Swelblog / Swelbar on Airlines

tagged

US aviation competition policy,

Sir Richard Branson,

Virgin America,

Virgin Atlantic,

antitrust immunity

Wednesday

Apr152009

04.15.2009

Liquidity, Labor and Legislation

Earnings season is upon us and we all anxiously await guidance from airline executives on a forward looking basis. On the eve of past earning seasons, cues from industry executives have mostly used words starting with “C.” This time around, I want to hear commentary on topics starting with “L” namely:

Liquidity

I believe that we are nearing the final chapters for one carrier, possibly two. I do not know which they might be, only that there are not enough rabbits left in the hat for every airline to survive in this market.

Why?

- Because labor will not be the internal source of capital that it has been in the past;
- Fuel costs are uncontrollable;
- Maintenance repair and overhaul will not offer hundreds of millions of dollars in savings in the future as most airlines already have outsourced as much of that business as they can;
- Distribution costs already have been wrung out of the system at every airline;
- Airport costs ebb and flow with the level of traffic;
- Aircraft rentals and other vendor contracts are largely fixed;
- Commitments made to feed providers are contractual;
- Interest obligations are known.

In other words, there just is not much room on the income statement for airlines to maneuver.

In the U.S. airline industry, we could be fast approaching the tipping point– the critical juncture in an evolving situation that leads to a new and irreversible development. With credit tight, would you put money into an industry that has historically destroyed capital? Would you bankroll an industry that has few opportunities to reduce costs in a weak economy? Would you lend money to companies facing labor strife? To get to the bottom line, would you invest in a company in an industry that has never made a dime? In this economy, there may not be many takers.

The airline industry is not special. Like other industries, it needs a plan to earn at least its cost of capital and compete for a limited pool of funding. And those who hold the capital will likely look first toward companies and industries that reward their capital providers more than once or twice every two decades.

I share the belief of some others that the domestic market may be stabilizing, but think this recovery will be an uneven one. The real driver may be the international market and the global economy’s interdependencies that I do not pretend to fully grasp. So I have concerns about American, Continental, Delta and United. Asia has been troubled in certain spots for nearly a decade now. Europe was a strong performer while the US industry faltered, but now shows signs of weakness across the continent. And Latin America’s economy appears to be similarly troubled.

Beginning today, when American leads the first quarter’s earnings parade, I will be all ears. Because what I see for some is troubling. Others will benefit from the weakness.

Labor

The recalcitrant unions at American remain the lead story as outlined in Mike Esterl’s piece in an April 14 Wall Street Journal entitled: Labor Negotiations Cloud Outlook for American Airlines Parent. American is being joined by United which opens negotiations with all of its major unions this month. Between the two, there will be plenty to read and write about as union leaders at each airline continue to promise outcomes to their members that could not be met even in the best of times. Real leadership would instead recognize that no airline can long survive overpriced labor contracts that put them at a competitive disadvantage in the industry.

I read somewhere this week that the United Airlines flight attendants union is promising its members a new contract that will give them industry-leading pay rates. The American pilots union is taking an old page out of the Continental pilots’ playbook that “the loan is due” to gain back pay levels the industry no longer supports. The problem is that concessions granted or forced in past years were a necessary correction of market costs that had risen above the industry’s ability to absorb those costs. Those concessions were never a “loan” and there isn’t a labor contract in the industry that includes terms on rates or principal that would make them so.

American has a first – at least in my recollection – in having all of its negotiations in mediation at the same time. United could be in the same place as date certain contractual understandings are in place to file for mediation in the event no agreement is reached. As for US Airways and the labor unions that have not been able to complete an agreement following the airline’s merger with America West, I have given up trying to apply logic to that situation. The damage done to employees is done and that was the work of the unions involved.

OhhhhhhBama – Release Me (And Let Me Love Again)

The Allied Pilots Association, which represents American pilots, has been on an ill-conceived, death-march strategy that the leadership somehow believes will get them closer to a release from mediation. Negotiations began in September 2006 -- a long haul by any perspective – but the clock was reset when a new union president, Lloyd Hill, was elected in June 2007. I don’t pretend to know the union’s strategy in these negotiations beyond what plays out publicly, but I do know that the Hill administration has made contract demands that are so far removed from reality that I question whether he is really representing the best interests of AA pilots.

With each union that files for mediation, my guess is the American pilots move yet another group down the pecking order for a release and thus the ability to engage in Self Help. The APA should be taking a clue from the Obama administration and its dealings with the UAW. The UAW’s Gettelfinger demonstrated a real understanding of that industry in balancing the interests of his members with the economic reality, in part by working to preserve wages and benefits of current employees by negotiating lower rates for new employees. But even that didn’t change the reality that, as the economy continues to collapse; the UAW is still not close to having moved far enough from work rules and wage rates that put the Big Three at a huge cost disadvantage in the global auto industry.

Finally, to the pilot leadership, I can’t imagine what possible benefit you would gain through strikes or other work actions that few airlines could survive. First, there is little chance the White House would allow a union at a carrier the size of American or United or Continental to actually go on strike and potentially threaten the economy’s ability to recover. No matter how labor friendly the new administration is, I believe that any union will need to make a pretty powerful case to the White House as to why a strike is more important than the recovery of the United States economy. Any union that can make a case that restoration of inflation-adjusted wages can be easily paid for by the airlines may have a chance, but that’s going to be a tough case to make.

I refer to the American pilots union in this example, but it applies to any large airline. Too much stimulus is potentially threatened by a strike in an industry as crucial to commerce as the airline industry.

Here’s my bet on where pilot contract negotiations will end up at the legacy airlines: With the Delta deal done under the leadership of ALPA’s Captain Lee Moak, the remaining negotiations will be completed in the following order: 2) Continental; 3) United (following the lead taken in the CO negotiations); 4) US Airways (assuming a final resolution to the seniority issues scheduled for the end of April); and 5) American (and perhaps only after a “leadership” change takes place.)

Congrats to Southwest for having put to bed their negotiation with multiple groups at reasonable rate increases. With little management distraction, the airline can focus on finding needed revenue.

Legislation

Finally, there are legislative issues important to this industry that deserves color in the upcoming earnings calls. First and foremost is a reauthorization bill that will fund the FAA’s activities. A committed industry must find a way to fund enhancements to the air traffic control system. Everyone in the industry recognizes the need to make changes. Now we’re just fighting over who will pay for them. It’s time to move forward and for the various factions to present a united front on "who will pay what".

Second on the legislative front is Oberstar’s bill to evaluate airline alliances every three years -- a clear attempt to make the formation of these alliances increasingly difficult. Never did I think I would write that former AMR Chairman Bob Crandall and Minnesota Congressman Jim Oberstar are on the same page regarding a controversial commercial issue, but I am - and I am even writing it in the same sentence.

In an interview with the National Journal’s Lisa Caruso, Crandall actually says: “In my view, an objective observer would have to look very hard to find a way in which alliances have benefited consumers.” His remarks point to the “dominance” of slots at Frankfurt and Paris by the aligned carriers. Is this any different than the structure "Crandall built" in the US domestic market where carriers were reluctant to offer service between the hubs of a competitor? Absolutely not. Instead, the competition offered a menu of one-stop competing services that presented the consumer a choice.

Are we not to acknowledge that the air travel consumer in Toledo benefited significantly from the Northwest – KLM alliance that offered seamless connecting service to Amsterdam and points beyond? Wasn’t it Crandall that coveted a partner in Brussels to partake in these very same traffic flows? Does Crandall really believe that Detroit and Minneapolis would have multiple non-stop services to Amsterdam if not for the alliance? Does Oberstar really believe that Minneapolis would have the international service to Europe it does without the network of KLM and now Air France on the other end?

Crandall even makes the point that the foreign carriers have been the beneficiaries at the expense of US carrier interests. Crandall is the one that brought the concept of time-of-day departures to the networks of the nation’s carriers. This alone has contributed to a significant amount of the uneconomic capacity that pervades the industry today. Do we really think that all of the departures that “Bob built” were good for anyone? If we did not have alliances to begin filling all of the ill-conceived capacity deployed in Crandall’s domestic network, then we would have even fewer US carrier domestic departures than we do today – even after all of the cuts.

For a guy I admired, Crandall’s comments leave me perplexed, confused and confounded. Some of his fixes are on point, like a changed labor structure. But Crandall should accept some of the blame for an industry struggling today as his pit bull instinct toward competition became a blueprint to build an industry too big. Or maybe he should explain to airline employees that his blueprint caused an industry to hire too many people that now believe they are entitled to wages higher than the industry can pay.

More to come on this one.

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Airline Labor Negotiations,

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Allied Pilots Association,

Monday

Mar092009

03.9.2009

Jim "Hell NO”berstar and Thomas K. Merton

Jim "Hell NO”berstar and the Fear Mongers; Thomas K. Merton and the Unintended Consequences

Saturday morning’s headline in the Washington Post read: “Job Losses Could Drown Stimulus.” The headlines in the Wall Street Journal read: “Jobless Rate Tops 8%, Highest in 26 years”. Getting the FAA Reauthorization bill moving toward action on the floor of the House, Congressman Jim Oberstar does the unthinkable. He attaches ill-conceived language to the reauthorization bill that would make it increasingly difficult for airlines to form new, or maintain international alliances to augment revenue –whether those airlines with applications for alliances now under consideration, or current alliances that must win anti-trust immunity every three years.

The FAA Reauthorization bill is, in and of itself, critical to commercial aviation. It funds many of the operations and projects necessary for the effective functioning of the nation’s airspace, and also includes monies to implement NextGen technology to upgrade the nation’s air traffic control system. In an industry in which all stakeholders will benefit from enhanced efficiency, NextGen is critically important.

But the current version of the reauthorization bill does not come close to making this a priority. Instead it is a bill that serves primarily as a vehicle for the amendments that Oberstar and his labor constituents find appealing, including funding for US-based maintenance and aviation repair facilities; an initiative to legislate the Aviation and Safety Action Program (ASAP); and language that includes key elements of the Passenger Bill of Rights.

As I read what the House and Congressman Oberstar are proposing, I started thinking back on my courses in economics and public policy. And in this case, the law of unintended consequences comes to mind.

In the Concise Encyclopedia of Economics, Rob Norton writes: “The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it”.

Some Background on the Subtitle

It was during the Delta-Northwest merger discussions and related testimony before Congress that I first began to pay close attention to Oberstar’s remarks and motivations. When asked if there would be any airline mergers, it was Oberstar who responded “Hell, no.” Thus my nickname for the Congressman, Jim “Hell NO”berstar.

Then it was the witness list of past critics of consolidation, including the Business Travel Coalition and others, who lined up to offer their “analysis” -- insisting that the world was coming to an end because the airline alliances would soon control over 90 percent of the activity across the Atlantic. It was this group that I dubbed the Fear Mongers. As the process continued, the one hit wonders were born.

Bands are often influenced by those that came before them. Unfortunately, “Hell NO”berstar and the Fear Mongers failed to acknowledge the sounds of Thomas K. Merton and the Unintended Consequences.

Thomas K. Merton

In a 1936 paper, American Sociologist Merton wrote the first meaningful analysis of unintended consequences in a paper entitled: “The Unanticipated Consequences of Purposive Social Action.” According to Wikipedia: Possible causes of unintended consequences include the world's inherent complexity (parts of a system responding to changes in the environment), perverse incentives, human stupidity, self-deception or other cognitive or emotional biases.

Merton listed five possible causes of unanticipated consequences:[3]

Ignorance (It is impossible to anticipate everything, thereby leading to incomplete analysis)
Error (Incorrect analysis of the problem or following habits that worked in the past but may not apply to the current situation)
Immediate interest, which may override long-term interests
Basic values may require or prohibit certain actions even if the long-term result might be unfavorable (these long-term consequences may eventually cause changes in basic values)
Self-defeating prophecy (Fear of some consequence drives people to find solutions before the problem occurs, thus the non-occurrence of the problem is unanticipated)

Of the five possible causes, ignorance and error are perhaps the most insidious. Oberstar has clearly demonstrated error in assessing the structure of the airline industry. Most recently, Oberstar insisted that the Delta-Northwest merger would lead to a domino effect of other mergers in the industry.

That certainly did not happen.

The Unintended Consequences

For whatever reason, the 8th District Congressman from Minnesota remains a loud voice on aviation issues. Perhaps, as it has been described to me, aviation is so far down the ladder that the industry is assigned the lowest common denominator when it comes to representation. When I compare the Congressional advocate voices of aviation to Congressional advocates like Bob Corker and the business acumen he has lent to the public policy debate on the auto industry, this airline industry is best described as suffering a leadership void.

In his analysis of Oberstar’s legislative objectives, Merrill Lynch analyst Mike Linenberg said: “The first major ATI agreement was implemented between Northwest and KLM in 1992 and became the basis for a major joint venture which as of KLM’s last fiscal year (ending March 2008) generated approximately $600 million of operating income on about $4 billion of revenue,” Linenberg said in commentary released on March 6: “The ATI agreement has been a huge positive for the growth in air travel to Minnesota (Northwest has a major hub in Minneapolis) and the company’s local employees, which, ironically are constituents of Representative Oberstar who hails from the same state.”

Linenberg continues: “Our view is that if airlines could operate like most other global industries and be allowed to pursue cross-border mergers, then there would be no need for alliances, and therefore, legislation like what is being proposed above would be unnecessary. But oddly enough, Representative Oberstar is also proposing another clause in the aforementioned FAA bill that would potentially make it difficult to achieve some of the foreign ownership objectives expected to be part of phase two negotiations of the U.S. – EU Open Skies Agreement.”

I am also reminded of a piece I read recently on American Airlines’ Negotiations website by Jeff Brundage citing the number of passengers American carries each and every day as a result of relationships with partners. Brundage writes that American carries 8,200 passengers each day from international feed, or enough to fill 73 MD-80’s. 73 MD-80’s represents approximately 25 percent of American’s domestic narrowbody fleet and approximately 15 percent of its total fleet. And this, despite the fact that American does not even have anti-trust immunity.

But if this is where we are headed, then organized labor’s mouthpiece Oberstar potentially causes employment in the industry to be cut yet again – not because of the price of fuel or a failing economy - but rather because of twisted logic being used in implementing public policy. The very thing Merton’s paper addressed in 1936. The Air Transport Association estimates that 15,000 airline industry jobs are at risk. I believe the number is significantly greater even before considering reprisals from the international community.

It is sad when all you can be is cynical when it comes to airline issues on Capitol Hill. In other words, let’s not make the most fundamental infrastructure architecture efficient because that might translate into an improved bottom line for the industry’s air service providers. Instead, let’s punish all things outsourcing even if it is in the best interest of a specific airline; and let’s be sure to legislate provisions from the Passenger Bill of Rights because that will surely aid all stakeholders.

Aviation labor, which has been a long time financial supporter of Oberstar’s campaigns, should be thinking long and hard about this. Unions are about dues-paying members. If Oberstar is successful in this effort, then labor may well have fewer members.

CONCLUDING THOUGHTS

It is true that the airline industry needs to get smaller just like banks and other far flung network-based industries in this economic environment. Past legislation and bad management-labor decisions have pushed the auto industry to the brink. Past legislation and bad labor-management decisions ensured that the US would be only a secondary producer of steel. If Oberstar wants to implement public policy that ensures that US commercial aviation is nothing but a feeder system to the more efficient global carriers, then public policy, like H.R. 915, should be passed. If labor wants fewer jobs as a result of their PAC contributions and inward thinking, then you succeeded in your lobbying efforts. But I am sure that is not how you will explain it to your remaining members.

At some point Oberstar and Congress must recognize the conflict of interest between consumers and labor. I thought the Obama administration is first about job creation, then job preservation. Not only does this bill work to reduce jobs it also has a detrimental effect on consumers as well through reduced service options, the loss of reciprocal frequent flyer benefits and increased costs to the consumer based on the failure to address issues fundamental to the industry’s success to name a few.

Ignorance, error and self-serving interests seem to be guiding aviation public policy yet again. Will we ever learn?

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FAA Reauthorization 2009,

Rob Norton,

Thomas K. Merton,

Unintended Consequences

Friday

Feb062009

02.6.2009

Disequilibrium Everywhere; Stimulus Nowhere

It will be clear soon as to why my writing time has largely been invested elsewhere.

I have been thinking about a theme for this post for a few days as I criss-crossed the country. I started considering “Pigs at the Trough” as a theme as I read story after story about the pork finding its way into the various versions of the stimulus bill. I then moved to something like, “For Organized Labor: Will It Be OHbama or NObama” as it pertains to the controversial “card check” legislation? Then it was something like, “And this Little Piggy Cried Wee, Wee, Wee All the Way Home” after reading about Jim “Hell NO”berstar introducing legislation to block additional immunization of airline alliances and explore ways to undo those that exist.

What a sad state of affairs this country finds itself in. What a sad state of affairs airline labor finds itself in . . . where union leaders have time and again failed to lead because they’ve put politics and self-promotion first rather than face hard truths and labor’s role in improving productivity and helping turn around the long decline of the domestic airline industry. What a sad state of affairs the US and global airline industries find themselves in because of patronizing, parochial protectionists like Oberstar whose antiquated, short-sighted views fly in the face of everything we know about the industry’s current financial challenges and competitive burdens.

I am not only disheartened but dismayed. There is plenty of blame to go around. Some goes to the airline executives that have returned to cutting fares in a misguided stimulus plan to fill seats – and too few controls on the number of cheap seats up for sale. There is little to “stimulate” when you consider that some major portion of historic demand for air travel was created by consumer access to easy credit – whether through the new Mastercard that arrived every few months in the mail or the willingness of Americans to take out a third home equity loan to finance yet another family trip to see Mickey Mouse.

By looking at the traffic, capacity and load factor data for January 2009 it becomes pretty clear that the aligning of supply and demand still requires work. Moreover, a realignment will have to occur in international flying as the economies in Europe and Asia particularly are sick and getting sicker.

What is it going to take to get the politicians – whether those in Congress or big labor– to understand that the US airline industry is headed down the very same destructive path that the US auto industry is headed? Many airlines did the right thing last year when, faced with record fuel costs, cut capacity and made some hard choices about pricing and costs. That was an industry that demonstrated discipline with conviction. But to work for the long term, capacity discipline must be practiced with pricing discipline too. After all, that is the theory at work with the industry’s too little, too late recognition that it is the revenue line holds promise for profits.

In my view, the system should have let the weaker airlines liquidate because, in the longer run, they aren’t strong enough to survive. Just look at US auto industry, which supports too many brands; has too much manufacturing capacity; carries legacy labor costs that can possibly be sustained only by a growing industry; and is modeled on an outdated demand curve built on cheap oil and readily-available capital.

The airline industry, too, has too many brands; too many hubs; a product priced below cost; and a high-cost, inflexible labor construct that limits a company’s flexibility and ability to adapt the size of the operation to economic realities. Current contracts and labor assumptions force airlines to pay nothing short of ransom to make necessary operational changes, and only because that is the way it has always been done. Just like the job bank provision in the auto industry.

To bet on a profitable 2009 just because of the price of oil today is, to me, nothing but an attempt to mine fool’s gold. I get the math..... On the other hand, liquidating an airline or two, and investing the proceeds in gold could be a proposition with some upside for airline shareholders.

The Virtuous Circle of Value Destruction is taxiing into position to prepare for a rendezvous with history – I fear.

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Capacity Discipline,

US Economic Stimulus Package,

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Saturday

Jan242009

01.24.2009

“South by Southwest”: A Theme of Mistaken Identity; Deception; or the Airline’s New Reality?

Hitchcock’s “North by Northwest” title offered no clue about the movie’s content either. It has even been said that it is an “anomaly and a clue to the absurd, confused plot where no one is who they appear to be.” “South by Southwest” is an anomaly at least from the growth story that has defined its corporate life. But a confused plot – no. It is nothing more than the reality this blogger has been writing and talking about for years. There are simply few profitable route opportunities even for those with very low unit costs. And nobody really wants to acknowledge it.

Three airline earnings calls down. More to go. The general consensus is that the fourth quarter of 2008 would result in deep losses as would the first quarter of 2009 largely due to “hedges gone bad,” as well as the fact that the two quarters define the shoulder season for this industry and the fact that demand in this new world is not fully understood. Jamie Baker, airline analyst with J.P Morgan, went as far as to say to a reporter: "Out of respect for our clients and managements, we do intend to show up for work during earnings season, in the event anything interesting should occur." Baker went on to say, "Our suspicion is that nothing will."

I have agreed with Mr. Baker on many points over the years. But I do not agree that this quarter’s calls are lacking in storylines. Items of interest have emerged from this week’s calls with United, American and Southwest that will prove important as 2009 unfolds. In fact, they may prove to be among the most important stories -- ones that dictate the evolution of the North American marketplace as we know it.

Cost per Available Seat Mile (ex-Fuel)

This year, non-fuel unit costs in a time of decreasing capacity will test management at all airlines. Managing unit costs of any kind, in any network industry, in a shrinking capacity environment challenges the best managers even in the most favorable economic conditions. Between United and American, we heard two very different stories.

United demonstrated excellent non-fuel CASM performance during the quarter, reporting that it will be able to manage 2009 costs at something less than a 3 percent increase. On the other hand, American pointed to sharply higher non-fuel CASM performance as its capacity shrinks further and underperforming pension assets add to the carrier’s numerator. For 2009, its non-fuel CASM is expected to increase more than 7.5 percent.

Yep, it is one thing to talk about managing unit costs at American and United – two carriers that have been forced to rethink many old operating practices as options for cost cutting dwindle. Yet, it is an entirely different thing to think about Southwest sans growth. I’m talking about the “G” word. Growth is the bedrock strategy that arguably has been the single most important component of the company’s ability to build – and maintain – its enviable culture and low unit operating costs. Growth does many things: moves a pilot from the right seat to the left seat; allows a flight attendant to have weekends off; and even masks cost mistakes in the short term.

A Redrawing of the Competitive Landscape?

A Southwest in capacity retreat – albeit only 4 percent worth – is a very different story than the one written between 2002 and 2006 when the carrier grew at the expense of the crippled network carriers. And it is a very different story than the one that sets Southwest apart from the industry’s competitors: its low unit costs, ex labor, ex fuel. Yes, its "hedges gone good" made Southwest nothing more than a "flying trading desk" since 2004, a carrier setting profitability records while on the Airline Growth Hormone (AGH). Now it is time for the airline to be something very different.

I admire Southwest CEO Gary Kelly. I, and others, acknowledge that there is no harder CEO Job in the global industry today because the storybook company must now remake itself just as the network carriers were forced to do. Southwest must undergo surgery as capacity shrinks. And it cannot do cosmetic surgery; it must do invasive surgery.

The Revenue Line

Southwest anticipated that it would have to begin a process of weaning itself off of AGH. Kelly has done what any good CEO would do in fully anticipating that cosmetic surgery was not an option. He and his team focused on the revenue line - and they have delivered good results. Despite Southwest’s dominance in frequency in the markets it serves though, the airline was still pricing itself more than 40 percent less than competitors in common origin-destination markets as early as 2000.

Since that time, Southwest has worked hard to increase fares as its cost advantage was eroded by the restructuring network carriers undertook – a restructuring forced in part by Southwest’s competitive challenge. I predict that Southwest will still be pricing fares well below its competition across its network for years to come. And therein lies the rub.

For a carrier that is so reliant on low unit costs to offset its historic pricing strategy (read: low non-labor unit costs,) a shrinking of capacity only makes the carrier’s job harder. As I have written and lectured, the carrier’s costs will only increase due to structural issues that define the few remaining markets without Southwest or low-cost carrier competition.

Tables Turning?

Much is being written about fares on the decline. While I am not happy to hear this, the economic headwinds and the need to manage revenue in the shoulder season probably drive pricing actions – even with significantly less capacity. So, let’s think about this from a different point of view.

For the past 15 years, Southwest has largely dictated pricing actions in the US domestic market. Yes, up until the late 1990s, the actions were mostly predicated on the carrier’s limited geographic presence. But today it can be said that Southwest is at least virtually present (including highway access) in US markets that comprise 95+ percent of domestic demand.

Southwest absolutely needs to raise fares – or find other revenue. The carrier can now be said to have a cost disadvantage - particularly its labor costs. The other carriers in Southwest markets can cross-subsidize their base fares with ancillary fees -- fees that Southwest has said it will not charge. My guess is that the network carriers are now setting the base fare price and are more than happy to decrease base fares to keep a non-hedged Southwest in detox as it gets treatment for AGH and the fact that it is no longer a flying trading desk.

Just Another Airline?

Of course, Southwest is anything but just another airline. But it is about to have to deal for the first time with issues that other airlines have struggled with for two decades, in many cases contributing to the undoing of their respective cultures. This is particularly true of carriers that had weaned themselves off of AGH in the late 1980’s, even when AMR’s-revered CEO Bob Crandall was preaching “time of day” service was the only answer to tomorrow’s success.

How does Southwest tell its workers that it cannot afford increases in its union contracts? Can it generate enough revenue to close its historic pricing gap? Can it even consider pulling out of markets that are economically challenging given its long track record of staying? Can Southwest be a US domestic player alone? Can it be only a US provider for international revenue sources? Can it actually reduce costs and restructure its operations without layoffs or other changes that threaten the culture it has built?

Concluding Thoughts

I have been on the other side of Southwest issues for years. So with all due respect to Mr. Baker, I think there is a hell of a story to come from the earnings announcements. A shrinking Southwest is a big part of that story– one that has the potential to reset the many arguments that have been used to demonstrate US domestic competition. In fact, it potentially resets many myths surrounding the US’s most luved carrier.

Finally, maybe finally, the story will read that the network carriers are responsible for driving down fares and promoting competition as capacity goes “South by Southwest”. How do you think Jim “Hell No”berstar and the Fear Mongers will feel about that?

Much more to come.

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Alfred Hitchcock,

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Hell No,

Southwest Airlines,

United Airlines,

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Friday

Nov072008

11.7.2008

The Dinosaurs Are Extinct ... Right?

You would think that in a week with this much news, I could find something to write about. Obama is elected. General Motors' October sales fell by 45 percent. GM loses $2.54 billion in the third quarter. A legacy industry seeks government help. US Airways bolstering liquidity through deals with the same regional partners that...

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Continental - United Alliance,

Delta-Northwest Merger,

Obama's Secretary of Transportation

Monday

Sep152008

09.15.2008

Dear Richard: You Are Not a Virgin Anymore

But fundamentally, today’s airline industry is about networks and not city pairs. It is a simple fact that oneworld cannot sit and watch STAR and SkyTeam grow anymore. Air France/KLM and Lufthansa/Swiss have grown into the world’s largest revenue producing airlines. Delta and Northwest will alter the ranking once their merger is approved but that will probably only last as long as it takes Lufthansa to get its hands on SAS and/or Austrian. Branson mentions his thirst for British Midland (BMI) and its extensive LHR slot holdings, but what about Lufthansa’s option on those LHR slots? Surely Richard you are not implying that with meaningful STAR alliance presence at LHR a oneworld monopoly would exist?

At what point do we take you serious?

So go paint your airplanes and while doing so recognize that Willie Walsh is right. He said broken record and I will not take a shot at another of your brands. What I will say is that your arguments are not virgins anymore and maybe you should be writing letters to Oberstar rather than McCain and Obama. If you write to McCain and Obama, the subject should be about changing the ownership laws that stand in the way of allowing the industry to become the global industry that rewards world class competitors like Virgin Atlantic. Because the large and small can cohabitate and as you say, make competitors even better competitors.

Unless you recognize that 1997's arguments need to change the third time around, thanks for nothin’.

The Reality Show Called Airlines

The Biggest Loser(s)

Reality shows have become a fixture on American television. Like them or not, the ratings of many are hard to ignore. So at a time when US carriers consider whether charging by the pound would be good practice, the title today seems appropriate. 2008’s second quarter comes to a close today. Red ink will again be the color to describe the financial results for the US airline industry. Red will also be a color prevalent in calculating changes in liquidity positions for many of the US carriers.

Red should also be the color of the faces of analytical team employed by the Business Travel Coalition as they made public their latest of a long list of scare tactics. It is has been nice to see other bloggers and observers make their views known regarding the information and “analysis” that has been emanating from this group. There are many smart observers of this industry. To even allow BTC’s latest missive find its way from the idea table is head scratching enough. To allow a piece into the public domain without the supporting data and analysis underlying the “findings” is even more bothersome.

My guess is the BTC’s leader is nothing more than a pawn for Jim “Hell NO”berstar and the socialist ideals he thinks are best for the US airline industry.

Closer To Another Method of Treatment, Than A Cancer

Many times I have written about Willie Walsh, British Airways’ Chief Executive and his views on US regulation and its hindrance to the natural evolution of the global airline industry. Today, Mr. Walsh’s views were expanded upon by Martin Broughton, the Chairman of British Airways PLC in an interview in the Wall Street Journal by Daniel Michaels. Some of Mr. Broughton’s comments that I found to be spot on are as follows:

· An eventual relaxation of US airline-ownership rules would spark a world-wide wave of cross-border deals over the next five to 20 years. That would help the troubled aviation sector function more like other industries.
· Mr. Broughton still sees it [US – EU Open Skies Phase I] as a lousy deal because it opened Heathrow, but only opened a small crack in the US market for EU carriers.
· Mr. Broughton hopes economic pressures will do what diplomacy couldn’t. It could be the financial exigencies of the day that finally make for a breakthrough.
· In Europe he cites two cross-border mergers that have shown the potential of multiairline groups: Air France/KLM; and Lufthansa/Swiss. In Latin America, he cites the tremendous success of Chile’s LAN Airlines SA. In Asia he points to the success of Kuala Lumpur-based budget carrier Air Asia.
· Mr. Broughton points to the frustration of Lufthansa’s Chief Executive Wolfgang Mayrhuber with airline-ownership limits. He quotes Mr. Mayrhuber as saying this industry shouldn’t be treated like railroads. It should be like car makers or chemical companies and operate globally.
· Mr. Broughton called America the biggest impediment to relaxing the aviation industry’s ownership and nationality rules. He suggests that if you break US resistance then you have made a big breakthrough on a global scale.
· Broughton believes that financial considerations may soon overtake nationalistic ones. He suggests that even labor should welcome the changes because foreign investment is investment and that is something US carriers have lacked in recent years.

So as we carefully dismantle/deleverage the last 30 years of network architecture as a method to discover individual carrier’s profitable cores, I long for the day when we begin to grow again whether organically or through other means. The combinations cited by Mr. Broughton are those carriers that are leaders in a global context as far as return on invested capital; growth in virtually any measure; and in market capitalization. Moreover they are proof of successful models of cross-border combinations that are producing the right kind of returns for many stakeholders, not just a few.

US Airlines and Portfolio Theory

Attributes of a successful US airline industry are no different than an individual investor or a portfolio manager. Instead of diversifying a portfolio of financial assets, airlines hold a portfolio of routes. Modern Portfolio Theory (MPT) proposes how investors will employ diversification to optimize their portfolio of assets. The model that proposes this diversification assumes that investors are risk averse meaning that if the expected rates of return on two separate investments are equal, then the investor will choose the one with the least risk. On the other hand, an investor will not accept more risk without a commensurate increase in the expected rate of return.

Parochial-thinking lawmakers, regulators and aforementioned observers somehow think that the US airline industry should continually accept more risk all the while accepting a commensurately lower expected rate of return largely driven by policy -- all in the name of competition I guess. For the largest US carriers, the portfolio is simply made of up too many domestic routes. This is how you can characterize the first 30 years of deregulation. Now it is time to break the boom and bust cycles that have characterized this industry.

During the down cycles: Unhealthy competitors remained due to high barriers to exit; new entrants emerged, because of the very low barriers to entry, looking to exploit weaknesses; leading one to argue that this has led to the overcapacity situation that will begin to be addressed immediately after Labor Day. Compounding the “excess capacity” issue, the airline industry emulates other capital intensive, commodity industries by over-expanding during the up cycles.

Surely the Naysayers Recognize that Something Is Wrong?

So here we sit. With nowhere to run, nowhere to hide, and few options to find new capital to invest in a lacking product that will require the consumer to pay more for as a result of high oil prices over the coming months – it will get interesting. Moreover, the consumer will surely have an expectation that increased prices sure as hell better produce an improved product.

I like the idea of foreign capital for this very reason – the need to invest in product that facilitates a new cycle where the ultimate US flag bearers in the global industry begin to differentiate themselves from the local service carriers (formerly called Republic, Ozark and Western) – or today’s equivalent (Southwest, jetBlue and AirTran) – tomorrow. But if I had capital I would not make that investment without commensurate voting power either.

So over the next 12 months or so, it will be interesting to see just who gets voted off of the show.

Pondering the Next Move; But Before I Do…….

Wednesday’s Hearings: “Forgetting About History”

If there is another “something” in the works, surely no one really believed that anything would be announced before yesterday’s House hearings on Delta – Northwest? Jim “Hell NO”berstar was anything but “Hell No” in yesterday’s hearings. To be sure, he was anything but Hell Yes. He seemed to save his “powder” for the testimony of the Departments of Justice and Transportation. But even that was dry and in the end about all we could do was “take heart” that the investigation would be thorough.

I am not one that is going to give a protectionist much slack. But I kind of felt sorry for him when it became clear that he had not quite grasped that Phase I of the US-EU liberalization deal was in effect and that all six US legacy carriers could fly to Heathrow. But where I really struggled was with the continued pointing to American Airlines and their purchase of TWA’s assets. Remember, not a merger but rather, an acquisition of assets. There was much discussion about how St. Louis was reduced from 500 flights per day to 250 flights per day.

When American made the decision to purchase TWA’s assets, congestion was the rule/industry fear of the day. The “Summer from Hell”, or the Summer of 2000, was in the books. Chicago O’Hare was in the headlines most days during that summer. Delays in Chicago were either based on thunderstorms or Rick Dubinsky choking the golden goose. From American’s strategic perspective, St. Louis could potentially be that reliever of congestion in Chicago as connecting traffic is well connecting traffic and can be accomplished in either city.

But “NOberstar and the Fear Mongers” sang the tune that American sat in the very same hearing room and vowed to keep St. Louis whole. We heard it over and over. If we forgot about Phase I being in place; surely we did not forget about September 11, 2001 and the effects it had on the US domestic airline industry in general and the network legacy carriers specifically. Yes, St. Louis was downsized and most non-hub flying was eliminated. Pittsburgh was carefully eliminated. Atlantic Coast died under its own lack of weight. And an over-exhuberant industry replaced mainline flying with regional flying.

St. Louis was a dying hub. McDonnell Douglas was gone. Its local economy was built on reputation and not on strong underlying economic attributes. American made the only decision that was in its best corporate interest. Remove capacity from a weak point and focus on a strong one – Chicago. Nuff’ said.

Pondering the Next Move

My guess is Jim “Hell NO”berstar is keeping his powder dry until the next move is announced. The next move will face more intense scrutiny based on the “I told you so” line that was most prevalent yesterday. Honestly, I do not know of another deal scenario that is interesting – let alone transformational – and provides the kind of investment thesis that helps this period come alive.

We have United and US Airways merger discussions being tossed around by “those close to the situation”. Now we have a United and Continental alliance in the news. Readers know I like what Tilton says as he talks about the industry from 40,000 feet – and I am in fundamental agreement that the current construct is good for no stakeholder group.

If I lean to one of the two scenarios being painted in today’s mainstream press, I lean to a United - Continental alliance. Gravity takes me there because it differentiates the combination from Delta and Northwest. Delta and Northwest individually, and collectively, are/will be highly reliant on connecting traffic as their hubs are located in smaller population centers. [And this is why their commitment to maintaining the most extensive network possible is absolutely factual] United and Continental would be building around hubs/gateways where core onboard traffic would be largely local.

Now, I understand that the transatlantic onboard traffic mix can be different based on other competitors in the market. We do not have to look much further than Washington Dulles and the fact that Lufthansa carries more Washington local traffic to Germany and beyond than United. United’s airplanes are filled with more behind and bridge traffic based on the connection to its US domestic network at Washington Dulles.

But doesn’t this also suggest intra-alliance competition for traffic that is being bastardized by comments from the fear mongers that the transatlantic will soon face a scenario where barriers to entry are much too high?

LIQUIDITY AND SOUTHWEST AND UNITED

Over the last couple of months, this blogger has written about how liquidity will be back in the headlines just as it was following the events of September 11, 2001. American has looked to relax fixed charge covenants. Delta and Northwest are looking to a combined balance sheet. United has worked to relax covenants in its loan agreements. US Airways balance sheet is actually in pretty good shape for the moment. Southwest recently borrowed $600 million against owned aircraft to bolster an already strong liquidity position. jetBlue has sold aircraft and sold equity to Lufthansa to bolster liquidity. AirTran has sold delivery positions and just completed a convertible to bolster its liquidity. And the market yawns.

Holly Hegeman of Planebuzz.com asks the question: PlaneBuzz: Follow up on Southwest Nuts: Why Do They Need More? If she had not written before I had a chance, I would have asked the same question but probably not as eloquently. Me thinks, Southwest plays a meaningful role in the next move. These guys – and sorry Laura – are smart. Based on their model, there are just simply not many markets left in the US.

Now, I have no clue as to what the plans are – or if there are any - as I am not a source close to the situation. But I am willing to bet that the next move involves Southwest purchasing assets. Whether they are Washington National assets; Laguardia assets; or something else they are the only name that can assure “NOberstar and the Fear Mongers” that competition will remain robust. If Southwest is involved, the strategy is brilliant. And I am not one that will discount Tilton.

I am the guy that has lived a life liking and rooting for: Illie Nastase; Jimmy Connors; Derek Sanderson; Craig Stadler; well you get the picture.

As I have said, this time is cruel but it will lead to something better. Simply because the current construct just does not work for anyone. So for the consumer groups: you will pay more and it is not because of a changing industry structure, rather it is an industry that must simply charge at least as much as it costs to produce the product. And for labor, the best bet to recapture what you think is entitled is to bet on the future. It just might be good.

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Thursday

Mar132008

03.13.2008

Just Wondering, Or Am I Wandering?

A Few Issues in the Press

1. With the Euro reaching an all time high relative to the dollar yesterday, how will this impact international travel? Can the potential loss of US-origin customers that now deem an EU trip unaffordable because of the currency relationship be offset by EU-origin demand that will find the US cheap?

a. Headline in today’s Wall Street Journal: "Lufthansa Expects Growth in 2008". As the company’s net profit doubled in 2007 v. 2006, the company cites its broad business model that includes aviation services, catering, airports and other areas as a mitigation of downside macro risks. For the US, that might mean increasing the foreign ownership limits?

2. In late 2007, United warned of the potential to “put down” as much as 10 percent of its capacity if oil prices stayed above $100 per barrel. Well, yesterday oil actually traded over $110 per barrel. The $100 price point has become a level that most oil watchers expect to be sustained. My question for the politicians is: will there be more industry capacity removed as a result of oil prices or consolidation?

a. My suggestion to the "know all" politicians: Be very careful for what you say no to.

3. Yesterday, Jamie Baker of JP Morgan downgraded the US airline industry for all intents and purposes. Terry Maxon of the Dallas Morning News blogged on Baker’s research note that suggests a best case scenario, based on current oil prices and a minimal demand loss due to an economic slowdown, is for the US industry to lose $4 billion. The worse case scenario calls for an industry loss of $9 billion.

a. So much for the robust, and sustainable, industry turnaround we hear from labor leaders and others.

4. Speaking of labor, Baker makes a very powerful point, and one that I have used a number of times. He says that since 2002, the industry’s fuel cost will have increased in the neighborhood of $25 billion. This contrasts with his estimate of labor savings over the same period of $7 billion.

a. Will we ever hear the end of the refrain that the industry recovery has been built on the backs of labor? First, and again, what recovery? Then, and again, what is the industry’s ability to repay that $7 billion? This just underscores what will prove to be the most difficult labor negotiations cycle since deregulation.

5. As if the industry needs more weighty issues to test its resolve, the story at Southwest over maintenance practices is most troubling. I am in no way going to suggest anything regarding this situation until all of the facts are known. But, this story will not be going away for awhile.

a. If the economy can be expected to have a dampening effect on demand, will concerns over maintenance have a compounding effect?

b. Jim “Hell NO”berstar gets yet another bully pulpit issue.

6. On another labor issue. I find it interesting that, included in labor’s chants against consolidation of the industry it says it will be looking out for its members (OK, that is their job) and the traveling public?

a. I guess the threats from labor of a strike, or a slowdown, are beneficial to the consumer because the system can quickly reaccomodate demand and there will be minimal disruption to the affected consumer? NOT

7. Yesterday the Continental pilots rallied in Battery Park along with other ALPA carriers and independent unions to call for the repayment of the concessions that the Continental group calls a loan made to the company in 2005.

a. What loan? Did you negotiate terms like those negotiated when money is borrowed?

b. Isn’t it ironic that the labor groups chose Wall Street as the venue for their rally? There must have been a lot of sympathetic observers given that Wall Street employees largely rely on variable earnings to comprise their total compensation and not fixed rates of pay? Oh I digress.

8. The Allied Pilots Association have told us many times and through many different mediums that just a modest increase in passenger fares will pay for one of the most outrageous asks made by a union of a company in my career. NOT

a. In the face of current oil prices, at what point do “pass throughs” of increased fuel costs negatively impact demand? At what point do the US macro economic issues negatively impact demand as consumer disposable income is negatively impacted from a long list of possible reasons?

b. If demand begins to weaken, I do not think fare increases will be the tactic employed by the industry to address the issue.

b. Maybe the CR Smith Museum should be enlarged rather than being refurbished?

9. Politicians and labor should think real hard about the fallout that could stem from the current economic environment versus what the perceived fallout could be in a consolidation scenario.

More to come.

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Wednesday

Feb272008

02.27.2008

Time Well Spent; Unchanged Catalysts to Consolidation; and Concerns Surrounding the Delta – Northwest Deal

Time Well Spent

A significant amount of my career has been spent participating in labor negotiations surrounding a distressed situation. There are two principles I always adhered to when advising clients: 1) you can always make a bad deal; and 2) strive to make a deal where either both sides are happy or both sides are unhappy because in both scenarios that probably means you have negotiated the best deal possible. Trying to avoid a scenario where one side is happy and the other side unhappy means you have negotiated a bad deal – and that is precisely what Northwest and Delta are trying to avoid.

Justin Baer of the Financial Times writes an excellent piece describing why seniority is critical for pilots. So it is important to understand just why these discussions are taking so long. Given that we are more than 20 years from the US industry’s last round of consolidation involving multiple carriers, pilots recognize that decisions made today will more than likely impact the majority of their remaining careers. But the always thoughtful and insightful Liz Fedor of the Minneapolis Star Tribune raises the specter of a negotiating clock. Another important negotiating rule is that it is hard to negotiate without a deadline.

Whereas many journalists and pundits are suggesting that the end is near in these negotiations, and as a result the much discussed deal will die, I am not one of them. Ms. Fedor in her opening paragraph writes: “A veil of silence has encircled the pilot leaders at Delta Air Lines and Northwest Airlines who are struggling to integrate their seniority lists -- the lone impediment to a merger announcement”. So why is this important? I typically read no talking as a positive sign. And the only people I have heard say Hell No to this deal before seeing the details is Congressman Jim “Hell NO”berstar and members of his staff.

I am an open proponent of change. I am an opponent of closed mindedness. One of the big points that I think is being missed: if there is concern over a political clock running out to get regulatory approval, then weeks spent today could possibly save months gaining regulatory approval for the deal tomorrow. In concluding her piece, Ms. Fedor raises this very important point that I have not seen written elsewhere as well: “If an agreement is negotiated in advance of a merger announcement, the two pilot groups also would be expected to be political allies for a merger during a regulatory review in Washington”.

The Catalysts to Consolidation Remain Unchanged

This morning, William Greene, analyst at Morgan Stanley writes a research note referencing the widely covered internal Delta memo to employees yesterday. The text of Mr. Greene’s note follows:

Delta Air Lines, Inc.
Quick Comment: CEO Memo Does Not Change Our Views

Impact on our views: The Delta CEO memo made public on Tuesday highlights the difficulties involved in completing airline mergers. That said, we still believe a deal is possible near-term for 2 reasons: (1) Oil prices at $100/bbl and a slowing US economy will keep the pressure on major airlines “to do a deal” and (2) the very substantial pay increases and equity ownership that labor stands to receive should a deal happen will increasingly put pressure on labor leaders to find common ground on seniority issues. Moreover, the economic arguments supporting consolidation are as compelling today (if not more so given the macro backdrop) as they were 6-12 months ago.

What's new: On Tuesday, Delta released a memo from CEO Richard Anderson to employees that outlined guiding principles for Delta in the event of a merger. The memo is intended to allay concerns that Delta employees have regarding a merger. Key concerns for employees include: seniority, job security, career growth and maintaining pensions. The memo indicates that any deal must satisfy these key concerns and a deal that does has not yet been attained (see memo on next page for more details).

Investment thesis: We maintain an Overweight-V rating on DAL primarily due to the company’s positive stance toward consolidation and good position vis-à-vis our key themes (market exposure, strategic actions, and labor risk). We also see relative value in DAL, although we note that we see the group as a whole as overvalued on an absolute basis at current oil prices. This is one reason we continue to recommend that investors sell into strength on news of consolidation. Should the stock run sharply higher from current levels or if the outlook for consolidation changes dramatically, we may need to revisit our rating.

Concerns – And Yes I Have Some

In a post earlier this month, I asked the following question regarding a labor leader’s decision making whether to support a deal or not: is the implementation risk of a merger deal (seniority integration, single collective bargaining agreement etc.) any greater than a leader having to manage the expectations of any employee group that actually believes they can make themselves whole in the next round of Section 6 negotiations?

While I understand the Northwest pilots are not prepared to sign on just because they would work under Delta rates of pay on the day following consummation of a deal. But doesn’t the question beg, as far as career earnings are concerned, just how much would pilots earn at Northwest if the company were to remain a stand alone entity? What are Northwest’s 20 year growth prospects? Will Northwest be able to duplicate organically what it would get fairly quickly in a deal with Delta? Will labor have any better opportunity over the next 5 years to do any better by their members?

Only the Northwest MEC can answer these questions. Where I am concerned is that the Northwest MEC is being advised by counsel in the Northwest – Republic seniority integration and in the most recent US Airways – America West pilot seniority integration (also reported by Ms. Fedor). By now everyone is aware that there are few, if any, success stories in either of these two cases. I just hope that decision making is not being clouded by the prospect that somehow past wrongs can be righted through this deal. But only those that know, know.

So hopefully either all will be happy or all will be unhappy. Otherwise just go ahead and say "Hell No". At least someone will be happy.

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