Archive Widget

Entries in Financial Times (4)

Monday
Apr072008

The First Four Out Are Not the Final Four

Memphis v. Kansas

We awaken this morning anticipating the final game of the 2007-2008 college basketball season. And lest you think I’m drifting off topic here, the geographic locations of each school have some relevance to happenings in the US airline industry. Lawrence, Kansas does not have direct air service; residents are dependent on the highway system to access air transportation. With the airlines’ costs for fuel now nearing an "in the wing" $130 per barrel, Lawrence is simply one among many rural/small communities that have little hope of supporting direct air service.

With fuel prices forcing a re-examination of the entire route structure, there are some analysts who believe Memphis – and some cities like it – can’t justify the air service it receives given the city’s modest scope, scale and contribution to the US air transportation system as a passenger air transportation hub. This is particularly true in light of the renewed merger talks between Northwest and Delta as reported by Justin Baer and Francesco Guerrera of the Financial Times. If negotiations are indeed underway, there will be heavy scrutiny on the deal structure, network structure, labor construct and cost containment strategies. Will the hard questions be addressed or deferred?

The only thing we’ll know for certain by the end of today is the national champion of college basketball. For the US airline industry, we are just beginning the journey down the road to the Final ????????

The First Four Out

The first four US airlines out: Aloha; ATA; Skybus and Champion, which announces out on 5/31. Let’s not forget about Maxjet, which exited the market in December 2007. Even before the Skybus exit, some pundits and analysts were writing that the U.S. would not lose any more airlines. That’s not the bet I’d put money on. But the real question is whether any of these exits from the market will have meaningful impact on the structure of the ailing US domestic market. The answer is no.

What is interesting is that each of these carriers was a niche player with presence only in a relatively contained market space. Aloha in Hawaii. ATA, which was arguably the most confused carrier in determining what it wanted to be when it grew up, was best known for its late-in-the-game code share relationship with Southwest to serve Hawaii. With Champion, the airline’s claim to fame doesn’t go much beyond its business as the non-scheduled carrier of professional sports teams. Skybus, a carrier trying to bring the Ryanair model to the US five years too late, focused its operation in Columbus, OH (yawn). And Maxjet built its model on the transatlantic business class passenger.

A game-changing development? Not in my opinion. A start, perhaps, in addressing certain regionally concentrated capacity – but in no way contributing to a meaningful improvement in US airline results. The saga surrounding Alitalia is much more interesting than anything happening in the US right now. There, the sixth largest carrier in Europe is on the ropes, largely due to labor and politics standing in the way of what everyone knows needs to be done. The media this week actually suggested that the airline needs an exorcist as much as it needs a business plan. In my view, the Alitalia story is a precursor to what could be coming in the US. And when this begins to happen, then it will get truly interesting.

Get ready to put yourself in the same mindset the industry adopted after 9/11. The discussion will be all about liquidity (Clark Kellogg of CBS Sports might call it spurtability), assuming that fuel prices remain at this level. Already, 24/7 Wall Street and The Street.com have written that it is not entirely out of the question that American Airlines will follow the path of the other legacy carriers in filing for bankruptcy, even with $4.5 billion of unrestricted cash in the bank. I’d say it’s a little too soon to make the call, but it sure does underscore a rough and tumble environment out there. As a friend in the industry wrote to me last week: “We do live in interesting times.” In China, that’s considered a curse.

No #16 seed has ever beaten a #1 seed, and at this point all we have lost in the airline tournament is four very low seeds. Hell, we have not even gotten to a meaningful matchup between a power conference team and a mid major. Every year March Madness produces that game and every year a mid major knocks off a power conference team, and when we get there, the tournament gets more interesting.

What makes the NCAA tournament so much more fun to watch than the US airline industry is the fact that there are no barriers to exit and a lot more barriers to entry - you earn your place.

The real airline tournament begins with the next four out of the US market. Enjoy the game.

Saturday
Mar082008

The Era of Transition, and Hopefully Transformation, Is Top of Mind for British Airways as Well

Industry cycles often adopt a theme – and often too late. The late 1990’s through, at least, the first three quarters of 2000 was arguably a bubble period where revenue generation was too good to be true – even in hindsight. Yet the US industry added billions dollars of costs believing that the revenue trajectory was sustainable. For US carriers, the period from late 2001-2007 was a restructuring period. A period necessary to begin making wholesale changes based on the unrealistic cost structures that developed during the inflating of the bubble.

Now today, we find an industry that has indeed taken billions of dollars of cost out of any number of carrier’s respective operations. But it was clearly not enough to produce an industry structure that can profitably support all of the current players. All you have to do is read 2008’s best-selling daily horror novel named the Wall Street Journal to realize that we are on very shaky ground. And about the only thing we know for sure is that the revenue health of the US and global airline industries is inextricably tied to the health of the US and global macro economies.

Views from Willie Walsh

Back in October, I wrote the shortest swelblog.com post to date. And the themes from that post are the one’s I use most when speaking. In Transforming the Transatlantic Market Into a Transcon Market, I reference a Reuters article that interviewed British Airways’ Chairman Willie Walsh. In that post I characterize the story in the following sentences: “Clearly British Airways is (re)evaluating the best use of its capital as the current architecture of the transatlantic market is being (re)examined. This story comes on the heels of reports that BA is considering a major expansion of new services into the US market”.

In the Reuters article, Walsh uses the term transformational. Transforming the global airline industry is precisely what is being done in Singapore, Dubai, Abu Dhabi, Frankfurt, Paris, Amsterdam, Hong Kong and Sydney. It is precisely what Glenn Tilton of United, Doug Parker of US Airways, and now Richard Anderson of Delta and Doug Steenland of Northwest have been/are saying as well.

There are Many Parallels Between BA’s Views and US Industry Views…..

……and I will touch on a few.

Individual airline growth around the world is taking place in multiple ways. Among the elite Asian carriers, the robust growth is largely organic. The same is true in Latin America. Except for LAN who is expanding through both organic growth as well as providing a brand on which flags of countries with struggling airlines can rely on for access to the global air transportation system. In the Middle East region, it is all about organic growth. This region is blessed with geography, capital and a vision that I appreciate more today than I did just a month ago.

In Europe though, growth for the legacy carriers has largely come through acquisition strategies. Sure Ryanair and Easyjet are growing organically but they are not the answer to Europe’s global access anymore than Southwest, jetBlue and AirTran are in the United States. It is just naïve to believe that the low cost sector is that answer.

On March 7, 2008 the Financial Times wrote a very good story entitled: BA looks to play the consolidation game. It is from this story that I will attempt to draw out some of the many parallels that exist between BA and the thoughts on industry structure espoused by the leaders of the US legacy carriers.

For British Airways, global travel is everything. For the US legacy carriers, global travel is quickly becoming everything as the US domestic market’s fragmented structure promises little to nothing in terms of profitable new business. But when BA looks at the size its principal regional competition (Air France/KLM and Lufthansa/Swiss) has grown to through acquisition, it, like its US counterparts, need to be concerned. They are big in virtually any metric imaginable.

While much is being written about what the new open skies agreement means for the industry in 2008, arguably the most important event for BA begins in December of 2008 when Lufthansa has a call option to begin buying BMI British Midland. With BMI comes a large London Heathrow slot portfolio that is sure to bring lots of interest from carriers around the globe. As BA moves to the brand new T5, and with the move the ability to move many more passengers, the slot issue is not lost on Walsh.

Like the US carriers, BA has shown very little growth since 2001. It has been engaged in its very own restructuring process. BA generates strong cash flow like the US legacy carriers but also relatively low returns on capital which also resembles the US legacy carriers. The FT article states that BA is readying for a growth period that is likely to be some combination of organic and acquisition related. In a theme that is quite reminiscent of what US legacy CEOs have been saying, Walsh is quoted in the article as saying "Some of the shackles have been removed," he told investors and equity analysts on Thursday, "we have not quite fixed the core business, but we are well on the way".

Ah, that core business thing again. To invest? Or not to invest? - and let the enterprise attrit into oblivion. That IS the question.

The FT piece expands on BA’s interest in BMI and goes on to say that an interest remains in Iberia. But outside of these two carriers, there is little interest in anything else European. Walsh states, "We are mindful of the opportunities consolidation can offer," he said. And his gaze is not only fixed on Europe”.

But Before We Go There – Yet Another Parallel

In a paragraph which caused me to pause and read multiple times, Walsh commented on the acquisitions made by each Air France and Lufthansa: "we look with admiration" at how both deals had generated substantial revenue synergies, a possibility BA had largely discounted, as it concentrated much more on the potential for cutting costs”.

This sounds a lot like what Delta and Northwest have been discussing. Network and revenue synergies first. I, along with many observers, have also struggled with the strategy outlined in a number of press reports which suggest that Northwest and Delta will maintain their current network structures. But after a period of domestic cuts and a restructuring of networks with a sharp focus on an international strategy, we will just have to wait and see whether the same synergies can be realized here in the US as are being realized in Paris and Frankfurt.

On US Consolidation and Views on the Regulatory Landscape

The article and Mr. Walsh offer views on US consolidation that are also in concert with statements made by US legacy carrier CEOs. "US consolidation would be a good step forward," said Mr Walsh, "it would benefit the US and the global industries".

There has to be a strong US industry for there to be progress in the next stage of transatlantic liberalisation and a dismantling of US restrictions on the foreign ownership and control of US airlines.

BA had a "good relationship" with its US partner American Airlines, but the development of any deeper deal was "inhibited" by the two groups' lack of antitrust immunity from the US and European competition authorities.

"There is evidence that the regulatory landscape is changing," said Mr Walsh, but it was not yet clear that it had changed sufficiently to make a fresh application for a deal with American, he said. "We will continue to look and examine."

Bringing Back a Few of My Favorite Glenn Tilton Statements

For those of you that have read this blog since the beginning, you will have seen these quotes used before. For the purposes of this blog post, the parallels between a US airline CEO and Mr. Walsh are certainly evident.

Glenn Tilton, UAL’s Chairman and CEO said in a speech to the Nikkei Global Management Forum in Tokyo: “If there is one imperative for every business in the global economy today, it is simply this: evolve, adapt, reinvent . . . or risk irrelevance in the global marketplace”. He went on to say: “As everyone here today knows well: the reality of our world is that globalization is relentless. Think of any industry represented in this room; choose any business listed on the Tokyo Stock Exchange; and one can be sure: it looks nothing like it did ten years ago; and looks nothing like it will ten years from now”.

In his Tokyo speech, Tilton asks the following question: “As globalization gives rise to new economic powers within the developing world, the real question for all of us operating in mature economies today is this: will the legacy systems that contributed to the success in developed nations in the 20th Century be an asset or an impediment to growth in the 21st Century”?

He goes on: “The airline industry is a perfect platform from which to focus this discussion, because it is subject to virtually every imaginable challenge -- every human challenge, industrial challenge, financial, regulatory, and security challenge -- throughout the global economy. And then, of course, we also contend with the weather”.

So BA, like the US legacy carriers have evolved largely by being pushed by economic and competitive forces to engage in a necessary restructuring. The restructuring was necessary to adapt to both a changed and hypercompetitive domestic market and to better prepare for a world that has been largely liberalized. But, the reinvention of former legacy airlines into entities that can thrive in tomorrow’s economic world is not complete. And that is clear for each BA and United and Northwest and Delta and others to be sure.

More to come.

Wednesday
Feb272008

Time Well Spent; Unchanged Catalysts to Consolidation; and Concerns Surrounding the Delta – Northwest Deal

Time Well Spent

A significant amount of my career has been spent participating in labor negotiations surrounding a distressed situation. There are two principles I always adhered to when advising clients: 1) you can always make a bad deal; and 2) strive to make a deal where either both sides are happy or both sides are unhappy because in both scenarios that probably means you have negotiated the best deal possible. Trying to avoid a scenario where one side is happy and the other side unhappy means you have negotiated a bad deal – and that is precisely what Northwest and Delta are trying to avoid.

Justin Baer of the Financial Times writes an excellent piece describing why seniority is critical for pilots. So it is important to understand just why these discussions are taking so long. Given that we are more than 20 years from the US industry’s last round of consolidation involving multiple carriers, pilots recognize that decisions made today will more than likely impact the majority of their remaining careers. But the always thoughtful and insightful Liz Fedor of the Minneapolis Star Tribune raises the specter of a negotiating clock. Another important negotiating rule is that it is hard to negotiate without a deadline.

Whereas many journalists and pundits are suggesting that the end is near in these negotiations, and as a result the much discussed deal will die, I am not one of them. Ms. Fedor in her opening paragraph writes: “A veil of silence has encircled the pilot leaders at Delta Air Lines and Northwest Airlines who are struggling to integrate their seniority lists -- the lone impediment to a merger announcement”. So why is this important? I typically read no talking as a positive sign. And the only people I have heard say Hell No to this deal before seeing the details is Congressman Jim “Hell NO”berstar and members of his staff.

I am an open proponent of change. I am an opponent of closed mindedness. One of the big points that I think is being missed: if there is concern over a political clock running out to get regulatory approval, then weeks spent today could possibly save months gaining regulatory approval for the deal tomorrow. In concluding her piece, Ms. Fedor raises this very important point that I have not seen written elsewhere as well: “If an agreement is negotiated in advance of a merger announcement, the two pilot groups also would be expected to be political allies for a merger during a regulatory review in Washington”.

The Catalysts to Consolidation Remain Unchanged

This morning, William Greene, analyst at Morgan Stanley writes a research note referencing the widely covered internal Delta memo to employees yesterday. The text of Mr. Greene’s note follows:

Delta Air Lines, Inc.
Quick Comment: CEO Memo Does Not Change Our Views

Impact on our views: The Delta CEO memo made public on Tuesday highlights the difficulties involved in completing airline mergers. That said, we still believe a deal is possible near-term for 2 reasons: (1) Oil prices at $100/bbl and a slowing US economy will keep the pressure on major airlines “to do a deal” and (2) the very substantial pay increases and equity ownership that labor stands to receive should a deal happen will increasingly put pressure on labor leaders to find common ground on seniority issues. Moreover, the economic arguments supporting consolidation are as compelling today (if not more so given the macro backdrop) as they were 6-12 months ago.

What's new: On Tuesday, Delta released a memo from CEO Richard Anderson to employees that outlined guiding principles for Delta in the event of a merger. The memo is intended to allay concerns that Delta employees have regarding a merger. Key concerns for employees include: seniority, job security, career growth and maintaining pensions. The memo indicates that any deal must satisfy these key concerns and a deal that does has not yet been attained (see memo on next page for more details).

Investment thesis: We maintain an Overweight-V rating on DAL primarily due to the company’s positive stance toward consolidation and good position vis-à-vis our key themes (market exposure, strategic actions, and labor risk). We also see relative value in DAL, although we note that we see the group as a whole as overvalued on an absolute basis at current oil prices. This is one reason we continue to recommend that investors sell into strength on news of consolidation. Should the stock run sharply higher from current levels or if the outlook for consolidation changes dramatically, we may need to revisit our rating.

Concerns – And Yes I Have Some

In a post earlier this month, I asked the following question regarding a labor leader’s decision making whether to support a deal or not: is the implementation risk of a merger deal (seniority integration, single collective bargaining agreement etc.) any greater than a leader having to manage the expectations of any employee group that actually believes they can make themselves whole in the next round of Section 6 negotiations?

While I understand the Northwest pilots are not prepared to sign on just because they would work under Delta rates of pay on the day following consummation of a deal. But doesn’t the question beg, as far as career earnings are concerned, just how much would pilots earn at Northwest if the company were to remain a stand alone entity? What are Northwest’s 20 year growth prospects? Will Northwest be able to duplicate organically what it would get fairly quickly in a deal with Delta? Will labor have any better opportunity over the next 5 years to do any better by their members?

Only the Northwest MEC can answer these questions. Where I am concerned is that the Northwest MEC is being advised by counsel in the Northwest – Republic seniority integration and in the most recent US Airways – America West pilot seniority integration (also reported by Ms. Fedor). By now everyone is aware that there are few, if any, success stories in either of these two cases. I just hope that decision making is not being clouded by the prospect that somehow past wrongs can be righted through this deal. But only those that know, know.

So hopefully either all will be happy or all will be unhappy. Otherwise just go ahead and say "Hell No". At least someone will be happy.

Wednesday
Feb202008

Pondering a Delta – Northwest Merger Yet Again: Irony and Sad Irony

Review of the Catalysts

On February 18, 2008, Justin Baer of the Financial Times wrote a very good – must read - story outlining the catalysts underlying the US industry’s current move to consolidate. More importantly he provided the historical context as to why then was not right for Delta and why now is right. In the face of $100 oil, Mr. Baer reminds us that the industry is still susceptible to economic cycles. As the US economy struggles we now hear stories of its effect – potential effect - on the European economy.

I raise the issue of non-US economic activity because the current consolidation environment is every bit about the ability to address the fragmentation of the US domestic market as it is to position US airlines carrying the US flag around the world to be strong global players again. Economies of scope, scale and density are certainly important in the domestic market but will prove essential in the global market as competition from known competition increases.

But more importantly, it is the competition from the unknown competitors that requires the US industry to address its weaknesses today or face a continued loss of global market presence tomorrow. In the article he writes of the various stakeholders – labor, Oberstar, low cost carriers – and their respective views on change.

Irony #1

Yesterday, MSN's MoneyCentral ran a piece entitled: “$100 oil may just be the beginning”. Isn’t it ironic as we await word from the pilots that the number 1 catalyst for the industry to seriously consider consolidation - oil prices - oil closes above $100 per barrel for the first time? Remember when United and others suggested that oil at this level, and if sustained, would cause each carrier to evaluate the possibility of reducing capacity?

Consolidation more than likely results in a better outcome for communities of all sizes than does an oil environment that renders some markets not economic to serve. In no consolidation scenario being discussed are there markets that would be disenfranchised from the air transportation system. This is because network efficiencies can be found to maximize revenue – or to minimize the loss of continuing to serve marginal markets. Fewer frequencies is a much better outcome than outright exit from currently serving a market.

So rather than fear the loss of service due to consolidation, the alternative of losing service due to changed economic condition – whether oil or economy-driven - is every bit as great, if not greater. Something to consider for the naysayers.

Irony #2

Liz Fedor of the Minneapolis Star-Tribune writes about the issues facing the pilots of each Northwest and Delta on the difficulties of negotiating the workings of a merged seniority list. I am one who believes that time spent negotiating these details today will result in significant time saved tomorrow in getting the deal approved when the transaction in its entirety is scrutinized by the regulators, Congress and the various publics that will opine.

Irony #2a – Sad Irony

Whereas yesterday many stories ran regarding the status of the pilot negotiations at Northwest and Delta, the National Mediation Board approved the application of the US Airline Pilots Association (USAPA) to conduct an election for representation of the former US Airways and America West pilots. Why is this ironical and sad to boot? Because this is precisely what the management and labor at each Northwest and Delta are trying to avoid.

Merger synergies typically need to be captured early in the deal. US Airways realized immediate revenue line benefits of combining their two networks. But until these labor issues are concluded, synergies on the cost side are muted, if not mitigated. So the nation’s smallest network carrier just keeps getting smaller and the upside for its pilots will keep getting less and less. I agree with Captain Prater that this decision is emotional and not rational and does nothing to move the ball forward for either the pilots or the combined companies.

The USAPA is making promises it cannot keep. And that is why it is well worth waiting for the two labor parties at Delta and Northwest to come together. The wait is worth it for all involved.

And besides, is the anticipation of a final deal really any different than any other negotiation that takes place routinely in this industry?