United Has to Learn to Fly Solo

Getting the federal loan guarantees it's seeking will only prolong the pain. This airline needs to prove it can survive on its own

By Michael Arndt

Editor's Note: After this commentary was posted on June 17, the federal government indeed rejected UAL's request for $1.6 billion in loan guarantees. UAL says it will continue to press for additional aid.

United Airlines managers have done a lot of long-overdue cost-cutting during 18 months in Chapter 11 bankruptcy protection. They've chopped $2.5 billion a year from payroll expenses, with some pilots taking 40% wage reductions. They've renegotiated aircraft leases and contracts with regional affiliates for an additional savings of $1.25 billion a year. Add in other cutbacks, including lower health-care benefits for retirees, and United's managers figure they've brought costs down by $5 billion annually, or almost a third.

Now, comes the payback -- they hope. Any day now, the federal government's Air Transportation Stabilization Board (ATSB) is expected to vote on United's revised request for $1.6 billion in loan guarantees, a judgment that will be based on the carrier's cost-cutting efforts and its overall restructuring. If United wins the government backing, managers say, it'll be able to get $2 billion in loans from a consortium led by J.P. Morgan Chase and Citigroup (C ) and exit bankruptcy sometime this autumn. United Chairman and Chief Executive Glenn F. Tilton was in Washington, D.C., on June 17, going over his business plan with ATSB staff.

For United's sake, however, the three-member ATSB should say no. Despite their hard-won accomplishments, United's managers haven't reduced costs enough to give the airline a long-term future, say many analysts after reviewing the restructuring plan. Only if United is turned down, they assert, will it be forced to cut as deeply as it must to keep flying.

RIVALS EVERYWHERE.

  United's wage rates are now close to what other major airlines pay, but they're still much higher than at discount carriers, which are the only ones making money these days. United's nonlabor costs, moreover, remain above those of most of its big rivals, such as American Airlines (AMR ) and Northwest Airlines (NWAC ), according to an analysis by Standard & Poor's Ratings Services.

That's not all: United would emerge from Chapter 11 with little cash and the prospect that jet fuel alone will burn through up to $750 million more than anticipated in 2004, and an additional $300 million in 2005. Plus, with the June 16 launch of Independence Air at Washington's Dulles International Airport, United is facing brutal competition from low-fare carriers at almost every one of its hubs. That could stop it from charging the premium fares it's banking on.

Perhaps most significant, United's managers haven't shaved pension expenses by even a dollar. Thanks to Congress, the airline is off the hook for replenishing its underfunded pension plans for two years. Still, United owes $4.1 billion to its pension funds over the next five years. That's huge. Indeed, if Southwest Airlines (LUV ) had United's pension expenses, one analyst calculates that the discount carrier would have had a $255 million loss last year instead of a $445 million profit.

ONCE REJECTED.

  By some analysts' reckoning, even if United gets its $2 billion loan package, it could be cash-strapped by the end of 2005, after paying all its bills, which in post-bankruptcy would include nearly $500 million a year in interest. As a result, the airline could be forced back into Chapter 11 by as early as 2006, these analysts say. "They're still not where they need to be to have a viable future," concludes Philip Roberts, managing principal of Unisys' R2A Transportation Management Consultants.

What the ATSB will do is anyone's guess. The three-member board -- comprising appointees from the Transportation Dept., Treasury, and the Federal Reserve Board -- meets privately and follows no published schedule. It was established after the September 11 terrorist attacks to aid airlines that couldn't get money on their own as air traffic disappeared and industry losses deepened. Since then, the ATSB has backed loans to six airlines and turned away requests from nine others, including United. Within weeks of that initial rejection in November 2002, United went into bankruptcy.

Until a few months ago, most analysts had been wagering that this time, United would get its aid. It was meeting financial targets that lenders had set while in Chapter 11, and managers were methodically ticking off cost-cuts from their restructuring to-do list. But then US Airways Group (UAIR ), which has received the biggest loan guarantee, went into technical default on its loans, forcing the ATSB to renegotiate terms to salvage the deal. And after that, fuel prices shot up, blowing a big hole in United's budget.

Editor's Note: After this commentary was posted, the federal government rejected UAL Corp."s request for $1.6 billion in loan guarantees. But the airline said it will continue to press for additional aid. By Michael Arndt

OTHER OPTIONS?

  Now some rivals are lobbying against United. They point out that it was losing money even before September 11. They also note that they've been able to tap the capital market for financing this year, despite their own junk credit ratings and losses. Plus, now that almost three years have passed since the attacks, they argue that United's problems mostly have to do with its inability to compete with low-cost discounters that are taking over the domestic market. Analyst Samuel C. Buttrick with UBS Securities says a loan guarantee now looks iffy at best.

United's managers insist they have no backup plan. They must say that, of course, to qualify for ATSB assistance, since guarantees are available only to airlines that have no other options. But in private, the managers acknowledge that they would probably be able to get money from United's current bank consortium, though at higher rates, or from private-equity investors. But they also concede that they would have to cut much more from the labor budget to get the cash.

Money can still be saved. Before United's managers coerced the airline's labor unions into lowering their pay substantially a year ago, United paid its most-experienced pilots as much as $290,000 a year. Now, they get $195,000, or 33% less. Still, according to Aviation Information Resources, United pilots earn more than comparably experienced pilots at American and virtually every discount airline.

POISON RISK.

  Pensions provide the greatest potential for savings, however. In its annual statement, United lists $4.1 billion in obligations to its qualified pension plans and $400 million more to nonqualified plans. The reason for the shortfall: United contributed only $6 million to its pension plans since 2000, as it hoarded cash to pay for day-to-day operations. To restore the funds, it'll have to pay an average of $900 million a year over the next five years. Unless traffic and ticket prices surge, which both seem unlikely, analysts warn that United won't have that kind of money.

United can't simply dump these liabilities on the government's Pension Benefit Guaranty Corp. Only companies on the verge of liquidation can do that. But if United's managers are serious about saving the company, they should negotiate concessions with its unions. Of course, that risks poisoning management-labor relations, which, in turn, could undo United's recent successes in on-time performance and customer service. That explains why managers have kept this budget item off the negotiating table.

Unions might be more understanding than managers think, however. Though they grumbled, every one went along with pay cuts in 2003, and on June 10, they all went further by approving $50 million-a-year reductions in retiree health-care benefits.

FAINT HOPE.

  Earlier in June, United's Tilton went to Capitol Hill to update the House Aviation subcommittee on the airline's "self-help initiative," as he dubbed its restructuring. He highlighted the rounds of cost-cutting and the start of United's own discount carrier, Ted, to blunt the assault of low-fare rivals. But he said: "No network carrier or low-cost carrier is guaranteed, or should be guaranteed, survival. The company that survives should be the one that does the best work."

As things stand, United has only faint hope of being one of those survivors over the next few years. It will need more than 35 years, for instance, to pay off its debts, based on current revenue, according to S&P's Philip Baggaley. Recognizing United's half-steps, the ATSB should tell United no, again. By doing so, the board would force United managers to take full advantage of Chapter 11 status and bring costs down to levels the airline could sustain. Then, and only then, might United truly become a carrier for the long haul.

Arndt is a correspondent in BusinessWeek's Chicago bureau

Edited by Beth Belton

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