American Airlines' Last-Mover Disadvantage
When American Airlines parent AMR filed for bankruptcy on Nov. 29, the biggest question wasn’t how could this happen, but why didn’t it happen sooner? As the last of the so-called legacy carriers to seek court protection from creditors, AMR has for years operated with higher labor costs and debt than its peers. It’s on track to post its fourth straight annual loss, estimated to be $1.2 billion in 2011, while United Continental and Delta Air Lines managed to make money in the first nine months of this year. By holding out so long, American may have missed the opportunity to merge and create a more lucrative network. Bankruptcy protection will allow AMR to cut costs, but it won’t eliminate the advantages now enjoyed by its biggest rivals.
In most businesses, the stigma associated with seeking court protection from creditors makes the bankruptcy option an absolute last resort. Yet when an entire industry is under tremendous financial pressure, that hang-tough strategy may not be the shrewdest move. While General Motors and Chrysler filed for bankruptcy and simply walked away from many obligations, Ford Motor borrowed money to pay off its debts. Noble, perhaps, but that’s left Ford with more than $12 billion in debt, almost three times as much as GM. Ford had clear motives to stick it out: Not only did having a common auto union allow it to win similar labor concessions as its rivals, but the reputation hit of bankruptcy arguably carries more weight when buying a vehicle than an airline ticket.
The U.S. steel industry may be a more telling example. Kept on life support for years by government bailouts and protections, the industry didn’t experience a renaissance until a series of painful bankruptcies several years ago, enabling companies to offload pension obligations, cut jobs, and restructure debt. A smaller, more concentrated industry has since proven remarkably competitive, even in a sluggish economy.
Billionaire investor Wilbur Ross, who restructured and consolidated many of those dying steel mills, sees similar structural issues in commercial aviation. “The U.S. airline industry is in the midst of a major re-equipment cycle simultaneous with relatively high fuel costs,” he says. While companies can’t control the external factors, Chapter 11 typically enables them to lower interest costs and reduce the obligations that make it impossible to compete. Notes Ross: “These steps were taken by AMR’s competitors years ago.”
AMR estimates its annual labor costs now run about $800 million higher than rivals—Morningstar analyst Basili Alukos estimates it’s closer to double that—and it has been stuck with an older fleet that’s added to its fuel bill. With Delta’s acquisition of Northwest Airlines in 2008 and last year’s merger of United and Continental, the Fort Worth-based American fell from first in size to third. Only 15 percent of the passengers on U.S. carriers in October chose to fly American, compared with 21 percent for United and 20 percent for Delta.
What unites AMR’s rivals is the shared experience of using bankruptcy to bring down their labor costs and restructure debt. “The right time to do this was in 2005, when they would have had a ton of cover from [the bankruptcies of] Delta and Northwest,” says Stephen B. Selbst, a veteran bankruptcy attorney at Herrick, Feinstein. “Now they’re limping into it with stronger competition.”
Moreover, while AMR spent the past five years pushing to reduce costs in various contract talks, its major competitors joined forces to boost revenue with larger networks and a stronger presence in the fast-growing Asia-Pacific markets. That’s made it easier for them to woo the high-margin business travelers who provide much of an airline’s profits. American hasn’t had as much to leverage. AMR’s alliance with British Airways does give it more heft over the North Atlantic, but that’s a less lucrative market, and U.S. foreign ownership rules prevent BA from owning more than 25 percent of its troubled partner—precluding AMR’s most obvious endgame.
Analysts now point to a possible merger with US Airways Group, itself the product of a 2005 merger of America West and then-bankrupt US Airways. Even if that were consummated—a big if, given the antitrust implications—such an arrangement wouldn’t offer American a huge advantage in crucial overseas business markets.
So a restructuring that could have allowed AMR to build on its strength had it been taken several years ago seems too little, too late now. Although equity analyst Raymond Neidl of Maxim Group estimates AMR “could have muddled until next year with its cash reserves” (about $4.1 billion, now being used to finance bankruptcy costs), investors weren’t blindsided. The stock was already a shadow of its 2007 high of $40.66, having closed at $1.62 on the eve of its filing. The next day, shares fell to 26¢.
Bankruptcy has long been contemplated as an option for AMR. When airline traffic slowed after the terrorist attacks of Sept. 11, many thought it would be among the first to file for bankruptcy protection. Indeed, the company was preparing to do that in 2003 when its unions suddenly agreed to $1.6 billion in annual concessions. “We all made painful sacrifices,” says David Bates, president of the Allied Pilots Assn. While that proved to be a temporary victory for AMR, says Helane Becker, an equity analyst at Dahlman Rose, “it was a very big deal to [then CEO] Gerard Arpey that they didn’t have to file.” Becker says the perceived stigma of Chapter 11 was acute for Arpey, who retired after the board’s unanimous vote to seek bankruptcy protection. Former AMR President Thomas W. Horton, who was named CEO on Nov. 29, doesn’t appear to share such qualms. Said Horton after the filing: “The future on the other side of this restructuring we think is very bright.”
Not for everyone. The Pension Benefit Guaranty Corp. estimates retirees could lose $1 billion if AMR asks the federal agency to absorb those obligations. Investors will get burned, while customers will likely see fewer flights and higher fares.