Commentary: Big Airlines: Not Much Runway Left

United and the other major carriers must remake themselves -- or go down trying

For the nation's biggest airlines, the day of reckoning is at hand. And if they didn't already know it, they should now. With the rejection on June 17 of United Airlines Inc.'s (UALAQ ) second attempt to get $1.6 billion in federal loan guarantees, the Air Transportation Stabilization Board has made it clear that major carriers have nowhere to taxi to escape the onslaught of the discounters. Even if United does persuade the board to give it guarantees in its third and final attempt, that won't solve what's ailing United.

United has already made deep cuts since entering bankruptcy in December, 2002, lowering costs by almost a third. Pilots, aircraft lessors, and retirees have all chipped in to create $5 billion a year in savings. Still, that's nowhere near enough to return the carrier to health. With fuel costs soaring, United, like most legacy carriers, is still losing money. And low-cost players, which have gone from 16% of domestic capacity in 1998 to about 29% today, are flourishing. No amount of government aid can -- or should -- fix that.

That's why United is going to need more cost-cutting and perhaps a smaller network to save itself. Industry analysts believe the company must attract a private equity investor with or without loan guarantees.

But such a player would likely demand new management and cuts in areas once deemed untouchable. The biggest target: employee pensions that, in their present form, will cost the company at least $4 billion over the next five years. And if United cuts pensions, that would put pressure on American (AMR ), Delta (DAL ), and Northwest (NWAC ) to do the same.

United and other so-called legacy airlines must continue to remake themselves -- or die trying. Delta and Northwest are currently in negotiations with pilots to cut wages. Northwest is seeking givebacks from other unions, too. And Continental has warned it will need labor concessions to survive. Since 2001, the legacy carriers have chopped operating costs by $13.4 billion and have reduced payrolls by 100,000. Yet so far not one network major "has gotten to where they need to be for long-term viability," says airline expert Daniel M. Kasper of consultancy LECG Corp. (XPRT ) Pensions aren't the only problem. Health benefits, inefficient work rules, and seniority-based pay scales remain crippling. And with sky-high fuel prices and leaner winter travel ahead, maneuvering room for some big players may run out.

How the shakeout will unfold remains far from clear. Even some of the carriers that seem most endangered, like US Airways Group Inc. (UAIR ), could pull off a last-ditch transformation. And if the government rejects United's loan guarantee for a third time, the carrier could gain the leverage needed to win far lower benefits and wages, turning it into one of the most formidable network players.

It's more likely that one or more carriers will follow in the footsteps of such dinosaurs as Pan Am, Eastern, and TWA. "Labor will clearly do something" at both United and US Airways, predicts one high-ranking airline executive. "Whether it will be enough is the question." Vaughn Cordle, a United pilot and financial analyst who runs AirlineForecasts LLC, questions whether airline employees truly understand the magnitude of the problems facing their carriers, especially the crushing debt and pension costs. If workers refuse to make the necessary changes, he believes, airlines such as United will be forced to start selling assets. In short, they'll slowly begin to liquidate, and that will only exacerbate cost and revenue problems.

Of course, a move to shrink by some of the biggest players could certainly help the rest of their beleaguered brethren. But those carriers will hardly have room to breathe. Such low-cost juggernauts as Southwest (LUV ), JetBlue (JBLU ), and AirTran (AAI ), which could grab as much as 35% of domestic capacity by 2009, will continue to put pressure on costs and pricing. And those majors that do survive face a difficult future with debt-laden balance sheets. "I don't see any of them coming out strong," says credit analyst Philip Baggaley of Standard & Poor's (MHP ). More pain and turmoil clearly are on the horizon. And, as United is discovering, time is running out.

By Wendy ZellnerWith Michael Arndt

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