The Mess At Continental: `We Had To Change Course'

Bankruptcy is never pleasant, but for Continental Airlines Chief Executive Hollis L. Harris, Chapter 11 is becoming more and more agonizing. Since putting the carrier into Chapter 11 bankruptcy reorganization in December, the former Delta Air Lines Inc. president has tried to fly Continental out of its mess--growing in some markets and vowing to avoid layoffs. But the effort hasn't worked. While all carriers have been hurt by a sluggish market, Continental Airlines Inc. has been clobbered. By early July, after months of red ink, "we saw it was worse than we thought," says a person involved in board deliberations. "We knew we had to change course."

That may be an understatement. As part of a shakeup, the board has abandoned Harris' plans. While Harris will still be CEO, new Executive Vice-President Robert R. Ferguson III, a veteran of the Braniff Inc. and Eastern Air Lines Inc. bankruptcies, will be calling many of the shots. He was brought in from Continental's holding company and will report to Harris. But Ferguson has a mandate from the board to make changes as he sees fit.

SWIFT SHIFTS. Continental executives and people outside the airline with knowledge of its operations say that Ferguson is preparing a restructuring program that could include layoffs, big asset sales, and even some departures from certain markets. Says one lawyer who has dealt with both Ferguson and Continental: "Changes will be swift and far-reaching."

Harris, who declined repeated requests for comment, may not have steered Continental out of its mess, but he can't be blamed for landing it there. When Continental filed for Chapter 11, it was reeling from high fuel prices, heavy debt, and a legacy of poor management under Frank A. Lorenzo. Yet Harris did anything but retrench.

His rationale: Continental risked losing passengers unless it demonstrated it was more than just a liquidating entity, a la Eastern. Harris boldly expanded in some markets. In New York, he took over 11 planes and 64 landing slots from Eastern at LaGuardia Airport, making Continental the largest carrier in the area, with 344 flights a day. And while he matched rivals' fare cuts, he resisted big cost-cutting measures and refused to order layoffs. Why? "Everyone figured that after the Persian Gulf war, things would bounce back to normal," says one Continental executive.

Harris may have hung on too long. Even as Continental was being hammered by sluggish traffic and fare wars, Harris "kept operating like he was at Delta," says a former senior executive. "Costs got out of control."

FARE FIASCO. The costs wouldn't have been so onerous if Harris had attracted more full-fare business travelers. Instead, bargain hunters bought up seats on the cheap. As a result, while the average plane was 70% full in June, says Continental, yields--revenues per passenger--remained weak (chart). And rivals, such as Northwest Airlines Inc., continued to slash fares.

In early July, Continental tried a 5% fare increase. But when no competitors followed suit, it was forced to rescind the hike. The reversal wasn't just embarrassing. It also suggested strongly that Continental would be hard put to turn a decent profit in the normally strong summer quarter.

The weak returns distressed Minneapolis investor Carl R. Pohlad and other board members, say two people privy to the board's deliberations. So directors turned to Ferguson, Lorenzo's former right-hand man, who had tried to steer Eastern through Chapter 11. Directors were aware that it might appear that Lorenzo was behind the decision to bring in Ferguson. But while Lorenzo is on the board, he doesn't sit on the executive committee calling the shots. And appearances aside, the board felt it had little choice: Harris had already gotten rid of most of the Lorenzo-era staffers who knew the bankruptcy courts.

Now, Ferguson, as vice-president for finance and marketing, will review nearly every major cost, including marketing, which had scant control under Harris. Creditors say Ferguson may abandon unprofitable markets or even such hubs as Denver, where Continental has struggled against United Airlines Inc. Neither Harris nor the company is giving specifics, but a spokesman says: "We'll be reviewing everything."

Continental isn't about to crash. The court recently approved a loan package that will give it nearly $100 million in fresh cash, and it has begun cutting costs. And it has strong-armed its lessors into kicking in money for plane refurbishments and restructuring debt, saving it about $300 million. Still, it has to cut much deeper before it can hammer out a reorganization plan. If it does, it might emerge from bankruptcy sometime next year. But the latest moves at the top signal that Harris is likely to be a co-pilot, at best, when that day comes.

Before it's here, it's on the Bloomberg Terminal.