The United Airlines filing for Chapter 11 bankruptcy protection may have been expected but it is focusing minds across the industry over the potential impact and the lessons to be learned

By any measure, the United Airlines bankruptcy is big. Not only is it the industry's largest to date, comfortably topping the previous record set by Continental Airlines in 1990, but it ranks seventh on the world scale of corporate failures, joining the likes of US telecoms giant Worldcorp and energy firm Enron, which took Arthur Andersen with it. Yet Kevin Mitchell, director of the influential Business Travel Coalition, argues that the immediate impact and long-term risks of the United bankruptcy could be even greater than those three recent US failures combined.

United entered Chapter 11 with assets of some $24.2 billion and debt of around $23 billion, of which nearly $1 billion came due in December. The group was losing $20-22 million a day as it filed, with the burden of bankruptcy and likely loss of traffic adding to its burden. United's executives had all but resigned themselves to bankruptcy when the Air Transportation Stabilization Board rejected its plea for a $1.8 billion loan guarantee, calling the carrier's business plan "fundamentally unsound".

Exit financing

The board showed a real distaste for draining its $10 billion loan guarantee account, and seemed more comfortable taking the role of a provider of exit financing, leaving the heavy lifting to old-fashioned Chapter 11 processes.

Bankruptcy expert David Lemay of law firm Chadbourne and Parke says bankruptcy is not a public policy tool, but is concerned solely with one company's recovery. It builds stronger companies, not necessarily a stronger industry, says Lemay, who was central in Continental's restructuring.

Martin Zohn, a partner with reorganisation specialist Proskauer Rose, says the bankruptcy code is ideal for capital-intensive entities such as United because it brings suppliers to a more central role. The goal, he says, is "to create a capital structure that is more sound - companies don't have to deal with a gigantic overhanging debt or the cost of the debt".

But Morrison and Foerster bankruptcy expert Adam Lewis cautions: "It is not as simple as many think to reject aircraft leases or reject labour contracts. The company has to show the court it has made good-faith efforts to negotiate a new wage package and that no other recourse is open to it."

Even if rejecting aircraft leases is not as easy as is often thought, the current economic climate gives the carrier an advantage. John Gillick of Pillsbury Winthrop, who helped guide America West though its reorganisation, says: "No aircraft owners want to take back planes because of market conditions - there's no place else to put them." As of November, some 2,507 commercial aircraft (408 widebodies and 1,179 narrowbodies) were in storage.

After it filed, United had 60 days to secure obligations on its leased aircraft before the lessors have the right to take them. George Washington University Aviation Institute director Darryl Jenkins said United executives had told him they thought they could cut supplier and aircraft lease contracts by the same percentage as wages. "If they get a 15% reduction, they'll be able to make it work," he says. United's non-union employees have already taken pay cuts and chief executive Glenn Tilton warns of excruciating and painful cuts ahead.

Pace-setter role

Michael Levine, who was a top executive of Northwest Airlines before returning to academia at the Harvard Law School, thinks the awareness of bankruptcy, if not the immediate fear of it, will be enough to force other carriers into cost-cuts. Ironically the United bankruptcy could return the airline to its role as pace-setter: just as United was the driver of higher industry wages with its summer 2000 pilot contract, so it will be the driver of cutting costs now.

United has further to go than any other major carrier. A Unisys R2A team led by consultant Phil Roberts analysed the costs of the legacy of network carriers, taking Southwest Airlines as its baseline. By any measure, United's performance was the furthest adrift. Just in pilot productivity based on block hours flown, United pilots produced only 54% of the block hours of the average Southwest pilot. To reach overall Southwest levels, United would have to cut its cost base by 48% or $4 billion.

Although United's unions pledged good faith in working toward savings, they were already grumbling about the government's rejection of aid. Air Line Pilots Association president Duane Woerth casts blame on the government. "[This administration] intervened in more than one dispute, citing fears of crippling the economy, and is ironically idly sitting by". At least one equity analyst finds such an attitude "unnerving".

At least the United unions are blaming someone outside the company instead of the mistakes inherent in its attempt at employee ownership. That, arguably, is the way United painted itself into the corner from which Chapter 11 was the only escape. The 55% employee stake, created in 1994 in return for $4.9 billion in concessions, was more meaningful politically than financially. Pilots ended up giving most and taking most of the power too. Aaron Gellman, noted professor at the Transportation Centre and the Kellogg School of Management at Northwestern University, laments that pilots ended up being in control. "What do they know about managing a company?" he asks.

The employee stake will be legally wiped out in a bankruptcy, but their ownership lost any real value months ago. United staff were unable to sell their shares except on retirement or quitting. This forced them to be long-term investors, but deprived them of the basic freedom to turn shares into liquidity.

After a few months of a honeymoon that saw productivity shoot up, United's revenue fell off precipitously, and by 1999 was in full rout. The share value, which rose from $40 to $100 before falling into single digits, became a bargaining chip. To keep their members loyal and give them a sense of control, union leaders used the power of their dual roles as managers/employees to extract costly labour agreements such as the 2000 pilots pact, with rises of 22-29% - the industry's richest ever.

That contract was achieved at the cost of a widely publicised work-to-rule by the pilots, which drove away passengers as surely as if it had been a strike. Some estimate that the slowdown cost United more than full pilots' strike had cost American Airlines three years before.

United never recovered the passengers it drove away and other revenues dried up, leaving growth lagging even as costs ran ahead. As the revenue gap widened, United's structural flaws became obvious: it may have a vast route structure, but it is anchored by hubs that the carrier cannot dominate.

Even at its Chicago home, United's yield premium is below the industry average, as it is at San Francisco. Its Washington Dulles yield premium fell slightly below the national average by 2002, says Salomon Smith Barney analyst Brian Harris. Between mid-2000 and 2001, United's local revenue growth at its hubs fell by 7%, says Harris, while American's grew by nearly 30% and the industry average was just over 1%. Its average seat market-share at its hubs was 54%, below the 59.7% industry average.

Burst bubble

The severity of United's revenue problems stems in part from its exposure to the burst bubble of spending by technology companies. Two of its hubs, San Francisco and Dulles, are both in regions hit hard by the tech collapse as companies like America Online and Cisco slashed their travel spending. Since 2000, United's unit revenue per seat has fallen 17%, calculate consultants at Back Aviation. Continental's has dropped 13% in that period.

Continental is often mentioned as evidence that bankruptcy works. But although Lehman Brothers analyst Gary Chase thinks United has a stronger chance of a quick and substantial change to cost structure than he has seen in other bankruptcies, he cautions: "The success of Continental since the mid-1990s has nothing to do with bankruptcy and everything to do with major cultural and operating changes implemented by a new management team."


Source: Airline Business