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Entries in private equity investing in US airlines (1)

Wednesday
Jul092008

Are We Beginning to Define US Airline Industry Survivors?

All Sectors Present and …. Discounted

As the day ends and I finally get my thoughts away from preparing for tomorrow’s AAAE Energy/Air Service Summit to be held in Washington, D.C., I turned to Holly Hegeman’s blog Planebuzz. As she often does, Holly chronicled the day’s events on Wall Street. The drops in stock prices for AirTran, Continental, Northwest, Delta and Mesa are disturbing. But then again, why is today any different?

This has been a "Death March" that ends with the inevitability of structural attrition. It is unlike the loss of value experienced immediately post-9/11 in that nearly every airline has been punished by Wall Street. Post-9/11 actually saw some carriers be ascribed significantly higher equity values relative to other carriers based on the condition of their balance sheets and the view of their respective cost structures at the time. With exception of Southwest (do they run a trading desk or an airline?), every carrier has been hit very hard by the Street. Yes, airline equities are an option on the price of oil.

In her post referenced above, Holly ponders the Street’s view of AirTran. Yep, there is something going on here, and in hindsight, the bears have been leaving crumbs along the downward trajectory of its stock chart for months. Many question Northwest Airlines viability as a stand-alone entity. Today, Northwest put some specifics to its capacity reductions. And Northwest made that decision to charge for the first bag (that this blogger really dislikes).

Yesterday, we had the announcement that ExpressJet would terminate its branded flying. And today we have Mesa trading at 37 cents.

Renewed Bankruptcy Talk and My Blunt Talk on Private Equity

Over the past month or so, virtually every major airline reporter has written something on bankruptcy. But my fundamental question is: how do you restructure a market-driven commodity cost? Or is another bankruptcy period being created so that private-equity firms can finally buy what they determined they did not want to buy during the last round of Chapter 11 filings? Are we not watching this play out at Midwest where private equity holds a “passive stake” and is asking labor to make untenable concessions. Yep, they will probably file too and nope labor should not play as the outcome would remain fragile at best.

Private equity is smart money – right? Smart in that they did not play in the first round because they recognized that the work was not done. Smart because they knew the subsequent round of labor negotiations would result in dirty fingernails – particularly given the pension terminations and freezes that took place. So now we are down to the final act: removing capacity from the system and trying to educate lawmakers, communities and airports of these unpopular actions. As we make the final push to clear the last ten acres of 30 year-old underbrush, what a perfect time for private equity, right?

The right form of capital during this time is “internal stakeholder capital” and not external “private equity”. This can only be prevented absent a bankruptcy filing I fear, except for American I guess. As difficult as it may be, labor and management had best figure it out in a hurry. Think back to the early days of Southwest Airlines when the carrier was struggling mightily to stay alive. Southwest management put equity in the hands of the small number of employees that existed. History refers to them as the “North Dallas 40”. Millionaires, who would not have become millionaires, were made.

I am not saying that employees will be millionaires, but I can say with conviction that equity in lieu of hourly rate increases at this fragile time holds the promise of appreciation once this storm passes. And the long-term trend line of equity appreciation runs along a higher line parallel to inflation. So if I am labor and management, each of you has interests to protect. This is not about management compensation for god’s sake, it is about employee compensation and preserving as much of the enterprise that the macroeconomic environment allows. If labor believes it has somehow been wronged by management compensation structures of late, just wait until you lose control in bankruptcy the next time, or even for the first time, and the owner is Blackstone, TPG, or Pardus to name a few.

Thinking About Capacity Cuts and Industry Structure

Have you ever stopped to think that this is IT? Will the capacity reductions be an acclamation or an eulogy? There really is not much left to cut. As we raise fares, we will test 30 years of consumer attitudes in the making that air travel is among the greatest bargains ever delivered by a government’s action on an industry. As we cut capacity we will test the resolve of lawmakers to recognize that the airline business is a business and needs to earn a return on capital just like other industries. As we cut capacity, we will ultimately test organized labor’s mindset about pattern bargaining.

So as we march toward the airline graveyard, who will live to eulogize? Delta and Northwest have made their arrangement and it holds promise. Continental and United could prove to be a real powerhouse serving the largest US cities to metro areas around the globe. American will live because it has the “B” card to play where I fear others do not and it has the opportunity presented by an immunized alliance to generate revenue that has been limited because of regualtion. As for US Airways, labor got onboard too late for this one and I fear its ultimate death.

Turning to government’s beloved and answer to all industry ills: the LCCs. Isn’t it interesting that this sector has been rocked like no other sector. The price of oil has mitigated its previously inherent cost advantages. Yes, Southwest lives but it was really the only LCC to grow and prosper under deregulation anyway. jetBlue is taking on more characteristics of a network carrier recognizing the importance of local traffic in large metropolitan areas. ATA and SkyBus are gone. Spirit holds many of the attributes that characterize those carriers that have liquidated thus far: small footprint; private capital; market strength nowhere.

AirTran is the enigma. But there is something fundamentally wrong here despite a very strong management team. Maybe it comes down to that simple diversification thing that I like to write about. It has a presence in Atlanta. And Orlando I guess – and that market will prove to be a friend of a few that live to see another tomorrow. Oh, and Frontier. It too suffers from that diversification thing and my guess is the aircraft are much more valuable than the carrier’s value to the US air transportation system.

From this blogger’s perspective, what is missed on the regional sector is that there are legacy-regionals and LCC-regionals - for lack of a better descriptive term. It has much to do with labor rates as they are the only cost centers that allow this sector to differentiate their delivery of flying - at least under the current capacity purchase agreement construct. Republic and SkyWest are safe as each has been able to grow their jet-flying subsidiaries faster than their subsidiaries laden with employees that were in place when turboprops were the only game in town.

When it comes to rest of the regional sector, I just do not believe that the remaining carriers have been able to effect a business plan that transforms their structural beginnings.

So in the end, are we left with: United/Continental; Delta/Northwest; American/British Airways; Southwest; jetBlue; Virgin America (because of capital and branding); Allegiant; SkyWest; and Republic? I just do not know, but I am thinking that we are closing in on it.