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.

Northwest – Delta Back On?

Susan Carey and Paulo Prada report: Northwest Reworks Plan For Merger With Delta - WSJ.com.

Clearly, more to come.

Leaping Into Madness

Only every four years, do we get to write on February 29. But every year the month of March is Madness. One might argue that the month of February 2008 has been maddening as we await some kind of news – and a simple yes or no would work – coming from Delta and Northwest.

So I think it is only fitting that we get the following press release from NYU Stern Professor Robert Lamb and his take on the Delta – Northwest combination on the extra day in February. He suggests that the combination looks great on a map, but is doomed to fail. His reasoning is based on his book, co-authored with Thomas Grubb, Capitalize on Merger Chaos: Six Ways to Profit from Your Competitors' Consolidation on Your Own. While I agree it is a strategy that can be employed by players in a consolidating industry, I thought it might be just "mad fun" to consider the 7 points he makes pertaining to the Northwest – Delta combination:

1. Focusing inward on integration of Delta & Northwest will negatively affect their profit,

Precisely why this deal has not moved forward is because a decision has been made to avoid this very issue. Delta and Northwest can only work through the issues with the pilots because they are both represented by ALPA. Therefore, details can be negotiated as the collective bargaining agent is known. Moreover, by dealing with pilot issues upfront, limitations on how aircraft can be deployed will be settled and the important work of network configuration can begin.

While there will be representation issues to work through with the many non-pilot work groups, the direction of that work will also be decided by the employees. And that is whether there will be a collective bargaining agent or not. But non-pilot employees do not control the essential elements that impact how a network can be reworked.

2. The skills of employees from each company are not necessarily transferable,

The class and craft system of employees in the airline industry can be applied across the many companies that comprise the airline industry. The airline industry is made up of a lot of smart people. After some differences training, I feel confident that all employees performing a function at Northwest can perform the same function at Delta. So, I do not think this issue does much to stand in the way of a successful merger.

3. The lack of a strategically powerful merger plan will lead to chaos and uncertainty, and both companies’ most valuable resources—their best people—will probably flee,

Let’s think about this for a minute. We have a $20 billion deal sitting on ice while we await word as to whether a consensual integration of seniority can be accomplished between the two pilot groups. In an industry where seniority rules how employees work, there is a very long history of why employees do not leave one company for another in this industry.

4. The size of these two airlines combined creates the largest US airline, which poses a threat, according to studies indicating that larger companies are historically the least successful in mergers,

And today, the two largest airlines in the world are arguably among the most successful. And they are the byproduct of merger activity: Air France and KLM; and Lufthansa and Swiss. The economies of scope and scale are important in a network industry. And to continue the debate about size of an airline in the context of a US only industry ignores the economic forces of globalization. What was most refreshing for me on my trip to Dubai was to have multiple discussions where perspective was only considered in the global context and not on a regional scale. And the US is merely a region that is part of the global economy.

5. Most companies don’t know the statistics on merger failure and let egos alter their judgment when determining how much the enterprise can afford to pay and how much they will recoup,

Northwest and Delta are working hard to address the known issues that have stood in the way of successful attempts in the past. I think each company involved along with knowledgeable industry watchers is well aware of the statistics on merger failure in the airline industry. I guess the fact that the senior management team has already been decided does not suggest that egos have been put down in order to forge a combination that each company believes is in the best long term interest of their respective companies. And finally in a stock swap deal and given the certainty over oil prices and economic conditions, how much can be recouped is a fairly straight forward exercise.

6. Union issues may delay the merger, causing airline executives to focus too much on internal operations, and not enough on competitors,

I believe that this was answered in #1 above. Further without an agreement from the one similar, and known, union on the property, there is no deal based on what we know today.

7. A significantly more profitable merger would result from a joint venture between either Delta or Northwest and a strong foreign airline.

Now finally a point I can begin to embrace somewhat. But in some ways doesn’t Northwest already have a joint venture with KLM and Delta a joint venture with Air France and Northwest/Delta with Air France/KLM? This loose joint venture will be cemented by the equity investment the non-US group plans to make in the Northwest-Delta combination. I hope the combination results in a more profitable entity as today’s profit levels are not sufficient to enable the reinvestment in the business that is necessary.

Concluding Question

Is this delay in time good for the deal, bad for the deal or indifferent to the deal?

Concluding Thought

If nothing else, the delay brings with it many interesting nuance and analysis that is just simply not applicable. I do expect more from a prestigious academic institution than to think about mergers in a parochial US-centric way. Ignoring the forces of globalization is well…….