Wretched Wrench
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When Bankruptcy Is The Best Solution
Richard Lehmann, Forbes.com, 09.23.05, 11:20 AM ET
The management at AMR’s American Airlines should be praying hard, since only an act of God can now save their company from an eventual bankruptcy filing. The bankruptcies by Delta Air Lines and Northwest Airlines on Sept. 14 were close enough to Sept. 11 to revive memories of its impact on the airline industry. More importantly, it leaves American as the only legacy carrier that has not resorted to a court ordered restructuring.
From my 25 years of involvement in and reporting on bankruptcies, as well as lifetime career in finance, I have learned a few things about when bankruptcy becomes both inevitable and even desirable. AMR (nyse: AMR - news - people ) has reached that point. One need only look back at history to see why this is so.
Legacy airlines are those that grew fat and happy during a time when the government regulated the industry, dictating fares and route competition. When deregulation came more than 25 years ago, new carriers sprang up and highlighted the structural flaws that regulation had instilled in this industry.
Peter Drucker, in his writings on management, pointed out that all industries had one--or more--of three common structural weaknesses. They were either labor intensive, capital intensive or vulnerable to the cost and supply of a key commodity. Airlines are in the unhappy situation of having all three weaknesses. With deregulation, legacy carriers found themselves with labor costs, work rules and cost structures that could not compete against new upstarts. One-by-one, Pan Am, TWA, Eastern, Braniff, United, US Air, Continental (nyse: CAL - news - people ) and a multitude of smaller players threw in the towel.
AMR, like its peers, used the threat of bankruptcy to extract wage concessions and work-rule changes from its employees--changes that would have allowed it to become more efficient and enable it to trim back unprofitable routes. This did not, however, relieve it of employee seniority costs (i.e. the higher wages earned by its more senior “last to go†employees and their higher pension costs)--costs, which an upstart carrier doesn’t have. But even after squeezing its labor force, AMR is still left with billions in debt from the hundreds of aircraft it does not want and the expensive airport gates that are being under-utilized. Only through bankruptcy can they quickly reduce this large and costly accumulated debt.
The current spike in fuel prices--the third vulnerability--became the straw that broke the camel’s back for Delta (nyse: DAL - news - people ). Escalating fuel costs have been a perennial problem for airlines, because they make many aircraft obsolete even before they are able to recover their cost through operations. This is why the upstart airlines fly the newest fuel-efficient planes, not cheap, used ones. In short, the aircraft fleets of legacy carriers are overvalued.
In the past, the practice for airlines was to wait until they ran out of cash, had big payments coming due or lost their credit lines before filing bankruptcy. Hence, by the time they filed, the companies had a huge hole in their balance sheet or a negative net worth. In Delta’s case, this hole was $7 billion before counting an additional $10 billion for unfunded pension liability; in Northwest’s (nasdaq: NWAC - news - people ) case, $4 billion before a $6 billion pension shortfall.
This means shareholders will lose everything. Their shares continue to trade on the stock exchange at some price, but this has long just been an exercise in musical chairs. Since the beginning of the year, Delta’s bankruptcy filing before year-end was widely expected because of the debt and pension payments coming due--cash payments you don’t want to make if bankruptcy is inevitable. The Northwest filing caught many by surprise. Its filing was also inevitable, but its choice to file the same day as Delta showed an uncommon degree of wisdom and a sense of history.
Congress can help this industry--having half the industry in bankruptcy, as with asbestos-exposed companies, does grab their attention. The unfunded-pension costs will all fall on the U.S. taxpayers unless they act.
Yes, AMR can survive out of bankruptcy for another year or two, but it would be a pointless exercise. Its shareholders have no future, and with its current debt load, profitability is not on the horizon. With the latest bankruptcy filings, they become the only carrier left without the competitive advantage of a lean balance sheet and a lower cost bankruptcy or post-bankruptcy environment. In short, bankruptcy gives Delta and Northwest an immediate competitive advantage over AMR and, thus, only quickens the inevitable.
AMR should go for a prepackaged bankruptcy by stopping all debt payments now. It should set a negotiating deadline and offer to pay all legal fees--with incentives for all of the attorneys--if the deadline is met. This may have appeal in the Chicago legal community, where United’s bankruptcy is winding down and fresh meat is being sought. AMR's debt is already selling at a 30% to 40% discount to its par value. Asking creditors to give up that amount voluntarily--rather than face several years of uncertainty--and then have to surrender even more should not be a hard sell, especially with a motivated bar.
With the Delta and Northwest bankruptcies, the airline industry is near an inflection point where industry-wide consolidation and restructuring is possible. AMR can either be a leader in this process or wait and become the final victim. Sometimes bankruptcy is the answer to your prayers.
http://www.forbes.com/2005/09/23/amr-delta..._inl_print.html
Richard Lehmann, Forbes.com, 09.23.05, 11:20 AM ET
The management at AMR’s American Airlines should be praying hard, since only an act of God can now save their company from an eventual bankruptcy filing. The bankruptcies by Delta Air Lines and Northwest Airlines on Sept. 14 were close enough to Sept. 11 to revive memories of its impact on the airline industry. More importantly, it leaves American as the only legacy carrier that has not resorted to a court ordered restructuring.
From my 25 years of involvement in and reporting on bankruptcies, as well as lifetime career in finance, I have learned a few things about when bankruptcy becomes both inevitable and even desirable. AMR (nyse: AMR - news - people ) has reached that point. One need only look back at history to see why this is so.
Legacy airlines are those that grew fat and happy during a time when the government regulated the industry, dictating fares and route competition. When deregulation came more than 25 years ago, new carriers sprang up and highlighted the structural flaws that regulation had instilled in this industry.
Peter Drucker, in his writings on management, pointed out that all industries had one--or more--of three common structural weaknesses. They were either labor intensive, capital intensive or vulnerable to the cost and supply of a key commodity. Airlines are in the unhappy situation of having all three weaknesses. With deregulation, legacy carriers found themselves with labor costs, work rules and cost structures that could not compete against new upstarts. One-by-one, Pan Am, TWA, Eastern, Braniff, United, US Air, Continental (nyse: CAL - news - people ) and a multitude of smaller players threw in the towel.
AMR, like its peers, used the threat of bankruptcy to extract wage concessions and work-rule changes from its employees--changes that would have allowed it to become more efficient and enable it to trim back unprofitable routes. This did not, however, relieve it of employee seniority costs (i.e. the higher wages earned by its more senior “last to go†employees and their higher pension costs)--costs, which an upstart carrier doesn’t have. But even after squeezing its labor force, AMR is still left with billions in debt from the hundreds of aircraft it does not want and the expensive airport gates that are being under-utilized. Only through bankruptcy can they quickly reduce this large and costly accumulated debt.
The current spike in fuel prices--the third vulnerability--became the straw that broke the camel’s back for Delta (nyse: DAL - news - people ). Escalating fuel costs have been a perennial problem for airlines, because they make many aircraft obsolete even before they are able to recover their cost through operations. This is why the upstart airlines fly the newest fuel-efficient planes, not cheap, used ones. In short, the aircraft fleets of legacy carriers are overvalued.
In the past, the practice for airlines was to wait until they ran out of cash, had big payments coming due or lost their credit lines before filing bankruptcy. Hence, by the time they filed, the companies had a huge hole in their balance sheet or a negative net worth. In Delta’s case, this hole was $7 billion before counting an additional $10 billion for unfunded pension liability; in Northwest’s (nasdaq: NWAC - news - people ) case, $4 billion before a $6 billion pension shortfall.
This means shareholders will lose everything. Their shares continue to trade on the stock exchange at some price, but this has long just been an exercise in musical chairs. Since the beginning of the year, Delta’s bankruptcy filing before year-end was widely expected because of the debt and pension payments coming due--cash payments you don’t want to make if bankruptcy is inevitable. The Northwest filing caught many by surprise. Its filing was also inevitable, but its choice to file the same day as Delta showed an uncommon degree of wisdom and a sense of history.
Congress can help this industry--having half the industry in bankruptcy, as with asbestos-exposed companies, does grab their attention. The unfunded-pension costs will all fall on the U.S. taxpayers unless they act.
Yes, AMR can survive out of bankruptcy for another year or two, but it would be a pointless exercise. Its shareholders have no future, and with its current debt load, profitability is not on the horizon. With the latest bankruptcy filings, they become the only carrier left without the competitive advantage of a lean balance sheet and a lower cost bankruptcy or post-bankruptcy environment. In short, bankruptcy gives Delta and Northwest an immediate competitive advantage over AMR and, thus, only quickens the inevitable.
AMR should go for a prepackaged bankruptcy by stopping all debt payments now. It should set a negotiating deadline and offer to pay all legal fees--with incentives for all of the attorneys--if the deadline is met. This may have appeal in the Chicago legal community, where United’s bankruptcy is winding down and fresh meat is being sought. AMR's debt is already selling at a 30% to 40% discount to its par value. Asking creditors to give up that amount voluntarily--rather than face several years of uncertainty--and then have to surrender even more should not be a hard sell, especially with a motivated bar.
With the Delta and Northwest bankruptcies, the airline industry is near an inflection point where industry-wide consolidation and restructuring is possible. AMR can either be a leader in this process or wait and become the final victim. Sometimes bankruptcy is the answer to your prayers.
http://www.forbes.com/2005/09/23/amr-delta..._inl_print.html
