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.