Klm And Northwest: Rumble In The Cockpit

Their pact was seen as a model. Now it may be unraveling

It was a match made in heaven, or at least at 30,000 feet: the partnership of KLM Royal Dutch Airlines, a European carrier with a tiny home market, and Northwest Airlines Inc., a regional U.S. player with great Pacific routes. The seven-year KLM-Northwest union--which allows them to merge schedules, pricing, and service--has been adding $200 million annually to the carriers' combined revenue. And the link proved critical in 1993 when Northwest narrowly avoided bankruptcy thanks to $250 million in loans arranged by KLM.

Now that Northwest is prospering again, the deal may be unraveling. KLM is suing Northwest, which recently posted a record 1995 profit of $392 million and boasts the highest profit margin among U.S. carriers. At issue is a plan adopted by the Eagan (Minn.) carrier last November that would prevent the Dutch airline from adding to its 20% stake in Northwest's common stock. KLM holds an option to acquire an additional 4% of Northwest's stock in 1998--a right granted by Northwest's other original investors when they were desperate for cash during late 1992. Another KLM lawsuit challenges an October change in a stockholders' agreement that eliminates its veto power over a major sale of assets.

All this bickering could destroy a high-profile pact just as other carriers are attempting to imitate it. The recent "open skies" agreement struck by the U.S. and Germany to eliminate restrictions on flights between the two countries has sparked new interest in such arrangements. But "you can't have a good commercial alliance, which is based on trust, if you have fractious arguments over governance," warns Jon F. Ash, managing director with Global Aviation Associates Ltd. in Washington, D.C.

ANIMOSITY DEFUSED. The dispute is fierce. Dealmakers Gary L. Wilson and Alfred A. Checchi, who bought Northwest in a 1989 leveraged buyout, claim KLM is seeking "creeping control" of their airline--even though American law limits foreign carriers' ownership of U.S. airlines to 25%. A source close to KLM fires back that Wilson and Checchi are only interested in quickly selling Northwest to the highest bidder. Sources say Northwest and Continental Airlines Inc. discussed joining forces last year but couldn't agree on price. So far, Northwest employees, who are represented by three board members, and other original investors such as Bankers Trust New York Corp., are siding with Wilson and Checchi.

Many on Wall Street and in the airline industry, however, are sympathetic to KLM. "Wilson and Checchi agreed to [the stock option] and now they're trying to retrade the deal," says John Pincavage, airline analyst with Dillon Reed in New York. Since going public again in March, 1994, Northwest's stock has more than tripled, to around $43, greatly increasing the value of the options held by KLM.

Not every sign points to trouble. On Feb. 23, KLM said it would replace its president, Pieter Bouw, and two other KLM executives on Northwest's board with outsiders. The announcement was coordinated with Northwest and applauded by Checchi and Wilson, who had been complaining the KLM execs had a conflict of interest because of their roles at both companies. The move also defuses personal animosity between Northwest CEO and President John H. Dasburg and Bouw. KLM and Northwest both say they won't allow the dispute to kill a mutually beneficial arrangement.

Yet it is unlikely that the core of the dispute--ownership and control of Northwest--will be resolved any time soon. Northwest is seeking to dismiss both KLM suits. But if that gambit fails, expect protracted litigation. Checchi and Wilson are not allowed to sell their shares until 1997 under an agreement with employees. And Checchi says that he would be content to stay at the company "for many years in the future." For now, it appears that Northwest and KLM are stuck with each other. This once heavenly match may turn out to be the marriage from hell.

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