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

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

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

A Long and Overdue Reshaping of the Competitive Environment Gets Underway

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

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

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

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

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

Congress and the Regulators

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

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

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

“People dressed in plastic bags.  Directing Traffic.”

Aboard UA #2: Reading Captain Wallach’s Latest Half Truths

I have a long institutional history at United, primarily working on behalf of the Association of Flight Attendants. In this role, I worked with the flight attendants through every concessionary period, the ESOP attempts, and Phase One of bankruptcy -- a long association that ended when I spoke my mind in a media interview on the vulnerability of defined benefit pension plans and, in doing so, angered some in the union leadership with my candor. .

All by way of saying that there is very little in United’s recent history, at least between 1985 and 2003, that I did not witness up front and personal.

The Recent Spat

The latest static at UAL involves a war of words surrounding United, Continental, Air Canada and Lufthansa in their application for anti-trust immunity to operate an international alliance. This debate is creating much more noise in Chicago than it is in either Washington or Brussels and that’s for one reason: the noise comes from a desperate union leader who waited ten months to voice concern about any potential impact on United workers.

This is the very same union leader who sits on United’s Board of Directors. His administration was subject to a federal court injunction to end what Judge Joan H. Lefkow ruled was a job action in clear violation of federal law. This, in fact, is a union leader who fancies himself as the second coming of ALPA boss Rick Dubinsky – the legendary golden goose hunter that worked more than 15 years to create many of the problems that still plague United. But, Mr. Wallach, you are no Rick Dubinisky.

Sometime after Wallach’s anti-trust immunity concerns were made known via the press, United COO John Tague, sent a letter to employees explaining United’s successful alliances with ten airlines over the course of the past ten years – none of which had led to problems or complaints with the carrier’s unions. A day later, Wallach responded with an open letter to Tague and copied all United employees – a tirade he then shared with the media as demonstrated by this submission to Forbes.com.

Wallach’s Letter

Wallach opens citing what he calls blatant mischaracterizations and outright falsehoods contained in Tague’s letter. But after reading Wallach’s letter, I am of the mind that it is he who is guilty of blatant mischaracterizations and outright falsehoods.

In building his case, Wallach attempts to blame United’s role in the STAR Alliance for the airline’s trouble today . . . a dubious case he makes by comparing the size of United in 1997 when it first joined STAR to the carrier’s size today. That argument conveniently fails to note that 1997 marked the middle of the greatest up cycle in US airline history, and then neglects to account for all the industry trouble that has transpired since. But that’s what the industry has come to expect from unions that spend more time and capital attacking companies through half truths and blatant misinterpretations rather than working to address the economic and competitive realities at the root of the industry’s struggles.

A more honest analysis would take into account the full breadth of events that have had a profound impact on the airline industry since 1997, including but not limited to SARS

1. SARS
2. The growth of the US low cost carriers
3. The rapid deflation of the IPO bubble
4. The puncture of the stock market bubble
5. The advent of internet distribution and pricing (transparency that contributes to lower ticket prices
6. The Summer of 2000 (where actions by UA pilots to “work to rule” impacted service)
7. Ratification of a new pilot contract with rates far higher than the rest of the industry
8. September 11, 2001
9. US Airways bankruptcy filing that led to significant reductions in labor rates
10. United bankruptcy filing
11. Oil prices begin increase to historic levels; crack spreads depart from historic norms
12. Delta and Northwest bankruptcy filings
13. Oil reaches $147 per barrel, driving run up of other commodity prices
14. New rash of airline industry oil hedges in anticipation of further price spikes,
15. Followed by plummeting prices that put many hedge contracts underwater
16. Credit crisis takes hold
17. Consumer confidence falls
18. Economy enters recession in late 2007
19. Recession deepens to become worst on record since 1930’s with global reach into Asia and Europe
20. Pandemic flu outbreak with hardest initial impact in Mexico.
21. United pilots in negotiations over new contract for first time since bankruptcy agreement.

The real lesson is in the extent to which the entire industry has changed over the past 12 years with a permanent impact on the legacy carriers. Wallach weakens his own case by suggesting that alliances have hurt US airline employment without identifying the many factors in the equation.

In fact, I would argue that without the alliance partners United works with today, the airline would be even smaller.

Has the management at United made some mistakes along the way? Of course. The current UAL leadership has no compunction about forgetting the past other than to recognize that the carrier’s past was largely a dysfunctional disaster. But that recognition led to many of the changes to United’s structure and operations in place today. As CEO Glenn Tilton often makes the case, the industry has to earn its cost of capital – something the global industry has rarely achieved over its long history.

Corporate Campaigns and Organized Pilot Labor

The airline unions – particularly those now in contract negotiations, have not shied away from full-barrel attacks on the carriers as one method of soliciting support during labor talks. Ginning up opposition to airline alliances seems to have become the latest tactic in this long-running campaign. But it should not be lost on any industry watcher that the loudest rhetoric comes from the union halls of the pilots at United and American. Ironically, the least noise is coming from the most successful US legacy carriers – Continental and Delta. I’ll leave it to the readers to weigh in as to whether there’s a connection.

But outside the rhetoric there’s a pretty clear case for the benefits of these alliances, particularly for an industry that needs desperately to hold on to its customer base. Maintaining and expanding the current alliance structure is one sure way to do so.

Concluding Thoughts

It is important to filter the daily missives fired from the labor bunker with the understanding that many in the industry are understandably frustrated by the changes and challenges in the airline industry. At some level, the best labor leaders recognize that the industry will not return to the unsustainable bargaining patterns and demands of yesteryear. Captain Wallach should take a very careful look at his union’s history at United and role in contributing to the precarious position the airline now finds itself in.  In other words, make yourself relevant in shaping United's tomorrow.

That history lesson should begin with the pilot-led majority purchase of the company in 1994, a process that began following a strike in 1985. With that purchase, the unions had unprecedented power in the governance structure and influence so strong it included hiring and firing power. But as the ESOP sunset, there was no transformation – no new culture or structure that prepared the airline to weather the trials to come. Instead, the transformation has come as the result of seismic economic factors that are redrawing the global airline industry map. And that map includes alliances – a necessary partnership in an industry in which US airlines aren’t permitted to act like other global businesses and merge.

There is not one legacy carrier in the US today that could stand alone and compete on a global scale. To stand in the way of market evolution is to stand on a dangerous path.

Mumblin’, Bumblin’ and Stumblin’ for Something to Write

It’s pretty sad when . . .

. . . the reports that US Airways will discontinue charging for water and soft drinks is the best news out there. Not just in the airline industry, but in any industry for that matter. Water for nothin’ and cokes for free.My guess is Southwest was more than happy to have US Airways charging for water and soft drinks. And that is the nature of a competitive market– what is good for someone in this industry may not be good for another.

For me, the best news out there are reports that the government is telling the automotive industry that its turnaround plans do not go far enough in addressing the structural problems of Detroit’s automakers. The Big 3 is about to become the Big 1.75.

What will that mean for the airline industry which already is suffering from a sharp decline in business travel?For one, it will probably throw a klieg light on the fact that U.S. airlines have too many hubs in the middle part of the country. That might provide incentive for the industry to actually rid itself of marginal hubs that have outlived their useful lives. And that could portend well for the underlying economics of the industry once the toxins are extinguished from the macro economy.

In other news, Delta flight attendants have come up with a seniority list they say embraces the important tenets of equity and fairness for the former Northwest flight attendants who joined their ranks following the merger. The problem is that the Association of Flight Attendants, which represents the former Northwest cabin crews, does not yet recognize the combined airlines as a single carrier. It is no surprise that the AFA is digging in its heels – after all, Delta flight attendants are not unionized and in fact twice voted down the union’s organizing efforts -- in 2008 and in 2002. Merging workforces is never easy and anxiety over relative seniority will only grow if further capacity reductions become necessary. Expect a tough battle when the AFA goes back for yet another unionization vote.

Speaking of capacity, we are now seeing more impact from the transfer of industry capacity from domestic markets to international that began in 2004. All trends point to a very tough international environment, particularly for transatlantic services. Deteriorating fundamentals at British Airways have been in the news off and on for the past year. Now even Air France and KLM are cutting capacity. Lufthansa just keeps shopping but being the smart carrier it is – a deal is a deal and they will not pay too much.

Pacific region fundamentals are holding up, but China could change that equation. At a time that the West really needs China to increase consumption, that trend now is on hold as the Chinese economy continues to sicken. Economic problems in India that took route last fall continue to grow. Now the economic weakness is beginning to impact airlines throughout the region. Japan Air Lines is looking to its government for a $2+ billion dollar handout and economic ills already are beginning to hurt financial performance at Singapore and Qantas and Cathay Pacific.

The Middle East is perhaps the only economic bright spot for the airline industry, where both fledgling and well-financed carriers continue to grow and take delivery of new equipment, although not without occasional talk of potential mergers. And while Latin America shows pockets of strength, don’t forget that more than half of that region’s demand is focused on Mexico and Brazil.

In the US, we actually have some labor deals getting done. Earlier this year, Southwest ratified an agreement with its mechanics and announced an agreement in principle with its pilots. This month, Alaska Airlines announced a tentative agreement with its flight attendants with a vote scheduled for March. In each case, the contracts demonstrate the difficult state of labor negotiations in the industry. A prime example is the Southwest pilot agreement that attempts a delicate mix of pay increases, productivity measures and new scope restrictions.

Finally stock prices seem to be suggesting that another round of bankruptcy filings might just be around the corner. It is hard to totally discount what market values seem to tell us. Air Canada finds itself back in the news as a bankruptcy possibility following the financial engineering done in the prior bankruptcy that leaves the airline with nothing to fall back on this time around. At this point it looks like the only potential safety net is the Canadian government, which seems intent on increasing the ownership limit to 49 percent, but it is too soon to say how that will ultimately play.

Maybe the current economic Armageddon will generate interests in increasing the ownership limit for U.S. airlines– which could provide them a source of new capital and the opportunity to minimize expenses and leverage economies of scale. Most important, such a change would force recognition that competition for competition’s sake at home does not make for an industry structure that can grow and prosper.

Last week I had the opportunity to speak to the Aero Club of Washington and addressed the legislation limiting airline alliances that sponsors -- visionary Rep. James Oberstar among them – support based on misguided arguments of anti-trust issues. To make the point, I quoted economist Henry George who said:“What protectionism teaches us is to do to ourslves in time of peace what enemies seek to do to us in time of war”. George is absolutely right when it comes to those regulating the U.S. airline industry, which in their protectionist views have largely done what George suggests.

This time is different. Very different. The past is less prologue. Those companies that revise history will be best served because simply, you cannot do business today with yesterday’s mindset and practices and hope to be in business tomorrow. This will prove to be true in the airline industry over the next 18 months.

Stuffing Romy's Thanksgiving “Turkey”

Over the past month, news emanating from Wall Street has muted some of the stories taking place in the airline industry. So on this Thanksgiving morning, I thought I would stuff the bird with some stories that leave me scratching my head...

Click to read more ...

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.

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

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

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

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

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

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

Change is coming. What would Yogi say?

Is It True, Lufthansa to Buy Stake in jetBlue?

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

And Reuters offers this story click here.