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.   

Pondering Southwest’s Potential Play on Frontier

By a multiple, the most widely read swelblog.com post ever read was the piece entitled: Is Republic Changing the Face of the US Domestic Market? I wrote the piece thinking about the regional carrier holding company’s play for each Midwest and Frontier. In that piece, I suggested that technology was a, if not the, most important attribute supporting Republic’s decision to make the play for Frontier: “Now Frontier provides Republic with something it previously lacked: a technology infrastructure that gives it long-term viability in the market. A technology infrastructure not tied to a legacy system.”

Most importantly, the technology would give Republic the opportunity to begin selling tickets directly to air travel consumers, something it does not and cannot do today.

Last week as I was walking off of the eighteenth green at the storied Butler National Golf Club in Chicago with dear friends Jack Ginsburg, Pete Robison and Ro Dhanda, I turned on my iPhone and noted dozens of messages. The news had just broken that Southwest Airlines was considering upping the ante over Republic and will prepare its own bid for Frontier.

For Southwest, the Best Offense Is a Good Defense

History is not clear whether someone actually said that the best offense is a good defense. It is believed to be a misstatement of a quote attributed to Carl van Clausewitz, military strategist and the author of On War, a book, published in 1832, that was required reading for me in a graduate school marketing class. Clausewitz was quoted as saying the best defense is a good offense. Either way, Southwest’s motives for this deal had me thinking.

If Republic is successful in gaining control of Frontier, it would produce, overnight, a new and potentially threatening competitor to Southwest’s domestic dominance. This past April, I made a presentation to the 34th Annual FAA Forecast Conference entitled: Cost Differences Suggesting a New Mid-Term Structure. There, I warned of the difficulty of analyzing cost differences between carriers, particularly in light of Southwest’s unique influence on the market. I believe it is now wrong to include Southwest among the group traditionally known as “low cost carriers” because its sheer size distorts the results. It was clear to me then, as it is more so now, that Southwest is losing the significant cost advantages that have historically been its primary competitive weapon and driver of its organic growth.

My analysis relied on MIT's Airline Data Project. When I prepared the analysis for the FAA Conference, final fourth quarter 2008 data had not been filed but has now been updated. The story remains the same. In order to make an apples-to-apples comparison of cost per available seat mile, adjustments must be made.

First, transport-related expenses (largely the fees paid to regional carriers for capacity) must be removed as there is an offsetting revenue account. Second, fuel cost per available seat mile should be removed as varying hedging strategies make for distorted comparisons. This is particularly true of Southwest where I estimate that its fuel hedging strategy accounted for 53 percent of its cost advantage versus the network carriers for the first nine months of 2008.

I also compared unit costs of the network carriers (American, Continental, Delta/Northwest, United and US Airways) to Southwest and a group of carriers I refer to as Midscales (AirTran, Frontier and jetBlue). Absent removing transport-related and fuel expenses, Southwest has a cost advantage versus both groups of carriers –in the case of the network carriers, a 6.4 cent advantage. When transport-related expenses are removed, then Southwest’s cost advantage is nearly halved. When fuel expenses are removed, the advantage versus the network carriers shrinks to 1.6 cents.

Now consider this: When transport related and fuel expenses are removed Southwest has a cost disadvantage versus the Midscale group. Just imagine what Southwest’s cost disadvantage could be if Republic were to get its hands on Frontier? Southwest non-labor costs are the envy of any carrier, and it still has an advantage versus the network and Midscale carriers. But Southwest now has a labor cost disadvantage against those carriers. In fact, the unit labor costs of the Frontier, AirTran and jetBlue sub grouping are nearly a full penny per seat mile lower than the unit labor costs at Southwest. Pennies in this instance can quickly add up to tens of millions of dollars in cost to Southwest when competing directly.

Adding To the Speculation

Many observers already question whether Southwest would be adding to its burdens and its costs in acquiring Frontier’s airplanes and thereby introducing different aircraft to its famously one-sized-fits all fleet. That can be addressed.

Can the labor issues also be managed? In my view yes, even if that means Southwest buying labor’s favor. Independent unions represent the pilots at each airline, so the always-difficult task of integration would be made easier by the fact there is no national union constitution and bylaws to deal with. Frontier, through its bankruptcy, has moved toward more maintenance outsourcing and that fits Southwest’s current model. And because the Frontier flight attendants are not unionized, there are minimal labor hurdles there.

No doubt, the financial transaction would be accretive to whichever airline ends up making the play. I believe, though, that the most value from Frontier would be garnered only by another airline that could leverage its assets - a local market following and its IT platform – not by financial players that won’t see the same advantages.

Frontier would provide Republic a tremendous opportunity to transform not only itself but the US domestic market. For Southwest, the Frontier play is not so much transformative as it is defensive, by:

1. Removing a local market competitor for a company struggling to find new markets (and there are no profitable 3-carrier markets in today’s revenue environment)
2. Providing a solid technology foundation and expertise in value-added pricing
3. Thwarting future competition by ensuring that Republic remains a capacity provider to the nations’ legacy carriers – at least in the near term.

Ding: The “Southwest Effect” is Dead

The Denver market is unique in that there are few alternative modes of transportation that can compete with air travel because of sheer distances in the western US. Boulder, Colorado Springs and other surrounding cities’ traffic already access the air transportation system through Denver. The truth is today’s stimulation is largely diversion from another market or another carrier.

Many point to the pain a Southwest takeover would impose on United. But there are two sources of traffic: local and connecting. United runs a large connecting operation in Denver. Onboard United airplanes is a traffic mix of 1/3 local passengers and 2/3 connecting passengers.  On the other hand, each Frontier and Southwest are highly reliant on local passengers.  Before we count United dead in Denver as a result of this combination, this fact needs to be examined. 

Fares for local traffic in the Denver market are largely dictated by the competition between Southwest and Frontier. Publicly available data would show that nearly half of Frontier's traffic at Denver is local and Southwest's is near 70 percent. Therefore which direction do you think fares will go if Southwest is successful in taking out an important competitor for Denver local traffic? And after reducing certain duplicative Frontier capacity?  Southwest’s fares will prevail, even though Southwest is not always the low fare provider in each market.

Southwest Showing Its Age

Southwest built its Denver operations quickly at a time when Frontier’s future was in doubt and United was struggling. As Southwest’s organic growth slows because of the anemic revenue environment in the US domestic market, then buying the carrier that competes largely for the same local traffic makes good sense. With a cost structure that no longer sets them apart from the crowd, it is clear why Southwest continually talks of the need to augment its revenue streams.

To be fair, some will say that analysis of Southwest’s cost advantage shrinkage is flawed because it does not account for stage length -- the length of the average flight. But in comparing one airline’s performance and costs to another, adjusting for stage length is somewhat arbitrary.

Rather, what is most important is the relationship of [system] cost per available seat mile to [system] revenue per available seat mile. It is this relationship that finds Southwest struggling at Denver where load factors have been in modest decline as the airline has grown and has been increasing fares from the carrier’s initial offerings. The net effect has been a modest decline in RASM - as CASM has been increasing.

The network carriers are challenged in this regard because of the black revenue hole created by the downturn in first and business class travel on international routes. Just as the network carriers have to adapt for shrinking revenue relative to costs, so does Southwest – without the magic of stimulating a mature market replete with competition from low cost and network carriers alike.

Southwest just celebrated its 38^th birthday. It is a mature and maturing carrier operating in a mature domestic environment where it is no longer an innovator. What I find most interesting in Southwest’s potential bid for Frontier is that the carrier is being forced to act just as the network legacy carriers. Southwest is seeking a consolidation scenario that could and should lead to an improved revenue line in Denver where it has significant capacity deployed and where Frontier, a beloved (not LUVed) carrier in the region is all but assured of emerging from bankruptcy protection with its loyal local following in tow.

Keep tuned. 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 Frontier would lower airfares in the Denver region.

Funny how things change.

Is Republic Changing the Face of the US Domestic Market?

On June 22, Reuters reported that Republic Airways Holdings Inc. (RAH) will sponsor Frontier Airlines’ exit from bankruptcy, noting that the “US regional carrier” would pay $108 million for 100 percent of the equity in the reorganized entity. The next day, Republic announced that it will buy the remains of Midwest Airlines for a mere $31 million (only $6 million in cash), from TPG, the private equity group that has had some success in the US airline industry. While the story got some play in the mainstream press, the possibilities are much bigger than many may realize.

Think About It

Prior to these announcements (and keeping in mind that the Frontier deal is subject to Bankruptcy Court approval), Republic Airways Holdings was soley in business as a provider of “regional airline” capacity. The holding company offers potential purchasers three brands: Chautauqua Airlines, Shuttle America, and Republic Airlines. Under this model, Republic Airways Holdings operates under the flags of its contractual partners, including United Express; US Airways Express; Delta Connection; AmericanConnection; and Continental Express. Therefore it has its fingers into each of the five legacy carrier networks

RAH’s CEO, Bryan Bedford has been in this industry a long time. And he is smart, really smart. Bedford makes this move in an environment in which it is increasingly clear that the legacy carriers do not – and cannot – now operate under a cost structure that will support the number of airlines trying to survive in the hypercompetitive domestic US airline business.

Through May of 2009, airlines have cut capacity another 11 percent. At the same time, passenger revenue is down 21 percent versus the first five months of 2008. When compared to the heyday of 2000, mainline capacity is down 28 percent in the domestic market and passenger revenue is down 33 percent. Despite all of the work done by the legacy carriers to reduce costs – whether through the hammer of the bankruptcy court or not – these revenue trends illustrate an industry all but unsustainable in its current form. And while much has been made of the shift of capacity from domestic to international markets, those revenue trends are even worse in recent months.

Back to Republic

So what‘s behind Republic Airway’s maneuver? Consider this. Chautauqua is a carrier with relatively senior workforce and a fleet that offers little in terms of improvement in technology or scale. Shuttle America is much the same. And parts of Republic Airline’s fortunes are tied to United and US Airways where it operates the latest and greatest 70-seat technology. Happily for Republic, no other carrier is better positioned to capture this flying, in part because it owns its fleet rather than leases it from its mainline partner.

RAH’s structure allows it the necessary flexibility to provide a range of services for a range of clients. It has the flexibility to move from one segment of the business to another. The holding company is designed to work around pilot scope agreements. Nobody does it better. As a result, Republic and Bedford have built a business that provides them with a capital base that allows them to “pay to play.”

Indiana Hold 'em

Bedford “played the river” and now, in this observer’s view, has won enough chips to move to the final table. Providing debtor-in-possession financing is among the safest bets in restructuring. It results in little to no loss of capital in return for increased business. The result is a widely diversified portfolio of flying at increasing revenues as aircraft have gotten larger. Based on the cash flows, Republic has a fleet of aircraft well suited for tomorrow’s US domestic market. For Republic, the next move is building fleets in the 90-120 seat range and that will only augment its cost advantage.

The Frontier Card

Now Frontier provides Republic with something it previously lacked: a technology infrastructure that gives it long-term viability in the market. A technology infrastructure not tied to a legacy system. Today’s “regional carriers” are merely a wet lease of capacity to fly to small markets where mainline aircraft and crews cannot operate economically. They don’t sell tickets. Their purchased capacity merely moves people onto a mainline aircraft at a hub. With Frontier, Republic could change the game.

When it comes to changing the way consumers buy airline tickets, few see Air Canada as the bellwether - they were. But Frontier’s CEO, Sean Menke, came from Air Canada and brought with him the concept and a blueprint of giving consumers a choice of the services and amenities they want at a price they were willing to pay. There, he was recently joined by Air Canada’s Daniel Shurz, a marketing/strategy visionary wunderkind who has further strengthened the Frontier management team.

Frontier may well be the next new thing in the market. It’s not the Independence Air model or just another regional carrier. It is tomorrow’s solution for outdated domestic capacity. Bedford could now buy an Airbus fleet for a song. Bedford could now buy Milwaukee at a bargain. Who cares about Milwaukee? Only Southwest and AirTran and each and every legacy carrier that depends on Milwaukee traffic to feed operations at their hubs.

Imagine This Scenario. . .

1. Republic continues to collect revenue per departure for the feed it provides to each of its five current clients.
2. Republic maintains a financial interest in cities with three carriers trying to maintain or obtain market dominance. There is little evidence to suggest that many cities can support three aggressive carriers vying for market share. It’s been tried at DEN and it sure as hell cannot work at MKE.
3. Come Fall, as mainline carriers realize that previously announced capacity cuts are not sufficient, they turn to Republic and attempt to renegotiate their contracts. Republic says “Hell No” and instead makes a move to turn to develop its holding company portfolio into an airline that will compete for the very same traffic.
4. Maybe it then becomes apparent to one of those competing airlines that flying to DEN– largely reliant on feed traffic –no longer makes sense and it negotiates with Republic to replace its capacity there? Certainly, labor issues abound, but economic realities could prove persuasive.

All of this comes at a time of seachange for the big players in the US market. Ultimately, there is little left for the legacy carriers to restructure. There is no way to restructure zero demand. There is no way to restructure free-falling fares. There is no way to restructure rising fuel costs. And under current labor contracts, there is no way to restructure labor costs other than to get rid of minimum employment requirements.

That given, and with liquidations possible if conditions don't begin to quickly improve, Republic is well positioned to take advantage of vacuums in the domestic market. And we all know that nature abhors vacuums.

We’re entering a new era in the US airline industry. Change likely won’t depend on the kind of calamity or crisis that triggers the “force majeure” clause that allows airlines to suspend or break contracts. Instead, new market economics may force a restructuring of the industry in which the victors are those, like Republic, which simply have a better business model - a flexible and agile model. The top domestic airlines of tomorrow might be Southwest, jetBlue, Republic and maybe two of the five current legacy carriers.

Hubs will remain in the largest metro areas because that is where the population is gravitating. Thus, the focus of air service providers is no different today than it was in the early 1990’s when we lost Eastern and Pan Am. And once again, the industry will discover that presence in all the big markets doesn’t give them pricing power anywhere. Republic’s move demonstrates that the major carrier’s reliance on feed markets to cross subsidize this fact could be over. Air travelers want low fares and, time and again are showing they’ll drive to whatever airport – and airline -- offers them.

In the very near future, it might be a very different set of carriers that dominates the US domestic landscape.

Just Another Manic Monday

Dow down 800 points only to rally in the last 45 minutes to close down 370 points to just under 10,000. The Dow rose above 10,000 in 1999. Here we sit in 2008 at the same levels. Of the 3,500 or so stocks traded on the New York Stock Exchange, 1,700 traded at 52-week lows today while 1 stock traded at a yearly high. On the NASDAQ, 1,100 stocks traded at 52-week lows and 3 traded at highs. Oil traded down $6 and change per barrel to $85 and change, and the dollar to euro ended at 1.35+. (The relationship of oil prices and the strength of the dollar is proving quite meaningful)

Back in July I wrote about Leverage Detoxification: Banks and Airlines. Today’s analysis of the market’s activity can only highlight the deleveraging/unwinding well underway with no real sense – yet - of where the bottom just might be found. The same might be said of what is going on in the airline industry. But, the airline industry’s problems pale in comparison to what is happening in the US and global financial markets.

Today I heard it said that deleveraging the markets could lead to disinflation. This would be a very bad outcome. It was not that long ago that we were talking about stagflation as oil prices were marching toward unimagined levels while the global economy was showing every sign of the slowdown that now appears on every continent’s doorstep.

So as we search for the bottom in the markets, analysts will say that heavy volume on the down side is critical before the real buying can begin. In Wall Street terms, capitulation is the term that market strategists refer to when all investors sell all of their stocks just to get out when it appears there is little hope of profiting by holding the instrument. We do not see this activity as of yet.

Wall Street observers are referring to the market’s current activity as a “Buyer’s Strike” – meaning that they are neither buying nor selling. It is a buyer’s strike for air travel that makes me very nervous right now as I cannot imagine just how many airline tickets have been bought over the past 5 years with proceeds from home equity loans and lines of credit.

So, on this Manic Monday, Sun Country files for bankruptcy protection with very little cash. They join Frontier in reorganization. I would not want to be in either carrier’s shoes. But then again, I would not want to be in any airline’s shoes that might be forced to file. In the case of each Sun Country and Frontier, both carriers have loyal local followings but add very little to the overall air transportation system. Just as Lehman Brothers was determined to not be vital for tomorrow’s Wall Street, neither Sun Country nor Frontier is vital to tomorrow’s airline industry.

Back to the Future?

In a comment to my most recent, and only, post thus far in May a reader asked if I was suffering from Airline Fatigue Syndrome? I am thinking yes. I look at the news today and I see that Frontier is going to start flying to Fargo. WOW. And Virgin America is going to start flying to Chicago. WOW again. And Sun Country did Mother’s Day with flowers. Double WOW.

I admit I am hung up on wanting a real transformation of the industry – or at least a sense that one is underway. I want the UPS guy to redraw the lines without labor or political interference and present us with a way to work toward making each of those stakeholders more secure in tomorrow’s rendering of the US and global airline architecture.

I do not remember a time when more balance sheet risk presented itself. In the past there was typically a carrier or group of carriers that you were sure would emerge from the trials of a particular period. This time you give a nod to Southwest given the health of their balance sheet and their current hedge positions. After that, it is clear as mud.

I lectured today on issues confronting the industry and its evolution. We talked about the current actions being undertaken that feel like recycled ideas. We talked about Phase I of the US-EU deal and its lack of transformational attributes – unless Phase II is successfully negotiated. We talked about Delta – Northwest and the revenue synergy concept that they are employing -- and how it looks and feels a bit like the combinations of Air France/KLM and Lufthansa/Swiss. We talked about a potential United – US Airways deal and asked if the third time might be a charm?

We talked about the fragility of networks. At some point, the downsizing of a network collapses under its own weight. We talked about the dollar versus foreign currencies and the competitive advantage currently being enjoyed by our non-US competitors in reinvestment, growth and in the purchase of fuel. We talked about the need to raise fares, cover input costs and the need to emerge from the long-term value destruction cycle that has described this industry. We talked about the drive to find the inelastic demand component.

We talked about the difficulty of placing meaningful raises into the pockets of labor given all of the externalities impacting the industry – and we barely talked about the infrastructure. We talked about politics and their impact on the current industry structure. We talked about how the US does not have a strong bearer of the flag in foreign markets. We talked……..

Back to the Future

Maybe we do need to look back before we can go forward. Remember when we talked about yield and not RASM? Remember when we had turboprops with limited range that married them to a geographically centered hub market? Remember when we actually talked more about operating profits than EBITDAR? Remember when load factor was a data point and not the mantra?

Not that there was ever structural stability during these points in time either, but fuel is the real deal. It just might be that catalyst for change that has been missing during the deregulation experiment. And if the change causes an industry to be disciplined enough to charge the passenger "all-in plus some return on capital", then we just might look back and call this time the best thing that happened to the US airline industry.

Let's get smaller (whether by commercial choice or by market forces); focus on yield and not RASM; get rid of duplicative hub feed (whether by commercial choice or by market forces); and forget about load factor that is won largely by not charging anywhere near enough for those final 10, 20, 30 or even 40 seats. Surely these actions would lead us to some capacity level less than today and approaches an economic level.

As cp5000 commented on the previous post: “And assuming the industry is successful in raising fares (which they must), what alternatives will benefit? More teleconferencing, more driving, more conference calls? I don’t know. That question at least is new and fresh. Better than the same old, same old”.

“The market place is working. It is not pretty, nor should it be. More change has to come – hard to say what it is going to be. Stay tuned”.

April 15, 2008: A Day to Remember or a Day to Forget?

End the speculation. We can now begin to debate the facts surrounding the Delta-Northwest combination. I must say that I expected to see significant changes from the deal that wasn't. What appears unresolved today is not much different than what was unresolved yesterday. As this day closes, I am an industry observer that is pleased to see a consolidation round begin in earnest.

Over the coming days, weeks and months we will be hearing about how the sky is falling. I remain steadfast that consolidation is in the best interest of all US airline industry stakeholders in the long run at this juncture. For some, consolidation through merger and acquisition activity means that the sky is falling. For me this type of consolidation is much better than consolidation through liquidation. In that case, airlines are falling from the sky and dislocations are forever.

Over the coming days much will be written. I will write. In any number of conversations I had today, the issue of labor risk; technology risk; and any other risk that could be raised as standing in the way of a successful combination of Delta and Northwest required addressing. And oil, the number one catalyst (read risk) behind the discussion of consolidation traded at levels approaching $114 per barrel of crude. Assuming that the crack spread is similar to last week’s level, then the "in the wing" price for the industry approached $145 per barrel today.

All of us really do need to stop talking about oil in a per barrel of crude denomination. We have to remember to add the crack spread to the cost of a barrel of crude. Me included. John Heimlich, the Chief Economist at the Air Transport Association has made some additions to his presentation on oil and its impact on the industry. Read it as it provides great perspective and why we find the US industry in its current position.

There Was Other News

We cannot have a day with news of promise in the US without a story on the “Flying Pig”: Alitalia. Reuters reported on the ongoing saga and how, and why, newly elected Prime Minister Berlusconi vows to keep Alitalia flying. The article reports, “Alitalia's ready cash is shrinking by about 3 million euros a day and now has funds left only for the immediate future -- a question of weeks or at most a couple of months, observers say”. The article goes on to say, “IATA, the airline industry association, has told Alitalia it must provide guarantees to be able to stay in IATA's system to settle ticket purchases if it were to go into administration”. Time is a tickin’ in Milan.

And finally, as the day really does come to a close, I sit and watch Neil Cavuto interview Captain Sam Mayer representing the Allied Pilots Association regarding their march today on American Airlines’ largest customers and institutional investors. As I have written all too often, this situation of labor suggesting that they join with customers to force American (or the industry) to address internal issues is reckless and has a higher probability of backfiring than benefiting any one stakeholder at American Airlines (or any other carrier). This is about getting a contract. I just wonder if APA told these valued customers and investors about the magnitude of the ask in their proposal and that they claim that only minimal fare increases are necessary to fund their ask. Best I know, fare increases are what customers like to hear. I doubt it.

And Frontier Receives Notice of Delisting. This story for me truly underscores the fragility of the industry today and why liquidity is king. An interesting day indeed.

One step forward for some and steps back for others. But we will get there someway, somehow.

More to come.

This Week’s Conversation Will Be In Words that Start With “C”

It is Sunday afternoon and before I sit down to watch the Masters and what appears to be a five player chase for the green jacket, will the week ahead produce any eagles and birdies for the US airline industry? Or will bogeys or worse continue to dominate the headlines? Earnings season kicks off this week. And with earnings season, there will be a theme or two that will emerge as airlines talk about the business going forward.

As I ponder the week ahead, I am thinking the conversation about the business will be dominated by a lot of words that start with C. Yes CONSOLIDATION will remain top of mind. But that C word will be joined by others like: CREDIT CARD holdbacks and who might be next; COVENANT COMPLIANCE that might trigger a CREDIT CARD event; CREDIT CONDITIONS generally; CASH and more importantly, unrestricted cash; CAPITAL expenditure plans, whether aircraft or non-aircraft, and what adjustments to those plans are likely; COMPLIANCE with airworthiness directives and maintenance requirements; COMPENSATION and yes that will be executive compensation; CHAPTER and you pick the number; CAPACITY reductions and how much more can be expected or gaining more insight into plans; and CASH BURN rates are likely to be the new concern and hot topic.

Talk in oil denominated terms will likely continue. Something like: that was $20 a barrel or so ago. Assuming that Delta and Northwest finally announce something this week as is widely expected, then I am sure that changes to the deal structure will be discussed in those terms. But come to think about it, we never ever really knew what the structure of the deal that wasn’t really was. But while all the original CATALYSTS for CONSOLIDATION remain, at what point do we begin to hear that CAPITAL is emerging as the real CATALYST driving CONSOLIDATION as the industry searches for a more stable operating platform – or as capital makes it clear that a bigger platform is necessary in the new world of high oil prices for the US industry.

But if the conversation does turn to CASH BURN, then talking in oil denominated terms is right. Based on what we know about expected capacity reductions largely taking place after the peak summer season, it is important to remember that while bookings for the summer are strong, those tickets were purchased some $20 per barrel ago. So while fare increases have been put in place, only some of those increases will be realized over the coming months. Simply, the industry will be carrying those passengers throughout the summer that purchased tickets earlier in the year at fuel prices that are much higher today. This is a primary reason for citing CASH BURN and liquidity as the hot topic.

So while there are lots of interesting topics that start with C that we could write about, I am going to end with the situation at Frontier. I read a news story that had a title something like: Frontier Pointing Its Finger at First Data. Yes the credit card company may have been the catalyst that caused the filing with very little notice, but is Frontier’s filing really a surprise? It just seems to me that this underscores the fragility of the industry today at nearly every corner.

If I am a credit card company and am concerned about customers defaulting on obligations, and I have a lot of exposure to a very risky industry I am probably going to make some very hard decisions. Do I think that this chapter filing will go the way of the others we have seen thus far. No. But then again, if we have not yet seen the bottom then maybe there will finally be a capital aversion for this industry or at least for business plans that just do not make sense or offer promise of solid returns for investors. A couple of posts ago we talked about how the historical barriers to exit just might not be the safety nets that they once were.

Well I think the Frontier story is the first test of those traditional barriers to exit. And not the last.