rather see the industry address those issues it knows will be important to all stakeholders before the spotlight is turned on. It seems to me that by learning from past mistakes, the political clock may be less important. And can something really be completed in 10 months?

The airline industry is not the only industry that is carefully studying and proposing possible acquisitions. Yesterday Microsoft said Yahoo - and not hell no - to a possibility of diversifying its business and in turn creating a stronger competitor to Google. Last time I checked, the internet was a global network business just like the airline industry. And we are proud of the iconish names that carry the US flag in the technology space. But I digress……

More to come.

Swelblog.com: Taking Great Exception with Congressman Oberstar

Congressman Oberstar says: “Hell No”; I Say What’s Different

In today’s Aviation Daily, Correspondent Madhu Unnikrishnan published a story entitled “Oberstar Strongly Opposed to Airline Consolidation”. The full text of the story is included at the end of this post.

Congressman Oberstar, I grew up in your congressional district and am quite familiar with the “Socialist Republic of Minnesota” moniker that is sometimes used to describe politics there.

You speak often, and proudly, about deregulation and the consumer benefits derived from the Act. But wasn’t it also designed to allow the free market to work? Wasn’t it designed to force efficiency that would ultimately bestow lower prices on the consumer and to get them flying?

A Lot of Questions About Why “Hell No”

I am attaching a 1979 - 2005 chronology of actions between the State of Minnesota and Northwest Airlines that were compiled by Senate Majority Research. Certainly there are a number of actions included on the list that are anything but free market. As you reflect back on many of these actions that have your fingerprints all over them, how would you measure their success? Certainly you would not make the case that this was the free market at work. Parochial and protectionist -- yes. Free market -- no.

A big question for you today asks: is it more important to have an airline with its headquarters based in Minneapolis/St. Paul or a strong industry carrying the US flag around the globe?

Did the numerous financial aid packages you helped to author keep Northwest out of bankruptcy?: No. Have Northwest workers been subject to the same loss of income and benefits that have been suffered across the industry?: Yes. Northwest’s need to reduce cost and the resultant employee loss of income is a function of the free market that you were part of creating. Are you confident that the current environment ensures the success and staying power of Northwest as an independent entity that will forever employ all its workers that remain?

If there was ever an airline antitrust issue that was bound to impact Minnesota – Minneapolis/St. Paul and Duluth for that matter - it was the Northwest – Republic merger that was announced in 1986 when you were a member of Congress. Why was it OK then to remove a competitor in a hub market and any talk of consolidation today of a fragmented and hypercompetitive domestic market gets a “Hell No” from you?

The Darwinian struggle to survive initiated by Airline Deregulation Act drove Northwest to buy its primary competitor in Minneapolis -- Republic. That new competitive environment created by the ADA caused virtually all incumbent airlines to evaluate the relative size of their respective networks to that of the other domestic competitors in the market. When Northwest bought Republic, the industry was in its infancy and the focus was on the domestic market as network size could not be built organically in the face of deregulated pricing.

Today US airline competitiveness in the global marketplace is in its infancy. All that is different is that now we’re talking about network size relative to the global marketplace. Just like when Northwest bought Republic, today’s networks that are necessary to survive cannot be built organically. Certainly not when airlines lack critical pricing power that stems from a fragmented and hypercompetitive home market.

The size of the commercial aviation market is not confined to the eighth district of Minnesota, the borders around Minnesota or the 48 contiguous states. I know you are sent to Washington to represent your Minnesota district – and you do it well. But in your Chairmanship role, you represent the entire US. I thought that Congress was interested in the success of US industries, particularly those that are inextricably linked to the health of the US economy and assuring that US industry can be as competitive as it can be in the global economy.

That is not what I read and hear in your public statements. Am I wrong on this one: “Hell No”.

Aviation Daily, January 31, 2008

Oberstar Strongly Opposed To
Airline Consolidation

The House Transportation and Infrastructure Committee this week reinforced its opposition to airline consolidation.

Aviation subcommittee Chair Rep. Jerry Costello, D-Ill. said at a news conference that airline consolidation will be on the Transportation Committee’s radar screen this year. He noted the subcommittee will “examine and investigate” any mergers that “develop beyond rumor and discussion.”

But Committee Chairman Rep. James Oberstar, D-Minn., stepped
up the rhetoric on airline consolidation considerably, offering his opinion on the subject as “hell no!”

“Airline mergers do not serve the best public interest,” Oberstar said, arguing that consolidation can cause service to decline in remote areas and will almost certainly cause fares to rise.

The architects of deregulation didn’t predict the hub-and-spoke system would be a result of their actions, Oberstar noted, and he fears that further consolidation will cause the passengers “at the end of the spokes” to suffer cuts in service. Moreover, passengers are benefiting from the lowest fares, in real dollar terms, since deregulation, and this will end if consolidation reduces choice in carriers, he said.

Airlines will take defensive actions against a “mega-carrier,” Oberstar believes, and this will further reduce passenger choice.

The Justice Dept.’s oversight of airline mergers has been “sporadic,”
Oberstar said, but if a merger does happen this year, he said he will press the DOJ to examine it closely for antitrust violations. The U.S. Transportation Dept. also has a role to play in “defending the public
interest in aviation,” and Oberstar said he will “badger” DOT if necessary to prevent its approval of any airline merger.

If any airlines move closer to merging, Oberstar said the Transportation
Committee will hold hearings to “mobilize public opinion against airline mergers.” Consolidation only “benefits airline executives,” he warned.

Costello implored the Senate to move on the FAA reauthorization bill. The passage of the bill is crucial to the committee’s continued “aggressive” oversight of FAA and the airline industry, he said. Costello added that the committee will pay special attention to the issue of runway incursions this year.
-madhu_unnikrishnan@aviationweek.com

Dear US Government: I hope you are reading the newspaper

Thinking About Three Headlines from January 24, 2008

So much of the current discussion surrounding US airline industry consolidation scenarios involves only the Network Legacy Carrier (NLC) sector. In an earlier post this week, I wrote about the catalysts for consolidation. In that post the importance of economies of scope, scale and density is discussed and how they are a most important ingredient to a healthy industry structure. These economies are critical to all players – even the LCCs.

Three headlines in yesterday’s news underscore the negative effects of a highly fragmented and hypercompetitive US domestic industry structure – and those negative effects are not limited to the sector of the industry that is forever blamed for the industry’s woes – the NLCs. Yes, there is even bad news emanating from the Low Cost Carrier (LCC) sector. The very sector that many policymakers believe is solely responsible for the consumer benefits that the entire industry delivers each and every day - NOT.

First off, Holly Hegeman writing in her blog Planebuzz reports the first credit downgrade of the period. No it is not one of the NLCs, it is Southwest Airlines. Not that this is anywhere near the end of the world for the carrier with the industry’s best credit rating – even after the downgrade – but noteworthy in my view.

Second, Terry Maxon in his Airline Biz blog writes about additional stock sales by David Neeleman, founder and non-executive Chairman of jetBlue. Whereas there are always multiple reasons for stock sales, Neeleman has sold nearly 30% of his holdings since May of 2007. This particular announcement comes just days after jetBlue finalized a stock sale to Lufthansa that was designed primarily to address some near term liquidity concerns.

Third, last night Reuters reported out on Frontier’s earnings. The short article was entitled: Frontier reports wider loss, to sell four jets. Enough said.

For government regulators generally: the bad news regarding the industry’s financial performance is not limited to one sector. If you were right, and I was wrong, that the LCCs were/are the sector that will keep the US industry in a global leadership position, then it is time to step back and recognize that even this sector is beginning to show signs of troubled economics. And given that this sector is largely confined to the 48 contiguous states, that would be a good place to start your analysis of the industry’s structure.

For government officials in smaller US communities: the bad news is that the LCC sector of the industry is not your answer. The bad news is that industry economics do not support all of the service currently being provided. The good news is there is an opportunity to look at the current industry structure and allow it to make necessary commercial changes. Scrutinize the proposed changes for sure. But, changes that keep your airport market connected to the US air transportation system is much better than being the subject of attrition from the airline map.

For government officials in cities that serve as corporate headquarters: keeping your city as a critical dot on the global airline and trading map is much more important than housing a few thousand workers. It is simple economic impact math.

Much more to come,

Pondering A Northwest – Delta Combination

A Thought for Today

How does the Northwest/TPG bid for Midwest factor into the various consolidation scenario considerations being explored?

On January 7, 2008, Liz Fedor, airline reporter for the Minneapolis Star Tribune, wrote a story suggesting that the Department of Justice would complete its review of the proposed transaction by January 31, 2008. In the article, Northwest suggests that the transaction is being reviewed by the DOJ much like a merger would be reviewed.

If approved, a Delta – Northwest combination just might receive more intense scrutiny than originally thought. Geographic concentration? I am not going to get too excited given the confluence of hub competition within this region. Or is this yet another reason why a decision regarding Comair – read Cincinnati – is being postponed?

Maybe an AirTran acquisition of Midwest might resurface? In today’s TheStreet.com, Ted Reed reports that PAR Capital has made a passive investment in AirTran. An AirTran/Midwest combination could be the low cost competition lacking in Minneapolis and Milwaukee? Just a thought and yet another example of the myriad of complex network issues that are sure to be scrutinized and considered as this consolidation round gets kicked off.

Converging Catalysts Making a Case for Consolidation?

Don’t look now…….

…..but there is something that feels different to me. In the vial, mix:

1. a lot of anxiety with commensurate posturing
2. non-traditional capital sources with skeptical labor
3. parochial tendencies against global economic forces
4. a weak dollar relative to foreign currencies
5. a weakening US economy and record high oil prices that appear to be the new standard

What do you get? Consolidation chatter that has the feel that it is real. Not talk; not speculation . . ..the real deal.

The US Home Market

The last meaningful airline consolidation period that involved multiple players began in the mid-1980s. Piedmont bought Empire; American bought AirCal; Northwest bought Republic; TWA bought Ozark; United bought Pan Am’s Pacific Division; Delta bought Western; USAir bought PSA; USAir and PSA bought Piedmont; United bought Pan Am’s London Heathrow authority; and American bought TWA’s London Heathrow authority. And that’s only the larger transactions of the period.

It is these transactions that formed the commercial backbone of the industry today. Nearly 20 years have passed since the industry recognized that economies of scope, scale and density would prove important to survival in a deregulated network industry. And it brought a significant regional concentration of services. Two Minneapolis hub carriers merged; two St. Louis hub carriers merged; and two predominantly East Coast carriers merged. Arguably, only Delta and Western represented an “end to end” merger of carriers.

In the years since, there have been periods of mainline capacity cuts, mainline capacity growth and regional carrier growth – explosive at times and largely facilitated by technological change and a disparity in labor rates. And by the late 1990s, we also had the explosion in new capacity by low-cost carriers, and not just Southwest. The growth by the LCC sector was largely driven by the gap in the cost structures between the upstarts and the legacy carriers.

That Was Then, This Is Now

We have talked on Swelblog.com about how the barriers to exit are greater for this industry than are the barriers to entry. We learned the latest lesson on this topic during the bankruptcy era when more-than-sufficient capital was available to fund each of the respective plans of reorganization.

I would be surprised if one serious analyst did not question the virtues of the reorganization plans. Costs were cut and network changes were made, to be sure. But now, compounding the price of fuel is a weakening economy. Airline share prices plummeted throughout the month of December. Thus far in 2008, virtually every market is off to one of the worst starts of any year on record. The markets know something. The only time I want to see the highs getting lower, and the lows getting lower, is in my golf score.

At some point, the current credit crisis, increasing food prices and the impact of rising fuel on the consumer pocketbook will begin to put real pressure on consumer disposable income. And this will impact airline travel. Consumers will simply be less inclined to travel, even if the ticket price is right. From everything I read, it is clear that planned capacity for 2008 has not factored in any meaningful loss of consumer disposable income, nor should it as the macro economic indicators continue to provide us with mixed signals at every turn.

The Catalysts for Consolidation

1. The price of fuel: Consolidate this time will mean consolidate, or risk getting smaller. Consolidate means eliminating any and all duplication of service and costs associated with providing that service. And no, it does not have to harm the consumer as I believe that the leadership of the US airline industry may actually be more concerned about further erosion of consumer confidence in the industry than the health of the economy and oil threats.

2. The US domestic economy: A weakening economy will only shine a harsher light on service to communities that can’t be operated at a profit. The US airline industry made a good bet on 50 seat capacity during the latter half of the 1990s. That bet helped the industry to remain connected during the dark days of 2001 – 2004. But if that capacity was not economic at $50 oil, then it certainly is not economic at $90 oil. I do not think the industry has any overt intentions to disenfranchise entire communities from access to the US air transportation system. Rather, the industry will rightly ask if the same revenue can be generated with six frequencies instead of nine or three frequencies instead of five.

3. Hyper domestic competition: If anyone on Capitol Hill ignores the simple fact that US airline industry growth has slowed at home because few profitable opportunities remain, then we will just keep having the circular conversation – mostly driven by parochial concerns – that rejects consolidation out of an irrational fear that it will limit competition.

4. Increased international competition: If not a catalyst today, incursions into our market from foreign carriers promise to become a pressure point in the near term. The immediate impact of the US-EU deal is not much more than a change of the three letter airport code from LGW to LHR. But LHR, like JFK, is important airline real estate. Given this fact, what will bmi do? It has significant slot holdings that are sure to be bid on by any number of carriers like BA, Virgin, Lufthansa (with rights to exercise), Singapore, Emirates or any one of the Indian carriers. Any one of these carriers can force a changed transAtlantic environment overnight if LHR slots land in their portfolio. And we will sit and watch just how BA will compete with its Open Skies subsidiary from non-LHR points on the continent. Game on.

5. Foreign Capital: Just as plenty of money was available from many sources to fund bankruptcy exits in the US, foreign capital will prove to be plentiful as the US considers merger partners and deal structures. I am not convinced that all alliance structures are set in concrete. This being said, the alliances are sure to be most interested parties in how the network structures might evolve. In fact, some of the competition among the alliances to secure their place at a preferred table may be the catalyst to satisfy the many currently unsatisfied shareholders in US airlines today.

6. Labor: In a recent post here (no, not the one where the Terrapins beat the Tar Heels), I wrote about the emerging leadership of Lee Moak, ALPA MEC Chairman at Delta. Since that posting, the leadership of the pilots at United and Northwest have also spoken. Why the rising volume in the union leadership ranks? Because I am increasingly convinced that the industry is moving beyond recognition that structural change is about to occur -- and with that recognition comes preparation. Unions representing pilots and the flight attendants signal that preparations are underway to address respective issues in any consolidation scenario. They are seeming to believe, as do I, that with a seat at the table comes opportunity.

7. Management: In their public statements, the leadership at each of the airlines is increasingly more resolute in their comments regarding consolidation. United’s Tilton and US Airways’ Parker have been joined in recent weeks by Delta’s Anderson and Northwest’s Steenland speaking out in support of consolidation. Keep watching – it appears that Continental’s Kellner and Southwest’s Kelly may not be far behind.

With jetBlue partnering with Lufthansa; Frontier under increasing competitive pressure in Denver; and AirTran certain to be challenged by a growing and more vibrant Delta footprint, this discussion is not confined to a single sector of the industry.

A Few Concluding Thoughts

There is just something different this time. If after taking billions of dollars of cost out of the industry’s operations, all we get is a two-year profit cycle, then there will have to be something different this time. Yes, we might get three years of profitability, but that’s not where the smart money is now. Already profit estimates for 2008 are being reduced by 40 percent versus what the industry earned in 2007.

The fact is, the industry already has used most of the rabbits in its hat. In 1985 the industry was in its infancy and the focus was on the domestic market as network size could not be built organically in the face of deregulated pricing. The same is true in 2008, but now we’re talking about network size in the global marketplace. Like in 1985, the networks that are necessary to survive cannot be built organically, not when airlines lack critical pricing power that stems from a fragmented and hypercompetitive home market.

Some very good things came out of that merger period in the 1980s. Some very good things will come out of this merger period as well. Yes, there will be dislocations and the loss of an icon or two. But we should embrace the change. It may be the last shot for many airlines. And it is a risk worth taking because the current model will only produce the same deaths by a thousand paper cuts.

Consolidation, Mediation and an Explanation

CONSOLIDATION

On Thursday, January 10, the Wall Street Journal breaks the news that Delta Air Lines will ask its Board of Directors for permission to explore a merger with either Northwest Airlines or United Airlines click here. The article is entitled: Delta’s Merger Buzz May Stir the Industry. And stir, and buzz, it did. After a month of sustained stock price declines, the airline sector rallied by more than 15% following the story finding its way onto the newswires.

While news regarding the Board’s deliberations is quiet at this writing click here, the news of a deal involving Delta should come of little surprise to airline industry watchers and readers of swelblog.com. Further, at this point, we do not even know how, or if the story will play out. But……

In a November AP story covering a New York investor conference, Delta’s President and Chief Financial Officer, Ed Bastian, called consolidation a “front burner” issue for the carrier. As the company discusses consolidation, its message to all stakeholders has been consistent – a deal that is good for shareholders, employees and communities will be explored.

It has been reported that Delta would like to answer the consolidation question before it makes any decisions regarding asset or subsidiary spin offs. Delta's public statements on this subject have held true and the carrier announced that it will delay a decision to spin off its Comair unit click here. Delta has not denied these reports.

In either merger scenario suggested by the Journal, Comair and Cincinnati will be a source of discussion. Beginning the process of paring 50 seat capacity and secondary hubs are certainly synergies in my analysis supporting any good, and viable, merger proposal. If it is a Delta/Northwest combination, what about Pinnacle and Memphis?

There Is Something Different In Atlanta

And it is labor. It is pilot labor. It is pilot labor leadership. His name is Lee Moak click here.

History has taught us that simply negotiating a term sheet does not a successful merger make. The two speed bumps to a successful culmination of negotiated terms are: the regulators; and labor.

For serious industry watchers, Captain Moak has been on the scene for some time. His presence was felt during Delta’s bankruptcy reorganization. But his real persona emerged following Pardus Capital’s announced intention to facilitate a combination of Delta and United in mid November 2007 click here. Moak then wrote in a letter to his pilots: "Pardus' demand for a merger between Delta and United is a poisonous vision built upon an artificial timeline and focused primarily on a financial transaction…"

Moak has publicly opined that he sees structural change ahead in the industry. And to the extent that it impacts his carrier and therefore his pilots, he will play a role. Just a day before the Wall Street Journal wrote its story, Moak wrote a letter to his pilots suggesting that consolidation was at the door click here. In my opinion, Pardus’ big mistake was that it proposed a deal that could easily be perceived by labor as a “cram down”. And suffice it to say that after bankruptcy/restructuring, labor’s appetite for a "cram down anything" is nil.

It is refreshing to see a real leader emerge in the labor space. Right now the labor space is generally devoid of good leadership -- with a few exceptions to be sure. Whether this story plays out or not, what is different is that you have a union leader who has made it clear that he will represent his constituents and a CEO who will do the same. More importantly, Moak is not saying no for the sake of saying no. Rather he must see an opportunity to better position his pilots in a changing world. How refreshing.

Parallel paths that may ultimately converge to create something better than today’s fragmented and fragile platform?

Concluding Thoughts

What is sure is that US Airways’ CEO Doug Parker’s idea to be a first mover in the consolidation arena was a good one. What is also sure is that Parker provided a blueprint for the industry to merge networks, ensure access to the air transportation system for communities of all sizes while at the same time reducing fixed costs. Now Parker is hamstrung by pilot leadership blinded by the prospect of an unlikely outcome – a better arbitration decision. For Parker, bringing labor along would certainly have proven expensive – and maybe just too expensive.

At Northwest, CEO Doug Steenland is mirroring statements made by Delta’s CEO Richard Anderson that the right transaction – one that benefits employees, shareholders and communities will be considered click here. Steenland and his pilots had to work through a very difficult, and adversarial, operational situation shortly following its emergence from bankruptcy. An outcome was reached that seemed to quiet the rhetoric emanating from the Twin Cities. A platform to build on?

As for United, a new pilot leadership is settling into office. They are presented with a potential opportunity to find a meeting of the minds with a management team that has been most vocal, and visionary, on industry change. Is there a sufficient blueprint out there for the two sides to work as a single mind so as to ensure that United will not just sit on the sidelines and watch others implement Tilton’s strategic vision? Maybe the holiday operational breakdown can be used as a platform -- like at Northwest?

Network and labor blueprints are emerging. Maybe the historic speed bumps to successful structural change are being reduced as a result?

MEDIATION

The Allied Pilots Association announced this past week that they will apply for mediation, with or without American management joining them in the formal request, to the National Mediation Board after the close of business on January 14, 2008. I guess we are now getting a window into a strategy designed for a quick resolution?? My guess is it will still ensure a very long and protracted negotiation that ultimately lands in front of a Presidential Emergency Board.

Is the APA making a bet early in the Presidential and Congressional election cycle that somehow a PEB will fall short of Congressional action? Sounds risky to me. From my viewpoint and based on APA's current table position, there is no "splitting the baby".

In a widely read blog post here click here I borrowed a term often used among the professional negotiators at the Board: put it on ice. The term of art describes a situation where the gulf between two sides is too wide and as a result progress is difficult to measure. In that circumstance, a case is put on ice. Mediation is suspended and the parties are sent home to reevaluate their respective positions.

In this case, I do not see newly elected APA officers moving off of an uneconomic, unpalatable and untenable position anymore than I see American management remotely willing to entertain many, if any, of the economic proposals put forth by the union.

Another widely used term of art by a negotiator is underbrush. Underbrush refers primarily to negotiations on non-economic issues that should largely be concluded before the NMB is engaged. Well, suffice it to say there is plenty of underbrush.

Yes -- the Board will probably take the case but not before encouraging the parties to engage in more direct negotiations. Once the Board accepts the case, the parties will/can meet with and without a mediator.

As Terry Maxon of the Dallas Morning News asked on his blog (and I paraphrase): who will the lucky mediator be to get assigned this case?

So -- while the airline world surrounding “today’s” largest US carrier is certain to be engaging in commercial transactions that strengthen their respective companies, American and the APA will be spending time discussing: a secondary revenue source like cargo and its relevance to commercial passenger pilot rates of pay; executive compensation; inflationary adjustments to 1992 rates of pay; Super Bowl Sunday -- and probably not at the water cooler; and hourly rates of pay that when used in isolation make a nice story but fail to address the productivity side of the equation just to name a few of the issues. Oh, and computer allowances so that everyone can log on and read how American lost its leadership position.

Pretty sad story. No, a really sad story.

EXPLANATION

Chitragupta, in a comment to my most recent post, suggests I return to my heritage and find some sympathy toward the executive compensation issue. As I wrote in click here my beginnings in this industry as a flight attendant, union leader, ESOP Steering Committee member and numerous consulting assignments have their roots in distressed negotiations. Variable compensation for employees, executive pay packages and labor advisor fee negotiations have been a part of my professional world for as long as I have participated.

Whether the amounts paid to Stephen Wolf on multiple occasions (Republic, United and US Airways) were excessive or not, labor was aware. Amounts paid to ALPA advisors in the 1990s for a failed deal and ultimately a successful deal exceeded $30 million. Whether excessive or not, labor was aware and made the decision to write those checks. Amounts paid to the ALPA and IAM chosen CEO to lead United in the post ESOP era, Gerry Greenwald, were significant at the time and labor was aware. The ALPA and IAM labor directors were present and engaged in the hiring of Glenn Tilton at United. At the time it was certainly not easy to find a qualified CEO for that troubled airline and under Tilton's leadership it has emerged from a bloody period with eyes on being part of a new airline industry structure.

So as I am asked to return to my heritage, I am constantly reminded of other points in history where executives and labor advisors were paid significant amounts of money and, in most instances, labor was at the center of the conversation. This is not different at AA today or any other carrier where executive compensation has been, and will be, paid. In every negotiation I am aware of, labor had access to all information in the distressed discussions that have transpired during the 2002 – 2007 period. Underscoring this fact is that each the IAM, AFA and ALPA were members of the Unsecured Creditors Committee at United – the very committee that approved the plan of reorganization.

I recognize the issue is an emotional one. I was concerned about the timing of the most recent payouts, but my history/heritage - or whatever it may be - is dotted with points in time where significant money was paid to certain individuals. My lack of "sympathy" regarding the issue is that labor knew about most of the payment schemes. Further, in each case, labor was armed with a battery of advisors.

The terms of the current executive compensation plans are documented in the public domain and should be considered a part of history. The future can be shaped, history cannot. It is over. It is time to move on. This issue is not confined to the airline industry. The last 8 years have been an ugly period in American business. There have been many casualties. My assumption is that the next time around, labor will be more aware and thus will be smarter on the issue. So will management.

I grow weary of emotional rhetoric. I have referred to the exec comp issue as a “one trick pony”. My words on the issue are in the public domain. I am more concerned about the competitive positioning of the US industry and its place in the global sphere, not what a CEO makes in Ft. Worth, Atlanta, Chicago or Minneapolis. If the same amount of energy was spent putting forth new ideas to replace the outdated and outmoded ways of doing business in the labor negotiations arena, I might have a different view.

Labor is not a victim. What I am hearing is that management cannot lead, cannot innovate, cannot implement. Labor has a seat. Where there is a seat, there is an opportunity. Just like the Democrats steal a page out of the Republican playbook from time to time, and vice versa, why doesn’t labor take a page out of management’s playbook and negotiate at risk compensation that has the possibility of providing income when the business cycle and the negotiating cycle do not line up. And this happens in most cases.

There has to be a better way. Ask Lee Moak. To others, stop bitchin’ and start doin’. And if that means burn the furniture, then burn the furniture as employees at other carriers in the industry will benefit from your arson. Otherwise, plenty of opportunity exists to make the world better and more secure for your members.

A Little Blackbook on Creative Destruction

For some of you, the comment areas on a blog are often the first place visited. For others, they are largely ignored. For all of you, I have made an entire comment, made by blackbook, available below including my response back. Blackbook's thoughts are well worth reading.

On January 4, 2008, Blackbook responded to a post click here and raised the idea that: “what is missing in the airline industry is the type of creative destruction that has kept America’s companies at the forefront of research, development, innovation and change”.

I like the term “creative destruction”. How can it be applied to the US airline industry in order to make it a sustainable and profitable business?

blackbook said...
Yes, there is a lot about which to be pessimistic concerning the state of the U.S. airline industry. But, I feel these concerns mirror those that we see worldwide in the media concerning the status of our country as whole.

While there are many factors that would lead to such pessimism, both the U.S. and the airline industry have historically been sources of creativity and have a talent for reinventing themselves. Perhaps it's the natural optimist in me but I feel that, while we might get a bit bloodied en route, we will still emerge on the top of the heap.

What is utterly lacking in the airline industry is the type of creative destruction which has kept America's companies at the forefront of research, development, innovation, and change. Whether or not this comes as consolidation or another form of players exiting the market, it is clearly necessary.

Swelbar, I think you might have posted something at one time about the airline industry having higher barriers to exit than barriers to entry. With such diverse constituencies as employee groups, airports, lenders, aircraft lessors, etc... all working to prevent such an exit from the market, it is hard to imagine how ANY airline could have gone out of business. If all the major carriers survived the post 9/11 upheaval more or less intact, how can such an exit take place now?

Consolidation for consolidation's sake is not the answer, in my opinion. Look at the only example of the recent generation of it, US Airways. With each passing day it reminds me more and more of a late 1980s Continental, with a ragtag fleet of airplanes, various employee groups that hate each other, and a product which is shoddy at best. It is the present-day version of Gordon Bethune's comment about making the pizza so cheap, no one would want to buy it. Certainly such an entity cannot compete in the global marketplace. Neither shareholder nor stakeholder value is enhancing with the current situation.

Perhaps the market would be better served with exits rather than consolidation. The difficulty is of course in how these would actually take place. The current labor situation at some of the legacies are filled with enough animosity to make an Eastern Airlines-style Pyrrhic victory possible. If I had been subjected to what some of these employees went through in the bankruptcies only to see their executives line their pockets with millions, I probably wouldn't be opposed to seeing the whole ship go down. Still, I would have to say this is the only option I find less palatable than consolidation. It will, indeed, be an interesting year.

Swelbar responded...
Welcome back and Happy New Year. You ask many great questions and I will attempt to answer them in this comment back. But I think many of the ideas you espouse will require some separate writing and thinking.

As for your source of optimism on US aviation emerging again as global leaders, nothing would make me happier. Bloody road, yes; better off, yes.

As I asked my audience in a talk given recently: Why should we fear individual carrier failures or consolidation? We should not, although it will be painful for the subject carrier or carriers lost. Labor wants changes to the bankruptcy laws. Be careful for you ask for as the European approach may indeed be right.

I did respond to a commenter's suggestion affirmatively that the barriers to exit are higher than the barriers to entry. We talk alot about the need for consolidation here but I like your term of creative destruction.

And destruction may just be beginning as some stocks are acting like another round of bankruptcies may be ahead. And some of these bankruptcies may be in the regional and LCC space which is precisely where this industry needs to begin the process of shedding duplicative capacity and the associated fixed costs and tax on the infrastructure.

I definitely agree with you that consolidation for consolidation's sake is not the answer. What I have stated here many times is that any combination where one plus one is less than two is good - if not very good for the industry as a whole. So yes, that is destruction of capacity in some form.

Your reference to Eastern serves as a reminder that icons can be tombstones and three carriers that can emulate that disappearance today are American, US Airways and United. My sense is you read here so it does not take much to sense the anger emanating from the AA pilots that write to this blog.

Whereas the timing of the executive payouts probably could not have been worse, I am not sympathetic to that issue. It is hard to attract experienced people to this industry when they have many other choices in front of them. My experience as a board member has made this very clear and real.

Maybe the only way to create value in the immediate term would be to engage in a prepackaged Chapter 7 filing where proceeds from the sale of core and non core assets would flow directly to the shareholders? Value creation and creative destruction all at once?

But yes, consolidation that is good for shareholders, employees and the health of the core business would certainly seem to be more palatable than a liquidation -- one would think.

Ringing Out the Old, Ringing In the New. NOT

It is the last day of 2007, and as I prepare to write my final blog post for the year, I want to say something positive about where I see the industry – particularly the US industry. There are plenty of encouraging things happening in Latin America, Europe, Asia and the Middle East with carriers like LAN, Air France/KLM/Alitalia, Lufthansa/Swiss, Singapore, Cathay and the Chinese airlines. The global marketplace is where it is happening

In the US, however, we seem stuck with the old and little hope for new – with only a few exceptions.

While CEOs are speaking to the structural deficiencies plaguing the US airline industry, there is little “public” effort being exerted to address those deficiencies. I am encouraged at what seems to be the beginnings of US carriers like United and American, who have been sitting on the sidelines for too long, again investing in their product. But my excitement is muted by the endless news accounts of poor customer service and flight delays that work only to chase travelers away.

There should be a connection between product and customer and revenue – right? Gary Kelly at Southwest sure seems to be focused on product; the one word that never leaves the LUV vernacular is “customer.” Many are questioning Southwest’s recent actions to expand its customer base. Not me. This is a great story unfolding– the low cost leader and low fare provider now openly discussing its need to change. This means a need to find new revenue and a need to make its product attractive to a wider range of customers. And they are actually doing something about it.

I encourage readers here to visit the Dallas Morning News’ blog click here and read Terry Maxon’s take on the top 10 aviation issues in 2007, and the Air Traveler’s Association’s Top 10 issues for 2008 click here. Finally, click here to read an interview with Herb Kelleher, Southwest Airline’s departing Chairman, in the Southwest Economy published by the Federal Reserve Bank of Dallas. Kelleher’s comments on globalization are particularly interesting.

For another barometer of how the financial markets view the US airline industry, consider select carrier’s stock price performance over the course of this past year. As of December 28, 2007, US Airways, jetBlue and American share prices have dropped by more than 50 percent; Continental, AirTran and Alaska shares have all declined between 30-50 percent; and Frontier, Southwest and United shares have fallen between 20-30 percent.

In the six months after coming out of bankruptcy, Northwest shares are down 36 percent, while Delta’s shares fell 26 percent.

Suffice it to say that I’m joined by many other industry watchers in failing to find many positives in the US airline industry space. Let’s hope that in 2008, the US industry makes some positive steps toward reclaiming a leadership role in this critical sector.

2007: Looking Back.

1. Crowded Skies: This was the (another) year of air traffic congestion and its troubling impact on airlines. Authorities have now enacted limits on air traffic in both New York and Chicago – an approach that can only be viewed as a Band-Aid solution to a much more serious problem. It’s time for Washington to get serious.

2. Consolidation: US Airways’ “hostile” play for Delta took talk of industry consolidation from a murmur to a roar. It was the right idea for the right reasons, only to again be thwarted by labor, the regulators and the legislators. At what point are the naysayers going to accept the fact that the current industry structure does not serve the best interests of the airlines, employees the transportation infrastructure or any stakeholder for that matter?

3. Fuel: The eye-popping price of fuel underscores the ongoing need for the industry to identify ways to cut fixed costs, despite the fact that most of the low-hanging fruit is already plucked. And that’s before we even begin to calculate the price tag of anticipated environmental mandates on an industry already groaning from the weight of taxes and fees.

4. Labor Voice: Lee Moak, Chairman of the Delta ALPA Master Executive Council, emerged as a new voice in the industry labor front with his nod to the need for structural change in the industry. Because he combined straight talk with a serious commitment to representing his pilot members when faced with an unwelcome advance to Delta from Pardus Capital, Mr. Moak demonstrated real leadership by suggesting that he will play a significant role in structuring any deal that impacts his constituents when his carrier is put in play.

5. Foreign Capital: Lufthansa’s investment in jetBlue appears pretty benign on the surface. But Lufthansa, with this investment, has put its money behind carriers housed in two of the most important airport markets in the world – jetBlue at JFK and bmi British Midland at LHR. At the end of the day, this business is nothing more than a real estate game connected by sexy things with wings. No real estate, no access. Ultimately, foreign capital in US carriers only ensures that the weak market structure surrounding the US industry remains intact. These investments are no different than the good money chasing bad business plans that allowed US carriers to fund their exits from bankruptcy.

6. Staffing Woes: The Northwest Airlines system breakdown that followed its emergence from bankruptcy was the fault of productivity changes that were too fast, too aggressive, and resulted in a staff shortage that wreaked havoc on its flight schedule. The only good news was the negotiation between ALPA and the company that provided incentives for flight crews as a way to man the planes. This may be one of brightest spots in the labor arena in 2007.

7. Capacity Chokehold: The sharp slowdown in capacity deployed by the low cost and regional sectors offers important perspective for regulators as consolidation talk continues. Too bad Congress remains convinced that every congressional district is entitled to air service, no matter whether the industry can fly all of these routes profitably.

8. Labor Leading with its Chin: The extraordinary opening proposal made by the Allied Pilots Association as it begins its Section 6 negotiations with American Airlines sought pay increases some estimate at more than 50 percent -- and that is before we even try to incorporate the headcount increases with the remainder of its initial demands. While the aggressive proposal underscores the deteriorating relationship between labor and management at the airline – and in the industry overall -- the question remains whether the APA’s gambit will be a bellwether for the industry or the first in a long line of mediation cases making their way to a Presidential Emergency Board.

9. Capital Connections: In an administration that has not had much to cheer, the US Department of Transportation has served the airline industry well under the leadership of Assistant Secretary’s, Andy Steinberg and Jeff Shane. Unfortunately, these two soldiers of change will be moving on this year at a time when their skill and expertise will be sorely needed.

10. Detroit’s Deal: The agreement forged between the United Auto Workers and the Big Three automakers click here, illustrates the many similarities between the auto and airline industries. Will we see these kind of talks at the airlines? No sign of it yet. Leaders please step forward.

11. Integration Frustration: That US Airways' East pilots believe a new, independent union will right the wrongs of an arbitrator’s decision and do better by pilots than ALPA, demonstrates the triumph of hope over experience. Experience shows us that there is no entitlement clause that applies in these situations. Under globablization, there will be fewer and fewer entitlements left in an increasingly competitive marketplace. But there is opportunity, and the US Airways' pilots should be working together to figure out how to make their airline stronger, and their members better off, rather than fight among themselves.

A Toast to the Customer

Some readers may interpret my views as unrealistic – that I’m looking for some incarnation of Air Nirvana without any of the usual industry friction – but neither is true. I know that structural change will inevitably lead to friction. And some of that friction will come as part of the reality that the airline industry will look very different in a few years, with some carriers no longer in the picture.

My real fear is not the loss of a carrier or carriers – it is the complete loss of customer confidence in an industry that relies on its reputation. Both labor and management should stop pointing fingers regarding customer issues and instead focus energy there first.

Richard Branson Gets the Final Word Here in 2007

As Virgin Atlantic faces a potential job action by its flight attendants, Richard Branson, the carrier’s flamboyant leader writes the following letter to his employees click here. The closing paragraphs state very clearly where I think we are headed and the words that will need to be spoken.

“There comes a time in any negotiation when a good management team has to draw a line in the sand and I agree with them that time has come. To go further would result in unacceptable risks and would set a dangerous precedent to the company as a whole. It would be irresponsible of our management and they, rightly, are not going to take that risk.

For some of you more pay than Virgin Atlantic can afford may be critical to your lifestyle and if that is the case you should consider working elsewhere. For the vast majority of you, the pay rise you were offered was the best in the industry this year, which is why the union strongly recommended it. I’d urge you not to put at risk our ability to solve this dispute by messing up our customers’ travel plans.

We all want to resolve this situation and give the best pay increase that the business can afford. The best way to achieve this is by keeping all of our planes flying and delivering what we do best - making sure that all of our passengers leave with a smile”.

Thank you for making Swelblog.com a read for you. Much more to come as the final chapters are a long way from written.

It Is True: Lufthansa to Buy 19% Stake in jetBlue

jetBlue announced that Lufthansa will purchase up to a 19% stake in the carrier click here. William Greene, the equity analyst at Morgan Stanley, said the deal will bolster liquidity for jetBlue at a time when near term debt obligations exceed expected cash flow from operations and cash on hand.

For Lufthansa, this would seem to be a smart investment in a quality US carrier with a product focus that recognizes that a one size fits all network does not appeal to all customers. Further, this transaction for Lufthansa would appear to be a very shrewd option play for a US carrier when equity values are low and the relationship of the euro to the dollar is high.

In this writer’s opinion, as well as Greene’s, jetBlue’s slot portfolio at JFK has strategic value. Down the road, connectivity to the many Star Alliance partners serving New York could be of value. But the first stage is a pure financial play and no commercial relationship is anticipated. The announcement comes just a day after a talk by Wolfgang Mayrhuber, the chief executive of German airline Lufthansa AG in China where he suggested that global consolidation is a necessary and logical development of the global market click here.

In that Reuter’s article, mention is made of Lufthansa moving away from the possibility of investing in Alitalia. In a previous blog post, we wrote about British Airways’ possibility of reconsidering the use of its capital to consolidate “at home” versus using that capital to invest in other countries, namely the US click here. Well it just happened – or at least the first step was taken. And BA has walked away from its interest in Iberia.

Yes, on the surface this deal may raise questions as to why would Lufthansa make such a deal. Is United, US Airways and/or Air Canada hurt by this transaction? Will this precipitate other similar types of transactions leveraging the current currency relationship to low equity values? WestJet and Air France are considering a closer relationship.

Change is coming. What would Yogi say?

Is It True, Lufthansa to Buy Stake in jetBlue?

From the New York Times Deal Book, blog: click here. Before we write or say anything, let’s wait and see if there is something to this story. But based on our writing here for the past month, these are precisely the type of transactions that we should expect.

And Reuters offers this story click here.

If It Doesn’t Add, Let’s Begin the Subtraction Process

What Is Wrong With US Regional Industry Attrition?

It is increasingly clear that, in addition to fuel, regional airline industry overcapacity – a “bubble” in this writer’s opinion - may be the second most important catalyst to consolidation in the US airline industry.

Today, USA Today wrote about the capacity issue in an article about cuts in airline schedules across the industry, even in the face of strong demand click here. Maybe this is a precursor of things to come.

When domestic market overlap is evaluated, it is the respective regional network webs that will give pause to regulators and legislators, particularly considering the extent to which consumers may be disadvantaged as the result of consolidation. This is where network overlap occurs, not on the densest routes replete with competition from all sectors of the industry.

At last week’s ACI-NA International Aviation Issues Seminar in Washington DC, I tried to come up with a politically astute answer when asked a question on consolidation. But given my inclination to tell it how it is, I ultimately acknowledged that, on this subject, there is no “politic” answer.

I think Doug Parker had it right. I’m in no position to make that call, but looking at Parker’s blueprint for US Airways, he was suggesting some smart decisions. Why does Jacksonville, NC need nine flights a day to connect its airport to the US air transportation system when six are sufficient? Why does Greenville-Spartanburg need 25 choices for 100 or so passengers a day to and from Los Angeles?

The US industry is now struggling to shed fixed costs in an era when many airlines already have achieved significant cost savings from labor; fuel costs are outside anyone’s control and therefore not an option; and most of the cost reductions already have been wrung out of the distribution area

Since 2002, transport related expenses as reported by the mainline carriers – the vast majority representing the purchase of capacity from regional partners - increased more than fourfold to more than $17 billion in 2006 click here. If there is a cost area that deserves, and needs, reevaluation it is regional capacity deployment.

To put it in perspective, the $17 billion in expense spent by the mainline carriers on regional capacity exceeds the market capitalizations of United, American, Northwest and US Airways combined.

A Contrarian View of American’s Decision to Shed Eagle

Since American announced its intention to spin out its wholly owned American Eagle unit, I am troubled by some of the analysis. This is not about American or even about the FL Group, an activist AMR shareholder that has pushed the company to divest assets. This is about a sector of the industry with failing economics – the regional sector. And this surely is not about mainline pilot scope clauses. This is about economics: pure and simple. This is about American continually persuing the cleanup of its balance sheet.

If Southwest is continually revising downward planned capacity, then this relatively expensive capacity is surely difficult to maintain, yet alone grow.

As I have written here before: there are too many network carriers; too many low cost carriers; too many hubs and too many regional carriers. Already, we are seeing some signs of a pilot shortage. And the growth of the regionals – much of it built on labor arbitrage and an over-reliance on regional jets over mainline narrowbodies – is now slowing to a crawl. So why shouldn’t we begin to shrink the regional sector? Delta has Comair up for sale or some other transaction, which has been public knowledge for some time.

Financial engineering the AA deal is not. Pinnacle was the last financial engineering attempt using a regional platform and in the end the market correctly valued the expected revenue streams based on activity in the industry at the time. Mainline carriers began paying lower margins based on reduced revenue flows as the bankruptcy parade commenced. If AA were looking to enhance shareholder value, they have two or three other options that surely would have been announced before this one.

Prior to its Chapter 11 filing, Delta sold ASA to Skywest for a fraction of the price it paid for the regional carrier. Skywest negotiated certain terms in the event of a bankruptcy filing by the parent. More importantly, the broken carrier Skywest bought at a deep discount also came with a 15-year Air Service Agreement with Delta on pay out terms that are believed to be significantly better than newcomers to Delta’s regional stable receive.

This is the type of deal I would expect in the case of AA and Eagle. American has signaled to the market that it plans to maintain the current lift being purchased from Eagle. Yes, a new Air Service Agreement would have to be negotiated along with the transaction. What will be different with this deal is that aircraft will begin to come “off lease” over the term so the “buyer” may be purchasing reduced cash flow streams going forward. This is not financial engineering but economic reality. But they will be buying cash flow streams nonetheless – and that revenue is what matters to the analysis, not scope clause limitations.

Some Concluding Thoughts

Maybe this deal could be a catalyst to begin a long and overdue attrition of the regional industry as we know it. If there is a pilot shortage, then you are buying pilots. If you are looking to build a capital base that could be leveraged in other areas, this could be an economical means to buy what you could not build organically – particularly in this environment.

Growth is not occurring with 50 seat flying; that has been a well- documented fact for the past two years. But it takes the same number of crews to fly a 70 or a 76 seat plane as it does to fly a 37, 44 or 50 seater. Carriers participating in new flying with mainline partners are now purchasing their own aircraft. The purchase of new aircraft requires both cash flow and a sufficient capital base. The inclusion of Eagle assets and cash flow will surely provide a regional provider with more long-term staying power to withstand the necessary changes within this sector.

Just as we have talked about a domestic airline industry that could ultimately shrink to three or four legacy carriers, then it also is safe to say that three or four regional carriers are more than sufficient to meet demand. Skywest and arguably Republic will be there in the end. The question is who will join them in supplying capacity to the mainline carriers. The regional carrier space needs multiple providers, not only to ensure the competition for feed that the buyers want in the marketplace, but also to avoid the labor disruptions possible when a carrier is dependent on feed from just one provider.

Concluding Thoughts For Government

This is not a time to be “knee jerk” in a federal response to U.S. carriers that are struggling to be profitable at home while quickly being relegated to secondary status in the global arena. Just because there is an airport in a congressman’s district does not necessarily mean it makes economic and financial sense for airlines to offer service.

Yes, the government should ensure access to the US and global air transportation systems for as many communities as possible. But it is not commercially viable to offer each of those airports around-the-clock service. This bubble has raised unrealistic expectations for air service. Now we need to relieve pressure on an industry before it breaks.

Heeding the Divestiture Cry? American to Spin Off Its Eagle Unit

This afternoon, American announced its intention to spin off its American Eagle unit click here. Given the talk surrounding the company to consider spinning off AAdvantage, American Beacon Advisors, American Eagle and its maintenance unit, this announcement should come as no surprise.

Calls for American to spin off AAdvantage were first made by Reykjavik-based FL Group, which owns 9.1 percent of American in September. All US carriers, and not just American, are considering means to respond to increased shareholder pressure as airline shares have significantly underperformed the Standard & Poor's 500 Index this year.

One might say that AA is considering the divestiture of a regional carrier late in the cycle when growth has slowed considerably. On the other hand, if you believe that the regional sector of the US airline industry is not immune from consolidation, it just may be the right time to participate in the purchase of a carrier with a $2+ billion revenue stream that American says will remain intact as the parent plans to maintain all current feed provided by Eagle.

That revenue stream and an increased capital base will certainly have some attraction to regional sector’s biggest players: Republic, SkyWest, Pinnacle and others looking to assure their survival as its sector of the industry matures as well. American suggests the transaction will be a 2008 event with all the necessary caveats. No details have been provided on a deal structure other than a blank whiteboard.