Business Travel Coalition
POSITION PAPER
Analysis Of United Airlines’ Application To The ATSB
November 1, 2002
Summary
Public policy in U.S. commercial air transport is premised upon generating consumer benefits, not protecting the interests of competitors, shareholders, lessors, creditors or employees. All these stakeholders have been heard from regarding their views on the efficacy of United Airlines’ application to the Air Transportation Stabilization Board (ATSB) for a loan guarantee. However, we have not heard from the consumer, specifically the corporate buyer of air transportation services.
The customer has a major stake in the decision of the ATSB; a decision that will no doubt have a profound impact on the health of airline industry competition for decades to come. The Business Travel Coalition (BTC) believes that the ATSB should review and approve United’s application with urgency so that the company can financially restructure outside of Chapter 11 bankruptcy protection on an expeditious basis. If United is forced to restructure inside bankruptcy protection, risks would increase exponentially for customers, the industry and the national economy.
Background
The ATSB was so named because its mission is to enable the financial stabilization of airlines that commit to a business plan that assures the federal government that a loan would be repaid. However, a business plan in this context is a narrowly defined one. It represents a financial restructuring the intent of which is to take significant costs out of the firm with a specific objective of creating and optimizing free cash flow. In other words, the purpose is to “stabilize the patient.â€
Such a business plan does not include product, pricing and marketing strategy components. By virtually all measures United never had a true business strategy for managing the enterprise through the full business cycle. Importantly, United clearly needs to understand what product its business travel customer wants, and at what price point, and what alternatives the customer has to a seat on United. United’s new CEO cannot address long-term strategy until financial stabilization is in place, which must be an urgent focus for him.
United’s cash reserves are dwindling, and it faces an expected Q4 daily cash burn rate of $9 million. United will face a cash squeeze in December when a non-deferrable debt payment of some $700 million is due. Compounding this financial problem is that other financial covenants require United to maintain a cash balance of several hundreds of millions of dollars. Very clearly, without ATSB loan guarantee approval by the end of November, United would be forced to seek Chapter 11 protection in December.
To be sure there are competitors to United, who through their surrogates, are working the Washington back channels arguing that United should be denied the loan guarantee because bankruptcy for United would allow the firm to abrogate costly union contracts and rid itself of a dysfunctional governance structure wherein employee Board of Director members have veto power over decisions of strategic import. These well-credentialed consultants crafted a similar message when the ATSB was reviewing US Airways’ loan guarantee application.
Such tactics, however, do not obfuscate these competitors’ true motivations. What these competitors really want is for United to enter into the risky waters of Chapter 11 only to slide into Chapter 7 wherein the airline is liquidated. Taking United’s capacity out of the system would, in their view, enable a return to the pricing power of the late 1990s where business travelers would once again finance major airlines bloated cost structures. In other words, these competitors would like to avoid painful restructuring decisions.
Alternatives
In 2000 and 2001 BTC endeavored to broaden the public policy debate regarding the proposed United Airlines – US Airways merger, which was ultimately disallowed by the U.S. DOJ. Among many BTC concerns was that such a merger would forever institutionalize two airlines’ excessive cost structures to be undergirded by ever-higher business airfares. US Airways’ current bankruptcy, and United’s significant cost reduction proposal to ATSB, validate these concerns.
BTC believes just as fervently that the best possible proposal has been developed by United and its unions and submitted to the ATSB. Labor costs would be reduced by some 18% and available seat miles would be reduced by 22%, compared with the first half of 2001. The upshot would be a 20% reduction in seat mile costs. Importantly, a resurgent low-fare airline sector would continue to encourage United, as it develops its long-term strategy, to become more efficient and to innovate.
While United’s proposal includes a permanent reduction in labor costs across the board and a permanent increase in employee productivity at all levels, the airline will never have the cost structure of a Southwest or an America West, but lower costs and more efficient staffing would allow the company to stabilize its operations and platform and gain the running room necessary to refocus its product on the business customer. The proposal before the ATSB is a strong one. The alternative, filing for Chapter 11 bankruptcy protection, is fraught with risk.
The Risks Of Bankruptcy
On one level bankruptcy could harm the enterprise, employees, customers, debt holders, creditors and shareholders. On another level, businesses, communities and the national economy could be harmed. A number of industry experts are of the view that if United enters bankruptcy, it would secure an immediate 20% cost advantage vis-Ã -vis American Airlines forcing that firm to seek protection as well. Never in our commercial history has the U.S. had two major airlines--two powerful national economic engines--in bankruptcy at the same time.
Beyond American Airlines, a United bankruptcy filing would ripple through the industry. Delta, Northwest and Continental would likely not be able to continue business as usual while United shed costs and liabilities in bankruptcy. Instead, it is most probable that every one of these carriers would either seek bankruptcy or a risky labor confrontation to match a restructured United. The result would be harm to consumers in the both the short and the long runs. Service in a bankrupt industry would be inconsistent, and withdrawn or sharply reduced in many markets. In the longer run, two or three superpower airlines would secure monopoly pricing power over business travel. This is uncharted, risky territory.
There several additional areas of risk that need to be considered by the ATSB and Congress, who authorized the ATSB.
1. It is pure myth that in bankruptcy United would be able to simply nullify labor contracts and pay employees wages and benefits it deemed competitive. There is not a single case of where there was labor – management animosity during a period of bankruptcy where the airline survived (e.g. Eastern Airlines). Management would have to enter into a negotiation process with each of its labor groups.
2. United could expect an immediate loss of revenue of 10% to 15% from leisure and business travelers booking away. These travelers would come to know that unlike in the past, competing airlines would not likely honor their tickets were United to fail because of these airlines’ own financial problems. Additional revenue erosion would
also likely occur as corporate incentive meetings and national conventions book away because large deposits are usually required upon signing contracts for such group movements.
3. Whether financial restructuring happens outside or inside bankruptcy protection, the same order of magnitude of borrowing would be necessary to stabilize the firm, i.e. $2 billion. There is no guarantee that United would be able to secure such lending. Indeed, once in bankruptcy, US Airways was unable to interest a single lending institution in participating in a loan.
4. United should not want to exploit its creditors under Chapter 11 as such a practice would limit United’s access to capital markets for years while driving up its long-term cost of funds.
5. United would be ceding significant control to a bankruptcy Judge whose job would be to balance competing stakeholders’ interests. The enterprise would surely change but in uncontrollable and unforeseeable ways. For example, would United exit bankruptcy without its Pacific or Atlantic routes, or with or without its wide-body jets?
6. A United bankruptcy would put airport services at risk at some of the country''s busiest airports including Chicago, Denver, San Francisco and Los Angeles. United provides substantial portions of the operating revenues and capital budgets for those airports through landing fees, project expenditures and bond issues. Were United to default on those obligations, airports would likely curtail services.
7. The prospect of United and American operating under court protection raises the serious problem of defaults on airport bond payments. A collapse of the airline bond market would impact millions of individual investors who participate in these bond funds as part of their retirement planning.
8. A United bankruptcy would disrupt an already shaky financing market. United backs more than $4 billion of public market secured bonds and more than $2 billion of unsecured bonds. The unsecured bonds would be wiped out in a bankruptcy and one could expect United to default on most of its secured bonds. An American bankruptcy would mean even more bond defaults. The airline financing market has never experienced anything approaching such a disruption. Some experts believe a series of defaults would likely shut down the public capital markets for two to three years for every major U.S. airline other than Southwest.
9. An uncertain bankruptcy process would negatively impact suppliers and vendors and their employees up and down the airline industry supply chain.
10. If unsuccessful, and United is liquidated in a Chapter 7 process, competition would suffer over the short and long terms. The customer needs as many viable airline competitors as possible. Losing a strong competitor such as United, especially on a global basis with its industry-leading STAR alliance, would damage the industry irreparably.
Conclusion
BTC believes that United Airlines, and its numerous stakeholders, would be far better off if a financial restructuring takes place outside of bankruptcy protection. It is not just an urgent matter due to United’s cash position. The prospect of hostilities with Iraq, where United would be required to redeploy aircraft to carry U.S. troops, and absorb an upward spike in jet fuel costs, also points to a need for the ATSB to move with great dispatch in approving United’s application for a loan guarantee.
The main concern of the ATSB should be whether United would be able to repay a $2 billion loan. It might be useful to put this loan application in the context of the larger public policy framework. The current guiding U.S. public policy, with regard to commercial air transportation, is deregulation, as opposed to government regulation.
United arguably has the best franchise of the major U.S. network airlines. If after significant cost reduction and productivity improvements United fails, then it is exceedingly probable that the top six major network airlines would likewise fail, in which case, we would require a new public policy. Put another way, if United fails, a $2 billion loan default would be the least of our government’s problems.
…
The mission of the Business Travel Coalition, located in Radnor, PA, is to advocate public policy and supplier issues of concern to customers of the business travel industry. Learn more about BTC at http://www.btctravelogue.com.
POSITION PAPER
Analysis Of United Airlines’ Application To The ATSB
November 1, 2002
Summary
Public policy in U.S. commercial air transport is premised upon generating consumer benefits, not protecting the interests of competitors, shareholders, lessors, creditors or employees. All these stakeholders have been heard from regarding their views on the efficacy of United Airlines’ application to the Air Transportation Stabilization Board (ATSB) for a loan guarantee. However, we have not heard from the consumer, specifically the corporate buyer of air transportation services.
The customer has a major stake in the decision of the ATSB; a decision that will no doubt have a profound impact on the health of airline industry competition for decades to come. The Business Travel Coalition (BTC) believes that the ATSB should review and approve United’s application with urgency so that the company can financially restructure outside of Chapter 11 bankruptcy protection on an expeditious basis. If United is forced to restructure inside bankruptcy protection, risks would increase exponentially for customers, the industry and the national economy.
Background
The ATSB was so named because its mission is to enable the financial stabilization of airlines that commit to a business plan that assures the federal government that a loan would be repaid. However, a business plan in this context is a narrowly defined one. It represents a financial restructuring the intent of which is to take significant costs out of the firm with a specific objective of creating and optimizing free cash flow. In other words, the purpose is to “stabilize the patient.â€
Such a business plan does not include product, pricing and marketing strategy components. By virtually all measures United never had a true business strategy for managing the enterprise through the full business cycle. Importantly, United clearly needs to understand what product its business travel customer wants, and at what price point, and what alternatives the customer has to a seat on United. United’s new CEO cannot address long-term strategy until financial stabilization is in place, which must be an urgent focus for him.
United’s cash reserves are dwindling, and it faces an expected Q4 daily cash burn rate of $9 million. United will face a cash squeeze in December when a non-deferrable debt payment of some $700 million is due. Compounding this financial problem is that other financial covenants require United to maintain a cash balance of several hundreds of millions of dollars. Very clearly, without ATSB loan guarantee approval by the end of November, United would be forced to seek Chapter 11 protection in December.
To be sure there are competitors to United, who through their surrogates, are working the Washington back channels arguing that United should be denied the loan guarantee because bankruptcy for United would allow the firm to abrogate costly union contracts and rid itself of a dysfunctional governance structure wherein employee Board of Director members have veto power over decisions of strategic import. These well-credentialed consultants crafted a similar message when the ATSB was reviewing US Airways’ loan guarantee application.
Such tactics, however, do not obfuscate these competitors’ true motivations. What these competitors really want is for United to enter into the risky waters of Chapter 11 only to slide into Chapter 7 wherein the airline is liquidated. Taking United’s capacity out of the system would, in their view, enable a return to the pricing power of the late 1990s where business travelers would once again finance major airlines bloated cost structures. In other words, these competitors would like to avoid painful restructuring decisions.
Alternatives
In 2000 and 2001 BTC endeavored to broaden the public policy debate regarding the proposed United Airlines – US Airways merger, which was ultimately disallowed by the U.S. DOJ. Among many BTC concerns was that such a merger would forever institutionalize two airlines’ excessive cost structures to be undergirded by ever-higher business airfares. US Airways’ current bankruptcy, and United’s significant cost reduction proposal to ATSB, validate these concerns.
BTC believes just as fervently that the best possible proposal has been developed by United and its unions and submitted to the ATSB. Labor costs would be reduced by some 18% and available seat miles would be reduced by 22%, compared with the first half of 2001. The upshot would be a 20% reduction in seat mile costs. Importantly, a resurgent low-fare airline sector would continue to encourage United, as it develops its long-term strategy, to become more efficient and to innovate.
While United’s proposal includes a permanent reduction in labor costs across the board and a permanent increase in employee productivity at all levels, the airline will never have the cost structure of a Southwest or an America West, but lower costs and more efficient staffing would allow the company to stabilize its operations and platform and gain the running room necessary to refocus its product on the business customer. The proposal before the ATSB is a strong one. The alternative, filing for Chapter 11 bankruptcy protection, is fraught with risk.
The Risks Of Bankruptcy
On one level bankruptcy could harm the enterprise, employees, customers, debt holders, creditors and shareholders. On another level, businesses, communities and the national economy could be harmed. A number of industry experts are of the view that if United enters bankruptcy, it would secure an immediate 20% cost advantage vis-Ã -vis American Airlines forcing that firm to seek protection as well. Never in our commercial history has the U.S. had two major airlines--two powerful national economic engines--in bankruptcy at the same time.
Beyond American Airlines, a United bankruptcy filing would ripple through the industry. Delta, Northwest and Continental would likely not be able to continue business as usual while United shed costs and liabilities in bankruptcy. Instead, it is most probable that every one of these carriers would either seek bankruptcy or a risky labor confrontation to match a restructured United. The result would be harm to consumers in the both the short and the long runs. Service in a bankrupt industry would be inconsistent, and withdrawn or sharply reduced in many markets. In the longer run, two or three superpower airlines would secure monopoly pricing power over business travel. This is uncharted, risky territory.
There several additional areas of risk that need to be considered by the ATSB and Congress, who authorized the ATSB.
1. It is pure myth that in bankruptcy United would be able to simply nullify labor contracts and pay employees wages and benefits it deemed competitive. There is not a single case of where there was labor – management animosity during a period of bankruptcy where the airline survived (e.g. Eastern Airlines). Management would have to enter into a negotiation process with each of its labor groups.
2. United could expect an immediate loss of revenue of 10% to 15% from leisure and business travelers booking away. These travelers would come to know that unlike in the past, competing airlines would not likely honor their tickets were United to fail because of these airlines’ own financial problems. Additional revenue erosion would
also likely occur as corporate incentive meetings and national conventions book away because large deposits are usually required upon signing contracts for such group movements.
3. Whether financial restructuring happens outside or inside bankruptcy protection, the same order of magnitude of borrowing would be necessary to stabilize the firm, i.e. $2 billion. There is no guarantee that United would be able to secure such lending. Indeed, once in bankruptcy, US Airways was unable to interest a single lending institution in participating in a loan.
4. United should not want to exploit its creditors under Chapter 11 as such a practice would limit United’s access to capital markets for years while driving up its long-term cost of funds.
5. United would be ceding significant control to a bankruptcy Judge whose job would be to balance competing stakeholders’ interests. The enterprise would surely change but in uncontrollable and unforeseeable ways. For example, would United exit bankruptcy without its Pacific or Atlantic routes, or with or without its wide-body jets?
6. A United bankruptcy would put airport services at risk at some of the country''s busiest airports including Chicago, Denver, San Francisco and Los Angeles. United provides substantial portions of the operating revenues and capital budgets for those airports through landing fees, project expenditures and bond issues. Were United to default on those obligations, airports would likely curtail services.
7. The prospect of United and American operating under court protection raises the serious problem of defaults on airport bond payments. A collapse of the airline bond market would impact millions of individual investors who participate in these bond funds as part of their retirement planning.
8. A United bankruptcy would disrupt an already shaky financing market. United backs more than $4 billion of public market secured bonds and more than $2 billion of unsecured bonds. The unsecured bonds would be wiped out in a bankruptcy and one could expect United to default on most of its secured bonds. An American bankruptcy would mean even more bond defaults. The airline financing market has never experienced anything approaching such a disruption. Some experts believe a series of defaults would likely shut down the public capital markets for two to three years for every major U.S. airline other than Southwest.
9. An uncertain bankruptcy process would negatively impact suppliers and vendors and their employees up and down the airline industry supply chain.
10. If unsuccessful, and United is liquidated in a Chapter 7 process, competition would suffer over the short and long terms. The customer needs as many viable airline competitors as possible. Losing a strong competitor such as United, especially on a global basis with its industry-leading STAR alliance, would damage the industry irreparably.
Conclusion
BTC believes that United Airlines, and its numerous stakeholders, would be far better off if a financial restructuring takes place outside of bankruptcy protection. It is not just an urgent matter due to United’s cash position. The prospect of hostilities with Iraq, where United would be required to redeploy aircraft to carry U.S. troops, and absorb an upward spike in jet fuel costs, also points to a need for the ATSB to move with great dispatch in approving United’s application for a loan guarantee.
The main concern of the ATSB should be whether United would be able to repay a $2 billion loan. It might be useful to put this loan application in the context of the larger public policy framework. The current guiding U.S. public policy, with regard to commercial air transportation, is deregulation, as opposed to government regulation.
United arguably has the best franchise of the major U.S. network airlines. If after significant cost reduction and productivity improvements United fails, then it is exceedingly probable that the top six major network airlines would likewise fail, in which case, we would require a new public policy. Put another way, if United fails, a $2 billion loan default would be the least of our government’s problems.
…
The mission of the Business Travel Coalition, located in Radnor, PA, is to advocate public policy and supplier issues of concern to customers of the business travel industry. Learn more about BTC at http://www.btctravelogue.com.
