Southwest Puts Its Money to Work – Announces Intention to Buy AirTran

In March of this year, I wrote a blog titled:   Dear Southwest: Grab Your Bag of Fiction; It’s On.  This widely-read piece was about Southwest’s role in the proposed US Airways – Delta slot swap transaction. “If Southwest wants to gain entry to the few remaining slot controlled airports,” I wrote at the time, “Then it should make the incumbents an offer – one that provides the slot holder a return on that carrier’s prior investment.”

Well today, Southwest announced an investment – a $1.4 billion investment – in purchasing AirTran Airways, lock, stock and landing slots.  And that is what I was pining for in that post.  That is, I believe Southwest should pay, not get something for free or at some rock bottom price for assets the incumbents paid dearly for over the years. With AirTran come slots at New York’s LaGuardia and Washington’s Reagan National Airports.  Along with slots, Southwest gains meaningful entry into the one remaining legacy carrier hub where it offers no service – Atlanta.  It also gains entry into Charlotte, a US Airways hub.

Should Delta at Atlanta and US Airways at Charlotte be concerned with this transaction?  No, and there are a number of reasons why not.  First and foremost, the network carriers already compete with the low cost sector for nearly 85 percent of their domestic revenues.  Whereas AirTran serves 37 markets that Southwest does not serve, some of them smaller, there will be some new competition for passengers in those markets.  But for the most part, those cities already enjoy the low fares delivered via AirTran’s initial entry.  A second consideration is that while Delta and US Airways depend on local traffic at Atlanta and Charlotte, each are major connecting complexes and are not solely reliant on originating passengers.

If you ask me, the losers in this announcement are not the network carriers but rather Frontier and Spirit.  jetBlue will survive just fine.  But Frontier is now confined to one [maybe two] traffic base for all intents and purposes.  And that makes them vulnerable.  As for Spirit, which just announced its intentions to launch a $300 million Initial Public Offering, it is one thing to have a highly fragmented market competing inside their network.  It is a totally different animal to have Southwest and AirTran focused on carrying traffic to the Caribbean. The investment thesis necessary to market the IPO just got tougher.

Southwest Needs A New Reference

In its press release Southwest said: “Based on an economic analysis by Campbell-Hill Aviation Group, LLP*, Southwest Airlines’ more expansive low-fare service at Atlanta, alone, has the potential to stimulate over two million new passengers and over $200 million in consumer savings, annually. These savings would be created from the new low-fare competition that Southwest Airlines would be able to provide as a result of the acquisition, expanding the well-known “Southwest Effect’” of reducing fares and stimulating new passenger traffic wherever it flies.”

So where is the “Southwest Effect” in Akron-Canton?  AirTran serves the market and Southwest serves Cleveland up the road.  There should be significant stimulation in that market area? And in Dayton and Columbus, OH?  Perhaps Southwest is looking far back to a 1993 study.  Ding: the “Southwest Effect” as we knew it is dead.  The truth is today’s stimulation is largely diversion from another market or another carrier.  Fares may still be reduced in certain AirTran markets where the network carriers rely mostly on regional jets, but some markets will more than likely just recapture certain traffic from an airport in the catchment area that offered better fares to a unique geography.

Labor Issues

Some have questioned whether the acquisition will lead to labor troubles down the road. But one thing is for sure: If I was an AirTran employee the first words out of my mouth upon hearing the news would be:  “Ding, cha-ching!”  Like employees at United who are looking forward to enjoying the feel of a new culture, one can be sure that the AirTran employees feel much the same.  For them it is an opportunity to join one of the most admired and beloved companies, not just in the airline industry, but in the entire country

There will need to be union representation elections as a result of the merger as pilots and flight attendants are represented by different unions at each airline.  But it’s hard to imagine any vote going the way of the AirTran unions.  The main difficulty then becomes seniority list integration.  Southwest CEO Gary Kelly told investors that “equitable and fair” will rule the integration process.  That sounds like the words in the Allegheny-Mohawk Labor Protective Provisions and should be music to the ears of AirTran employees.  The question is whether each union will have it’s own definition of what is equitable and fair.  That was the case in Southwest’s most recent acquisition attempt, when the Southwest Airlines Pilots’ Association could not find a formula to integrate Frontier Airlines pilots – and the deal failed.

The integration process has evolved over the years since the Allegheny-Mohawk Labor Protective Provisions were enacted. Over that time, there have been more failures than successes in adopting fairness and equity. But it is incumbent for Southwest labor and management leadership to ensure that career expectations are met for all employees. Simply put, this concept means that the relative seniority in a combined list is not significantly different for any respective employee than it would be in their respective entity today.

Concluding Thoughts

Southwest will celebrate its 40^th birthday next year. It is a mature and maturing carrier operating in a mature domestic environment where it is no longer THE innovator. What I find most interesting in Southwest’s potential bid for AirTran is that the carrier is being forced to act just like the network legacy carriers in seeking a consolidation scenario that would lead to an improved revenue line systemwide.

Let’s give credit where credit is due.  Southwest put its money where its route system was weakest and made a very smart acquisition -- one that recognizes that two carriers will accomplish more together than either carrier could on its own.  The two carriers offer a combined network with minimal overlap that ensures that new revenue synergies will be generated.  With the deal there also will be new international opportunities derived for Southwest’s loyal passenger base.  Multiple fleet types are not an issue as the smaller airframe will allow Southwest to serve some smaller communities.

But I can’t wait to hear the arguments Southwest uses in Washington to gain regulatory approval, particularly as it will be hard pressed to make the argument that acquiring AirTran would further lower airfares in the US domestic marketplace.  After all, Southwest is not the only airline offering low fares, no matter what its boosters in Washington may think.

To make its case, the little ol’ Texas carrier that flies only to secondary markets will probably use the very same arguments to gain approval as did Delta/Northwest and United/Continental used.  Interesting indeed.   

“Go Ahead, Bite the Big Apple; Don’t Mind the Maggots”

Yesterday, as I was awaiting a report from the Institute of Supply Management on August manufacturing activity, I was working on a piece I titled:  “Government Buys Junk; Consumer in Funk; Airline Recovery No Slam Dunk.”  But after reading Ann Keaton’s piece in the Wall Street Journal on how jetBlue and Lufthansa are looking for a code share deal, I started thinking about all the pieces in play in the New York market and, as it happens, of the 1977 Rolling Stones tune “Shattered.”

Was it US Airways’ that said “my brain’s been battered, splattered all over Manhattan?”  Or AirTran talking about “rats on the west side, bed bugs uptown?”  Was that Continental murmuring something about “all this chitter-chatter, chitter-chatter, chitter-chatter ‘bout shmatta, shmatta, shmatta -- I can’t give it away on 7th Avenue?”  [But I can in Newark]  I do think I heard Delta saying, “to live in this town you must be tough, tough, tough, tough, tough!”  And I am sure I will hear from American “don’t you know the crime rate is going up, up, up, up, up” if it is not granted an immunized alliance with its transatlantic partners.

A Long and Overdue Reshaping of the Competitive Environment Gets Underway

It began on August 11, when AirTran Airways announced a deal with Continental to vacate Newark and give its slots and one gate there to Continental in return for slots at New York’s Laguardia and Washington Reagan.  A day later, Delta and US Airways announced a monster deal in which US Airways will give up 125 pairs of Express slots at Laguardia in exchange for 42 pairs of slots at Washington Reagan and rights to fly to Tokyo and Sao Paulo.  Both swaps involve no cash and have no impact on the Northeast Shuttle operations run by each US Airways and Delta.

The Delta – US Airways swap all but ensures that Delta will surpass American as the largest carrier at Laguardia.  By any measure of market concentration, LGA will continue to have ample competition.  For Delta and US Airways, the deal gives each carrier the tools to build out markets they believe are market strongholds.  Some say that a split operation (Laguardia and JFK) for Delta is a mistake.  But I disagree.  Winning passenger loyalty from offering expanded domestic services at LGA should translate into making Delta a clearer choice for passengers to choose the carrier when traveling to international destinations from its operation at JFK.

Absent this kind of deal, there is not much that can be done to increase domestic flying at any of New York’s three major airports.  Applying US Department of Justice standards to determine market concentration, Laguardia, JFK and Newark would be considered concentrated or moderately concentrated per the Herfindahl-Hirschman Index.  And JFK has limited space to for an airline to run a large domestic operation because of the extensive international operations that occupy the critical late afternoon/early evening hours.

Given all of the constraints of the New York aviation infrastructure, the airlines involved in the slot swaps have taken a proactive approach to advance their competitive strategies.  By recognizing their individual strengths and weaknesses, the airlines involved will be better positioned when a recovery gets underway.  If the government says you cannot merge, then engage in binge and purge. 

Today’s environment does not afford any carrier the luxury of presence everywhere and pricing power nowhere.

Congress and the Regulators

Because these transactions require regulatory approval, I fear that critics will claim that the deals would give the carriers excessive pricing power in those markets. 

But look at the data. According to the Airline Transport Association, system passenger revenue is down 21 percent, or $12.5 billion when comparing the first seven months of 2009 to 2008.  Add in the $3.1 billion the industry has brought in from those damn fees that everyone likes to write about, and that means revenue is down $9.4 billion. 

Where is the pricing power?  Where is the gouging?  And when will the politicians and regulators take airlines at their word when they say they need change?

“People dressed in plastic bags.  Directing Traffic.”

Neither Ponzi nor Pyramid, but an End Game Nonetheless?

Liquidations and/or Use of the Failing Carrier Doctrine?

On the day when Bernie Madoff gets sentenced to 150 years for orchestrating the financial fleecing scheme that put its namesake, Charles Ponzi, to shame, I am pondering the balance sheets of airlines. And it comes down to this: some carriers have little room to maneuver. Investors (read: credit) are not lining up to provide new capital without demanding ransom in terms of collateral or sky-high coupon rates well above those paid in other industries.

Ponzi and pyramid schemes work by gathering proceeds from one group of investors to pay off earlier investors. It is no small irony, then, that much the same has been happening in the airline industry for years. The financial scams fall apart when they run out of money to pay new investors. In airlines, the end result is pretty much the same. Airlines continue to seek new capital even as previous investors fail to earn a respectable return on their investment. It’s not illegal, but neither is it sustainable. Indeed, it is fast becoming apparent that capital is quickly tiring of this industry and its inability to sustain profits, return its cost of capital and thus reinvest in itself at market rates.

In an industry that has succeeded mainly in destroying decades of capital, the end game for some airlines may be near. To inject new funds into its operation, United Airlines’ required collateral was reportedly three times the $175 million in cash it raised. More troubling yet -- the coupon rate on the new debt was 12.75 percent. Even with exorbitant collateral demands and above-market interest rates, new investors were willing to pay only 90 cents on the dollar for the security, which equates to an effective return to the investor closer to 17 percent.

At the same time, American announced it will sell $520.1 million in debt . American’s collateral requirements will be hefty, but slightly less than twice the amount it plans to raise. According to the Associated Press, American’s debt is investment grade based in part on the assets pledged as collateral. Therefore, American will pay significantly less for its capital than will United, even if the investor interest level is on par. But with corporations of this size, and of this importance to the US economy, “investment grade” ought to be the baseline, not the high bar. That’s not the case today. Earlier in the year, Southwest -- the industry’s only capital-worthy airline -- was forced to pay in excess of 10 percent on its loans. Wow. In other circumstances, that might be considered usury.

Data Points

Market perceptions, and cold, hard cash, demonstrate a new industry pecking order is emerging. Allegiant, AirTran, Alaska and SkyWest – airlines many Americans have never flown -- each today have a market capitalization greater than that of either United or US Airways.

In Spring 2009, Fitch’s Airline Credit Navigator outlined current liquidity and expected debt maturities for airlines over the next three years. It found “most of the biggest U.S. airlines ended the first quarter in "unfavorable liquidity positions.”

For three of the top seven carriers (US Airways, American and United), this liquidity ratio fell below 15 percent of trailing twelve month revenues - a benchmark commonly used to target an optimal amount of cash to be held on the balance sheet.

According to Fitch’s data, American, Continental, Delta, United, US Airways, Southwest and jetBlue held nearly $17 billion in liquidity at the end of the first quarter of 2009 (and with a market capitalization of $13.7 billion for the same group of carriers, the market says that a dollar today is not a dollar tomorrow). Southwest and Delta constitute two-thirds of the group’s market capitalization.

Assets are only one part of the disturbing picture the Fitch data paints. The other half is liabilities. Together, the carriers have debt obligations of nearly $12 billion due by the end of 2010. And these obligations come at a time where negative free cash flows are anticipated for the foreseeable future.

Take as one example Delta, which claimed title as the world’s largest airline following its merger with Northwest. While in the first quarter of this year Delta did not fall below Fitch’s relatively arbitrary liquidity rating. Fitch nonetheless downgraded the debt ratings of Delta and Northwest on June 25 to reflect “intense revenue pressure” and expected negative cash flows. As a result of its combined balance sheet with Northwest, Delta has a stronger absolute cash balance relative to the industry, but still faces nearly $5 billion of fixed debt obligations through 2011.

The shift of capacity by the U.S .legacy carriers to international markets has suffered from poor timing. For United, its exposure to once lucrative trans-Pacific markets is even more painful as the geographic region is closest to intensive care. By comparison, American and US Airways are fortunate to have little relative exposure in the Pacific. But the winner is likely the new Delta which, with lots of eggs in all international baskets. This diversification will certainly produce better results than either Northwest or Delta would have achieved individually.

Renewed Consolidation Focus Based on an Old Tool?

In prior eras, the airline industry has relied on the “failing carrier doctrine” to combine companies on the verge of collapse or unable to meet debt obligations. That doctrine might be dusted off and used again during the next 12 months. Precedent shows mergers and acquisitions are viewed more favorably – with fewer concerns about competition – when the economy is in a swoon and airlines are at greater risk of going under.

US Airways chief Doug Parker is not alone in making a case for consolidation. United’s Glenn Tilton is also in the chorus. Both carriers are on Fitch’s list of those in the “liquidity danger zone.” United and US Airways still have some room to maneuver, but recent attempts to raise capital have proven, in the airline industry particularly, money is getting increasingly expensive.

We may be entering a new era in which the “failing carrier doctrine” no longer applies. Instead, we are now facing the “failing industry doctrine.”

On Second Thought

One of the big issues related to mergers not discussed enough is the preservation of the tax loss carry forwards that each airline has accrued (accrued losses can be used to offset profits in future years). So in the short to medium term, the industry may resist the urge to merge because a change of control could or would have significant tax ramifications. If this is the case, why not apply the failing carrier doctrine to anti-trust immunity?

First, there is no doubt we will see additional capacity cuts, with the next round showing up in the schedules for fall of 2009. This industry is not shrinking because it wants to, but rather because it has to. By the time airlines cut further at the end of the summer travel season, the industry’s two decades of economics-be-damned growth may be nothing but a memory of bad decisions gone by. Then the U.S. airline industry can finally get down to the business of being a business. Or be resigned to failure.

As I have written time and again, in this economy, capital will determine the survivors. Access to capital is the lifeline airlines need now. Those who control that capital are sending a message to legacy carriers, and that is they will pay dearly for funding until they can demonstrate a sufficient return for investors.

Republic Airways Holdings, Inc.

Recognizing the importance of that lifeline might shape the airline industry of the future. Republic Airways CEO Bryan Bedford seems to already be moving that way. As a result of his purchase of Midwest, Bedford now has investment firm TPG on his board - - basically, capital now in is the role of decision maker.

Whether other carriers can accept that kind of change might very well decide the future of the industry and whether some airlines even survive. Right now, that future for many airlines and the hundreds of thousands of people they employ is anything but bright.

Keep in mind, the next industry shakeout is not reserved for the big players alone. Look for entities other than the five legacy carriers (American, Continental, Delta, United and US Airways) to have input into any new architectural renderings of network structure. And input will not only come from Alaska and from the so-called low cost carriers, (Southwest, jetBlue and AirTran) but also some regional carriers like SkyWest.

And I keep coming back to Republic.

Are We Beginning to Define US Airline Industry Survivors?

All Sectors Present and …. Discounted

As the day ends and I finally get my thoughts away from preparing for tomorrow’s AAAE Energy/Air Service Summit to be held in Washington, D.C., I turned to Holly Hegeman’s blog Planebuzz. As she often does, Holly chronicled the day’s events on Wall Street. The drops in stock prices for AirTran, Continental, Northwest, Delta and Mesa are disturbing. But then again, why is today any different?

This has been a "Death March" that ends with the inevitability of structural attrition. It is unlike the loss of value experienced immediately post-9/11 in that nearly every airline has been punished by Wall Street. Post-9/11 actually saw some carriers be ascribed significantly higher equity values relative to other carriers based on the condition of their balance sheets and the view of their respective cost structures at the time. With exception of Southwest (do they run a trading desk or an airline?), every carrier has been hit very hard by the Street. Yes, airline equities are an option on the price of oil.

In her post referenced above, Holly ponders the Street’s view of AirTran. Yep, there is something going on here, and in hindsight, the bears have been leaving crumbs along the downward trajectory of its stock chart for months. Many question Northwest Airlines viability as a stand-alone entity. Today, Northwest put some specifics to its capacity reductions. And Northwest made that decision to charge for the first bag (that this blogger really dislikes).

Yesterday, we had the announcement that ExpressJet would terminate its branded flying. And today we have Mesa trading at 37 cents.

Renewed Bankruptcy Talk and My Blunt Talk on Private Equity

Over the past month or so, virtually every major airline reporter has written something on bankruptcy. But my fundamental question is: how do you restructure a market-driven commodity cost? Or is another bankruptcy period being created so that private-equity firms can finally buy what they determined they did not want to buy during the last round of Chapter 11 filings? Are we not watching this play out at Midwest where private equity holds a “passive stake” and is asking labor to make untenable concessions. Yep, they will probably file too and nope labor should not play as the outcome would remain fragile at best.

Private equity is smart money – right? Smart in that they did not play in the first round because they recognized that the work was not done. Smart because they knew the subsequent round of labor negotiations would result in dirty fingernails – particularly given the pension terminations and freezes that took place. So now we are down to the final act: removing capacity from the system and trying to educate lawmakers, communities and airports of these unpopular actions. As we make the final push to clear the last ten acres of 30 year-old underbrush, what a perfect time for private equity, right?

The right form of capital during this time is “internal stakeholder capital” and not external “private equity”. This can only be prevented absent a bankruptcy filing I fear, except for American I guess. As difficult as it may be, labor and management had best figure it out in a hurry. Think back to the early days of Southwest Airlines when the carrier was struggling mightily to stay alive. Southwest management put equity in the hands of the small number of employees that existed. History refers to them as the “North Dallas 40”. Millionaires, who would not have become millionaires, were made.

I am not saying that employees will be millionaires, but I can say with conviction that equity in lieu of hourly rate increases at this fragile time holds the promise of appreciation once this storm passes. And the long-term trend line of equity appreciation runs along a higher line parallel to inflation. So if I am labor and management, each of you has interests to protect. This is not about management compensation for god’s sake, it is about employee compensation and preserving as much of the enterprise that the macroeconomic environment allows. If labor believes it has somehow been wronged by management compensation structures of late, just wait until you lose control in bankruptcy the next time, or even for the first time, and the owner is Blackstone, TPG, or Pardus to name a few.

Thinking About Capacity Cuts and Industry Structure

Have you ever stopped to think that this is IT? Will the capacity reductions be an acclamation or an eulogy? There really is not much left to cut. As we raise fares, we will test 30 years of consumer attitudes in the making that air travel is among the greatest bargains ever delivered by a government’s action on an industry. As we cut capacity we will test the resolve of lawmakers to recognize that the airline business is a business and needs to earn a return on capital just like other industries. As we cut capacity, we will ultimately test organized labor’s mindset about pattern bargaining.

So as we march toward the airline graveyard, who will live to eulogize? Delta and Northwest have made their arrangement and it holds promise. Continental and United could prove to be a real powerhouse serving the largest US cities to metro areas around the globe. American will live because it has the “B” card to play where I fear others do not and it has the opportunity presented by an immunized alliance to generate revenue that has been limited because of regualtion. As for US Airways, labor got onboard too late for this one and I fear its ultimate death.

Turning to government’s beloved and answer to all industry ills: the LCCs. Isn’t it interesting that this sector has been rocked like no other sector. The price of oil has mitigated its previously inherent cost advantages. Yes, Southwest lives but it was really the only LCC to grow and prosper under deregulation anyway. jetBlue is taking on more characteristics of a network carrier recognizing the importance of local traffic in large metropolitan areas. ATA and SkyBus are gone. Spirit holds many of the attributes that characterize those carriers that have liquidated thus far: small footprint; private capital; market strength nowhere.

AirTran is the enigma. But there is something fundamentally wrong here despite a very strong management team. Maybe it comes down to that simple diversification thing that I like to write about. It has a presence in Atlanta. And Orlando I guess – and that market will prove to be a friend of a few that live to see another tomorrow. Oh, and Frontier. It too suffers from that diversification thing and my guess is the aircraft are much more valuable than the carrier’s value to the US air transportation system.

From this blogger’s perspective, what is missed on the regional sector is that there are legacy-regionals and LCC-regionals - for lack of a better descriptive term. It has much to do with labor rates as they are the only cost centers that allow this sector to differentiate their delivery of flying - at least under the current capacity purchase agreement construct. Republic and SkyWest are safe as each has been able to grow their jet-flying subsidiaries faster than their subsidiaries laden with employees that were in place when turboprops were the only game in town.

When it comes to rest of the regional sector, I just do not believe that the remaining carriers have been able to effect a business plan that transforms their structural beginnings.

So in the end, are we left with: United/Continental; Delta/Northwest; American/British Airways; Southwest; jetBlue; Virgin America (because of capital and branding); Allegiant; SkyWest; and Republic? I just do not know, but I am thinking that we are closing in on it.

The Elastic Induced Ride to Inelasticity

I do not know what you have been doing this morning, but I have been listening to the earnings calls at AirTran Airways and United Airlines. Last week I listened to both American Airlines and Continental Airlines talk to the analysts. It is an accepted principle that volatile prices are most unsettling on commodity industries – and the US airline industry has become a commodity industry.

Beginning in late 2000, volatile prices came in the form of decreasing fares. Today, volatile prices come in the form of rising oil prices.

The initial ride down in fares resulted in the growth of the low cost carrier segment of the industry. That sector's rise occured commensurately with the shrinkage of the network legacy carrier capacity in the US domestic market. The new world of lower ticket prices forced necessary cost changes on the network carrier segment, altered the demand calculus and led many observers to conclude that high load factors demonstrated that there was no overcapacity in the market.

Ah, that elasticity of demand thing. The notion that an airline could fill every seat – but at some price that does not cover the cost -- underscores this shallow approach to the analysis of overcapacity.

Well, the rubber band is about to snap.

In a post last week,: This Week’s Conversation Will Be In Words that Start With “C”, I discussed capacity issues and a whole lot of other “C” words we’re going to be hearing more of as US airlines unveil their financial performance for the first quarter of this year. Covenants; credit card holdbacks; cash; capacity cuts; capx spending plans . . . all are being discussed as liquidity concerns are again top of mind for the industry just like they were in late 2001 and 2002. And I’m not even including consolidation. Based on the market’s embrace (or lack thereof) of the proposed Delta and Northwest merger, there are bigger and more fundamental questions to answer.

And every company has been asked how they might raise cash down the line if needed.

The unhealthy revenue environment that began to form in late 2000 is simply not capable of offsetting the daily spikes in fuel costs that began in 2004. Therefore the industry is left with difficult decisions regarding capacity reductions – a recurring theme as carriers announce additional cuts and slowdowns. Today United, keeping with its aggressive posture, announced the most aggressive capacity cuts of any carrier reporting to date. But say what you will about aggressive management actions, United’s first quarter numbers are hard to swallow.

Capacity reductions will ultimately lead to finding that demand which is inelastic. An elastic demand is one in which the change in quantity demanded due to a change in price is large. An inelastic demand is one in which the change in quantity demanded due to a change in price is small. Volatile changes in price need to be addressed/minimized for this industry to be healthy again – or at least produce that level of supply where costs can be passed on to the consumer. That is where we are headed and it is the right direction. Furthermore, I heard United make it clear on their call that unitary elasticity is not in their interest until it applies to a much smaller segment of their ridership.

Concluding Thoughts

Believe as we might, this industry is not impervious to outside influences that impact every industry. Those influences come in different ways. There will be some consumers displaced by some of these necessary pricing actions. There will be some consumers put out by the sense that they are being nickled and dimed for a change policy, a preferred seat, a second bag that consumes fuel by its weight, or even a meal. There is no free lunch as life teaches us everyday. And for the US airline industry, finally we are saying that no one is entitled to a free ride or at least a ride where the consumer does not pay for the cost of that carriage.

And I wrote this without mentioning force majeur or the need to craft a Failing Industry Doctrine.

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.

01-02-08: Manufacturing Sector Disappoints + $100 Oil = Continued Airline Stock Carnage

Just thought I would memorialize a few facts from the first trading day of 2008. Crude oil trades at over $100 per barrel for the first time. [Crude oil actually traded at less than $11 per barrel in December of 1998.] Gold trades at a 27 year high. 1 Euro can buy 1 US Dollar and 47 cents. A report issued by the Institute of Supply Management suggested a contraction in the manufacturing sector which is an important barometer of US economic activity.

Airline stocks continued their downward drift in the face of more and more signs pointing to a weakening US economy. Most experts I heard interviewed today suggested that they see little in the way of oil price relief unless there is a significant global economic slowdown.

Now some stock facts on select US airlines…….

Of the 9 US publicly traded US stocks I consider significant, 8 set new 52-week lows: American, Continental, Delta, Northwest, US Airways, Southwest, jetBlue and AirTran.

United closed 37 cents above its 52-week low.

For these stocks setting new 52-week lows; American, Continental, Delta, Northwest, US Airways and Southwest all traded at least 3 times their average daily volume.

jetBlue’s market capitalization closed the day at less than $1 billion. The carrier’s stock still trades at 61 times its forward earnings suggesting there still may be more stock price damage ahead.

Of the 9 airline equities analyzed, the three largest in terms of market capitalization are: Southwest, $8.7 billion; United and Delta, $3.7 billion each.

Southwest trades at 20 times its forward earnings and United trades at 14.5 times. American, Continental and US Airways all trade at, or below, 7.5 times forward earnings.

The market capitalization of the 6 US network carriers combined ($17.3 billion) is the equivalent of 17.5 cents per dollar of revenue ($98.9 billion).

The LCC carriers: Southwest, jetBlue and AirTran would cost considerably more as their combined market capitalization ($10.3 billion) is the equivalent of 70.9 cents per dollar of revenue ($14.5 billion). Southwest comprises nearly 85 percent of the three carrier's market capitalization. Southwest’s market capitalization is the equivalent of 90 cents per dollar of its revenue.

Wondering Thoughts From 5 Time Zones Away

The underpinning of this blog is that change in the US airline industry is underway -- whether some like it or not. Over the past week there were some stories that grabbed my eye and are listed in order of importance from my point of view. There were many stories that warranted discussion like the orders coming from the Dubai Air Show, another meeting between US Airways CEO Doug Parker and Senator Arlen Specter, oil prices testing $100 per barrel, airline stocks getting beaten down, schedules at JFK, United suggesting it might, and could, put up to 100 airplanes on the ground given the changing economics and the list goes on that further underscore change.

Speaking of the Dubai Air Show and the aircraft orders being placed there – doesn’t it bother US readers that the orders are not from US carriers but rather from previously obscure points on the map that have every plan to change the shape of global aviation? It sure does me. Is the US being relegated to a supporting role in tomorrow’s global aviation market? I sure hope not.

These Are Not “Competitively Virgin” Markets

Holly Hegeman in Planebuzz ran a great piece last week where she summarized a research note from Gary Chase at Lehman Brothers click here. In his note, Gary finds that Virgin America is pulling down capacity in its transcon markets without any noticeable shift of that capacity to other markets.

The markets where the low cost sector has chosen to operate have generally been the densest US domestic markets. You would have thought that Virgin would have learned something from jetBlue and others that the competitive profile of the network carriers is vastly different today than just 4 years ago. The days where the legacy carriers that are most dependent on transcon revenue, whether from nonstop or connecting flights, are going to stand idly by and see further market share and revenue degradation take place are over.

In a Spring 2003 MIT forum, I did a piece on the Low Cost Carriers, subtitled “Thou Shalt Not Inherit the Earth” click here. LCC growth was the talk of the time. This piece was shared with mainstream press but largely ignored. Now it is mainstream, and even “futurist” by some, to talk about the revenue generating difficulties faced by the LCC sector. Whereas, Virgin America is well capitalized and arguably has a brand, it further underscores the point that the opportunities are limited for this sector to grow at previous rates.

We talk about consolidation with respect to the legacy sector of the industry when in reality the more interesting plays may be in the LCC sector – a sector that is highly dependent on revenue in the largest US markets. A capacity shift here, a capacity pulldown there and ………

Say It Ain’t So Joe

AirTran Chairman, Joe Leonard, sells his remaining stock holdings a week after stepping down as CEO click here. As for AirTran, it is unfortunate that their bid for Midwest fell apart. This company has performed admirably, but remains badly in need of diversification of its route portfolio and Milwaukee, along with Minneapolis, remain two of the largest markets without meaningful LCC presence.

While Northwest suggests it is only passive in its partnership with TPG, you have to look at that partnership and wonder what TPG sees other than to know an exit strategy is there for them at any time. Midwest’s recent performance does not warrant that kind of interest from a TPG and its business plan is circa 1999.

Do these changes at AirTran signal something?

This Is Not Bill Nyrop’s Airline: At Least Today?

Following a wrenching summer of customer and labor strife after emerging from bankruptcy, the external messaging we hear from Northwest is quite different from what we have ever heard in Minneapolis? In an article by Liz Fedor in the Minneapolis Star-Tribune: NWA Puts An Emphasis on Service click here highlights comments from the Board’s new Chairman, Roy Bostock, citing his desire “to create a better environment for Northwest's employees and customers and develop more sophisticated techniques for measuring customer experiences”.

Is this real or will Northwest realize the same fate that is playing out in Ft. Worth between labor and management after an attempt to find a new way? Given the contentious nature of the labor-management relationship that has historically been the norm at Northwest, this would at least appear to be a good start. It is always easier to begin these programs when amendable dates are years away. However, with Northwest in the center of consolidation talk (click here and click here) we will be watchers of the airline’s progress on service and employee relations.

Maybe This Time, “Delta” Really Does Mean Change

In an AP story covering Delta’s President and Chief Financial Officer, Ed Bastian called consolidation a “front burner” issue for the carrier click here. And as the company discusses consolidation, its message to all stakeholders has been consistent. But while the company suggested it would like to answer the consolidation question before it makes any decisions regarding spin offs, it made an agreement last week that would grow its internal maintenance operation click here.

This on top of its transatlantic deal with Air France and KLM and a decision pending on whether to sell Comair suggest that this company is doing anything but managing its enterprise for the future. I could not have been more wrong on my views of this company. I have spoken publicly about an airline with presence everywhere, pricing power nowhere and generally lacking a plan and direction. We will not know for sometime whether or not their international strategy is the right one, but the results since emerging are impressive.

Business Week made a case that the logical acquisition target for Delta should be Northwest click here. This story is a good read, not so much for the combination case it makes but more to the references made about an industry badly in need of continued restructuring ….

American and the TWU: Talk of gAAin v. pAAin

Trebor Banstetter of the Ft. Worth Star-Telegram did a nice summary of the TWU’s remarks as it presented its Section 6 opener to the company last week click here. If there is a union at AA with a substantial opportunity, and a competitive platform, to discuss “gain sharing” with the company it is the TWU. But I would argue it is not the entire TWU membership that is in the same position. It is the mechanics, the skilled workforce, that have this substantial subject matter to discuss.

One does not have to read too many articles to realize that American has chosen to invest in its maintenance organization – obviously a profit center that warrants the use of internal capital to fund an operation that has been successful in bringing in new work – and new revenue. The TWU suggests that they would like to return to 2003 levels of pay and work rules (not likely given the industry’s profit position). The company seems open to linking earnings to performance and productivity goals click here (an opportunity to make at-risk compensation a reality).

Whereas the AP story suggests a union “less friendly” – that may be true. But at least on its face, there is an understanding that preventing an environment that has caused significant pain for their co-workers at other carriers that filed for bankruptcy is a better path to follow. My hope is that the TWU and AA find some inventive ways to proceed that can reward the skilled workforce that is making Tulsa a new revenue source.

I further hope that the TWU does not use the skilled workforce to cross-subsidize the other members it represents as the sub-labor markets are quite different. There are too many lessons to be learned from the IAM on this subject ….