American Airlines’ route to bankruptcy

20 Dec

American lost its spot as the largest U.S. carrier when Delta Air Lines merged with Northwest Airlines in 2008 and has struggled to retain top business customers in key markets like New York and Chicago. And analysts say the company’s handling of executive bonuses soured employee relations, making it difficult for American to gain necessary operating efficiencies with new union contracts.

These decisions contributed to the airline’s precarious financial position, as did rising jet fuel prices and the recession, analysts say. American has lost $12 billion in the past decade, and while other airlines are expected to post profits this year, American is on track to lose more than $1 billion.

“It hasn’t been easy for any airline to survive, period,” said Henry Harteveldt, an airline analyst at Atmosphere Research Group. “But American made some serious missteps along the way.

“American spokesman Andrew Backover said the company “worked tirelessly to overcome a series of challenges, ultimately putting in place key building blocks needed to compete against airlines that dramatically restructured their costs and debt through bankruptcy.” He cited network improvements, airline alliances and a record order for new airplanes.

“We have taken this necessary step to restore our profitability, operating flexibility and financial strength,” he said, referring to the bankruptcy filing. “We are committed to working as quickly and effectively as possible to appropriately restructure the company so that we can emerge from Chapter 11 well-positioned to assure American Airlines’ long-term viability.”

Five hubs

Last year, American began implementing its “cornerstone” strategy, designed to concentrate 98 percent of arrivals or departures in hubs at Chicago O’Hare, Dallas/Fort Worth, Los Angeles, New York JFK and Miami.

“We believe these network initiatives build the revenue-generating power of the best network in the airline industry and position us well for the future all without jeopardizing our long track record of capacity discipline,” Arpey told Wall Street analysts on an earnings call that spring.

But some analysts felt the strategy was too little, too late after low-cost carriers like JetBlue Airways and Southwest Airlines and merged airlines like Delta and United Continental had aggressively courted American’s passengers with lower fares and more amenities over the past decade.

“They failed to defend their turf in New York,” Harteveldt said. “Delta came in and JetBlue came in and in different ways took market share away from American in its original hometown, in a city that American Airlines traditionally owned.

“Although American dominates its DFW and Miami hubs, it is in third place in JFK and second at O’Hare and is fighting a four-way battle in Los Angeles, according to market share figures from the Bureau of Transportation Statistics.

According to an analysis by Avondale Partners analyst Bob McAdoo in May, American’s 10 worst markets, or routes, lose about $450 million a year before the price of oil is factored in.

For example, American’s Chicago-to-London route loses more than $75 million a year flying four round-trips a day with Boeing 777s while United flies three times a day using a smaller Boeing 767. That allows United to generate 25 percent more revenue per available seat mile than American, McAdoo wrote in the report. Since American had more seats to fill, it often discounted fares on the flight, filling it with customers from Los Angeles and DFW who were willing to make a connection if it meant a lower price and taking passengers from nonstop flights in those cities.

In Chicago, McAdoo wrote, the connecting traffic that American and its regional carrier, American Eagle, feed into O’Hare from cities like Des Moines, Iowa, or Columbus, Ohio, arrive on small planes that business customers find unattractive.

“That’s the kind of competitive disadvantage that you can only clean up first by changing the mainline pilot rules at American, which then allows you the next step to ground all of the 40- and 44-seat airplanes you have that aren’t particularly economic and are clearly not competitive to the 70-seat operation of United out of Chicago,” McAdoo said in an interview last week.

Wolfe Trahan analyst Hunter Keay says capacity cuts have begun since the carrier entered bankruptcy. DFW and O’Hare have been hit the most, he wrote in a research note to investors last week.”

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In total, 44 domestic routes were trimmed [11 percent of domestic routes], and every domestic route that was trimmed touches a cornerstone,” Keay said.

Good idea at the time

In 2004, American executives deferred a $2.7 billion plane order from Boeing. The 54 aircraft, mostly Boeing 737-800s, were scheduled for delivery between 2006 and 2010 and would have replaced some of the carrier’s older MD-80s.

At the time, Chief Financial Officer, James Beer said the deferral would “enhance our ability to restructure our finances.” Fuel prices were reaching their highest point in 20 years, with spot jet fuel prices rising to $1.50 a gallon.

“At the time, it was a good decision,” said Mike Boyd, an airline consultant at the Boyd Group. “The betting was more than even; at some point Boeing would bring out a whole new 737 line, then American could buy those. … No one thought the price of go juice would go over $2 a gallon.

“Three years later, Horton, then chief financial officer, said the carrier was still cautiously thinking about ordering new planes and might wait until Boeing designed a new narrow-body plane.

“Given how many MD-80s we have, we really do have an opportunity here to get the technology cycle right,” Horton told analysts in February 2007. A month later, American reinstated its delayed order.

As fuel prices continued to rise — spot jet fuel prices spiked to $3.88 a gallon in July 2008 — American’s aging fleet of gas guzzlers hurt operating costs, plunging American’s balance sheet into the red. Analysts say other carriers that went through bankruptcy reorganizations in the middle of the decade were able to replace older planes with more fuel-efficient aircraft.

Boeing still hasn’t designed a narrow-body plane. Instead, it will re-engine its 737 series aircraft, a decision announced in July when American said it would order 460 planes from Boeing and Airbus to replace almost its entire domestic fleet.

Bonus backlash

In 2003, American avoided bankruptcy by winning $1.6 billion in concessions from its major labor groups. Pilots, flight attendants, mechanics and ground crew workers all took pay cuts of 15 to 33 percent.

The company also initiated a cost-savings program, Pull Together — Win Together, that brought managers and employees together to develop strategies to save money and boost revenue.

But four years later, when nearly 900 managers received stock bonuses valued at $160 million, union workers were furious. Arpey defended the bonus plan, which dated to the 1990s, as essential for retaining top employees.

“Because so much of senior management’s compensation is based on stock, when the company does poorly, they don’t get paid” as much, he told analysts in April 2007, acknowledging that employees weren’t satisfied with the explanation. “I understand this is a subject where we disagree with the unions, and many employees have concerns about this issue.

“Although American restructured its executive bonus plans, the feelings of good will fostered between management and rank-and-file employees were gone.

“In any business you have to have trust between management and labor, and you have to have a sense of shared objectives and shared gain,” Harteveldt said. “It’s really hard for employees who were asked and did give up a lot in terms of wages and benefits to then see executives obtain a lot of money.

“Arpey’s management style, which was more subdued than that of predecessors Don Carty and Bob Crandall, also hurt employee morale. Analysts say he was rarely seen outside of the company’s headquarters, on Amon Carter Boulevard.

“They didn’t know who they were working for. They didn’t know what they were working for,” Boyd said. “That was a mistake Arpey made.”

Going it alone

In the decade after 9-11, mergers abounded in the airline industry: US Airways and America West in 2005, Delta and Northwest in 2008, United and Continental in 2010.

American stayed on the sidelines.

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In April 2005, Arpey said barriers to consolidation included government approval, labor unions and the fact that several carriers didn’t have large cash balances to buy competitors.

“First we have to get our own house in order,” Arpey said. “Consolidation isn’t some easy answer.

“At the time, American was the largest domestic carrier, and gaining government approval for a merger might have been challenging. Also, because of American’s size, there were few other airlines it would have made sense for American to merge with.

“Of all the U.S. airlines flying at that time, the one airline that American should have pursued and could have pursued was Northwest,” Harteveldt said, pointing to Northwest’s Pacific routes and Tokyo gateway.

American kept Japan Airlines in its Oneworld alliance after Delta tried to woo the Asian carrier to the SkyTeam alliance in 2009. But American remains a distant third in the fast-growing Asia-Pacific region, behind United Continental and Delta.

Now that AMR is in bankruptcy, merger rumors are flying again, particularly with US Airways. But not all analysts think a merger is necessary, and some say AMR executives need to focus on restructuring the company first.

“We have never been proponents of an AMR-[US Airways] combination,” J.P. Morgan analyst Jamie Baker told analysts a day after AMR’s bankruptcy filing. “We didn’t envision such a transaction as addressing AMR’s current challenges.

“Horton has talked publicly about the challenges of an airline merger and declined to comment on any speculation on the day his company entered bankruptcy.

“We are laser-focused on completely a successful restructuring of this company,” he said.

“When you look at the assets this company has I have no doubt, nor do many observers in the industry, we will be very successful.”

 

Read more here: http://www.star-telegram.com/2011/12/16/3601197/american-airlines-bankruptcy….

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One Response to “American Airlines’ route to bankruptcy”

  1. illinois bankruptcy December 23, 2011 at 5:46 am #

    Filing for bankruptcy is a big step. But, it can be just what you need to do. Or, maybe, it’s the last thing you should be considering.

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