US airlines hit turbulence - again
By
Simon Wilson Dec 12, 2005
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America’s airlines are struggling again, and some are already filing for Chapter 11 bankruptcy protection. But wouldn’t it be better to let them die, asks Simon Wilson
Why do so many US airlines go bust?
In part, because commercial aviation is a high-risk business with high fixed costs (expensive aircraft, hundreds of specialist workers, lots of fuel) that is hard to get right. The industry is also particularly vulnerable to big swings in demand and external shocks over which it has no control. In the past four years, US airlines have lost $32bn as they coped with a succession of shocks including the September 11th terrorist attacks, the collapse of the millennial stockmarket bubble, the Iraq war, and the Sars epidemic. There were signs of hope earlier this year that the worst was over for US airlines. In the second quarter (April-June), American Airlines made its first net profit in five years ($58m) and Continental saw revenues up 12% and a net profit of $100m. But since then the soaring oil price has had the industry on its knees once again. The six big airlines are now expected to make losses of $10bn this year.
Any other reasons?
In recent decades the big airlines have had to deal with the rise of low-cost, low-fare competitors, such as Southwest and JetBlue in the US. The major players, known as the ‘legacy’ carriers, typically have expensive, ‘hub-and-spoke’ business models based on huge investments in infrastructure – a legacy from the highly regulated pre-1978 era, when airlines were each required by law to handle designated domestic routes and so centred themselves around particular airports. They also have mature and heavily unionised workforces and high pension costs. By contrast, the new, smaller operators have built nimble businesses based on cherry-picking profitable routes and low fixed costs.
Who’s disappeared so far?
Famous names such as PanAm and TWA have disappeared. But outright liquidation is the exception rather than the rule in the US. In practice, the airlines are usually allowed to struggle on under Chapter 11 of the federal bankruptcy law, which gives them a breathing space to work things out with their creditors. Since the deregulation of the airline industry in the 1970s, more than 20 airlines have filed for Chapter 11, but the situation is now so bad that around half of American air passengers are now flying with airlines that are technically bankrupt. Last week’s Chapter 11 declarations from Delta, the third-biggest US carrier, and Northwestern, the number four, mean that four of America’s six main carriers are under Chapter 11 protection. United (second-biggest) has been in bankruptcy since 2002 and US Airways (sixth) will shortly come out of bankruptcy protection by merging with America West.
How does Chapter 11 operateIt’s a last-chance saloon – a form of legal protection designed to give struggling businesses a chance to get back on their feet. It gives firms temporary protection from creditors, and the chance to renegotiate contracts and restructure the business as a going concern, avoiding liquidation. Under Chapter 11, a firm’s existing managers are allowed to stay in charge of running the business and have the right to tear up wage agreements, sell off assets, renegotiate leases and terms of business and – crucially – scrap expensive defined benefit pension schemes and hand over pension liabilities to the state-run Pension Benefit Guaranty Corporation (which gets a stake in the business in return).
What’s wrong with Chapter 11?
It may keep ailing businesses going, but it distorts the airline industry: Chapter 11 businesses end up with unfair competitive advantages over competitors, thanks to their ability to renegotiate contracts, cut costs and dump debts. Worse, the most basic problem in the industry is excess capacity – too many seats and too few customers, something Chapter 11 doesn’t help: all too often it lets airlines restructure without cutting back capacity. This means the core problem is never resolved. International competitors believe Chapter 11 bankruptcy is a form of de facto protection by the US government, allowing US airlines to keep costs artificially low and so distorting the long-haul market. It is a way, says British Airways chairman Martin Broughton, of propping up the walking dead at everyone else’s expense. And there’s reason to think that, in some instances, Chapter 11 has become a strategic tool rather than a last resort.
For example?
Northwest Airlines is not broke, or even close to it: it has $1bn in cash or credit lines. On the same day it filed for bankruptcy last week, five Wall Street banks published research scoffing at the idea that Northwest would go bankrupt and reiterated their ‘buy’ recommendations. Cynics say it just wanted to make sure of Chapter 11 status before the rules governing who can declare bankruptcy are tightened up next month.
Is Chapter 11 really such an easy option?
Taking Chapter 11 bankruptcy doesn’t always mean that a business survives. Of the seven carriers that filed for Chapter 11 in the early 1990s, only two are still in business – America West and Continental. Nor is it cheap. United Airlines, which has just announced a further delay in coming out of bankruptcy until next spring, has spent more than $250m in related professional fees since 2002. The biggest Chapter 11 success story is Continental, which spent more than four years in bankruptcy in the 1980s and 1990s, and nowhas the lowest costs of any of the big hub-and-spoke airlines. Even Continental, however, is once again losing money – nearly $1.1bn since mid-2001.
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