A Rougher Atlantic Crossing Than Delta Bargained For

It was all in good fun. But the symbolism was apt on Nov. 1, when Delta Air Lines Inc. President W. Whitley Hawkins cut the ribbon to inaugurate the new European service Delta recently bought from Pan Am Corp. Just as Hawkins snipped the huge red ribbon wrapped around an Airbus jet, the wind whipped across the tarmac at New York's John F. Kennedy International Airport. As an oversized bow toppled over on the assembled officials, their startled expressions spoke volumes: Is nothing easy about expanding overseas?

Wall Street doesn't think so. While nobody doubts the Atlanta-based carrier's global potential, its expansion is turning out to be more expensive than anyone imagined. To buy Pan Am's European routes and its Northeast shuttle, Delta agreed in August to fund ongoing Pan Am losses and capitalize a new Pan Am reorganized to focus on Latin America. With that carrier burning through $2.5 million in cash per day, Delta has already had to pump in $105 million more than expected.

DEAD OF WINTER. That's giving analysts the shivers. On Nov. 5, Helane Becker of Shearson Lehman Brothers Inc. reduced her buy recommendation on Delta's stock to a hold, helping drive the stock below 61 from 70 on Oct. 16. Both Standard & Poor's Corp. and Moody's Investors Service Inc. have downgraded the carrier's debt.

Is Wall Street suffering another case of myopia? Yes and no. Given that rivals United Airlines Inc. and American Airlines Inc. are themselves expanding headlong overseas, Delta had little choice but to bite when the Pan Am routes became available. Pan Am's European system -- lacking a steady feed of domestic traffic and fraught with inefficiencies -- has long lost money. But as Delta Chairman Ronald W. Allen said in August: "Give Delta a chance, O. K."?

But what will it cost? Consider first that Delta is starting up its new European service in the dead of winter, when traffic always slows to a trickle, even in strong economic times. Moreover, as its revenues stall, Delta is taking on big new costs, such as training 7,000 Pan Am employees. Even Thomas J. Roeck Jr., Delta's senior vice-president for finance, admits that the European routes won't spin off profits until next summer.

While Europe eventually will turn around, however, Delta's ongoing exposure to Pan Am is more troublesome. Drawn into a bidding war for the company with Carl Icahn's Trans World Airlines Inc., Delta assumed many more obligations than it wanted to. And that's hurting already.

Here's an example. As part of the original deal, Delta agreed to fund as much as $100 million in Pan Am losses under certain conditions before Dec. 3, when the airline is scheduled to emerge from Chapter 11. But because Pan Am was chewing through cash so voraciously, Delta forced Pan Am's creditors to accept a new deal on Oct. 22. Delta agreed to provide $140 million in cash for Pan Am until Dec. 3. Assuming the cash is all used, $50 million of it will become debt owed to Delta by the post-Chapter 11 Pan Am. An additional $40 million will be paid back on Dec. 3.In any event, Delta will still have close ties to Pan Am. To capitalize the new company, Delta has agreed to pay $50 million for 45% of Pan Am's equity and will provide a $100 million credit line. It will also hold notes from Pan Am for $205 million, which, as part of the renegotiated deal, will sport an interest rate boosted from 10% to 15%. Delta's total exposure to Pan Am is about $1 billion, $726 million of it cash.

TALL ORDER. Pan Am's creditors, however, are already complaining that the new deal adds $33 million to the carrier's annual costs, and have asked Delta to consider extracting less through interest and fees. The creditors will own 55% of the new Pan Am's equity, and they say the payments to Delta are clouding Pan Am's outlook.

Ultimately, though, the new Pan Am has to flourish for Delta to look smart. That's a tall order. Beset with stiff competition from American, which bought the Latin American system of Eastern Air Lines Inc. in 1989, Pan Am's traffic in the region has been falling dramatically during its turmoil. New Pan Am President Russell L. Ray Jr. says a revamped ad campaign and passengers transferring from Delta flights will boost traffic considerably next year. But projections -- which concede $87.6 million in losses next year -- assume that Pan Am will do more business on the routes than it has in far better economic times.

There's little sign that prosperity is right around the corner. Buying those European routes was the right move for Delta. But the cost of its ambition is proving to be steep indeed.

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