Wall Street Hits Turbulence After United's Big Surprise
This post originally appeared in Money Stuff.
On Tuesday, United Continental Holdings Inc. announced that it will grow capacity at 4 to 6 percent a year until it stops being profitable. I mean it didn't actually say that last part, but that seems to be what Wall Street took away from it; one analyst called the move "snatching defeat from the jaws of victory." United's stock was down 11.4 percent yesterday. Warren Buffett's Berkshire Hathaway Inc., United's biggest shareholder, lost about $252 million on its United stake.
But Berkshire Hathaway is also the biggest shareholder of Delta Air Lines Inc., and the second-biggest shareholder of Southwest Airlines Co., and the third-biggest shareholder of American Airlines Group Inc., and all of their stocks were down too; Berkshire lost about $476 million on those stakes yesterday. United's decision to expand capacity "could lead other airlines down a similar path, forcing a drop in fares," a movie that airline investors have seen before. "In a business selling a commodity-type product, it's impossible to be a lot smarter than your dumbest competitor," a skeptic once said about the airline industry, and that skeptic was Warren Buffett.
This was not supposed to happen. "The industry has been more disciplinedin recent years," and, as regular Money Stuff readers know, there is an intriguing and increasingly influential theory about why that has happened. Warren Buffett is not the only person who is a big shareholder in a bunch of different airlines. Vanguard Group and BlackRock Inc. are both top-five holders of all the big U.S. airlines, which is no surprise because they are giant index-fund managers and the airlines are in stock indexes. Other big investors, both indexed and otherwise, are also cross-owners in multiple airlines. These investors have no interest in one airline adding capacity to take market share away from the other airlines. They don't care who has what market share; they own all of the airlines. They just want them all to be profitable.
And, the theory goes, corporate managers know this, and respond to it. Somehow. Perhaps the index-fund managers call up the airline CEOs and whisper "hey don't cut fares or add capacity," but this seems unlikely. Perhaps the cues are subtler. Perhaps compensation schemes incentivize managers to grow the pie rather than fight for a share of it. Perhaps the mere absence of shareholder pressure discourages competition, because more concentrated holders would push managers to compete more. Or perhaps the shareholders don't do anything, but the managers simply feel a fiduciary duty to maximize the shareholders' wealth, and they know that the way to do that is to maximize the value of all the airlines. The managers at United don't want to do anything that would reduce the value of Warren Buffett's investment in United; they certainly don't want to do anything that would reduce the value of his investment in United and Delta and American and Southwest.
But here we are! Presumably United's management has some idea of what it is doing; presumably it thinks adding capacity will be good for its business and will fulfill its fiduciary obligations to its shareholders. It is more of a stretch to assume that United's management thinks this move will be good for Delta's or American's business. But certainly the result of its announcement was a big one-day drop in the wealth of its shareholders, both as United shareholders and as shareholders in the industry more broadly. If, like a lot of airline investors (like Warren Buffett!), you thought that the airlines had finally solved the problem of overzealous competition and were on a path to sustainable profits, that will disappoint you. But if you thought that airlines were being driven by their institutional shareholders to abandon competition and become a cartel, then I guess this is good news?
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James Greiff at email@example.com