"Big Airlines: Not Much Runway Left"

Monday, July 5, 2004 Issue

Commentary
Big Airlines: Not Much Runway Left 
United and the other major carriers must remake themselves -- or go down
trying 
By Wendy Zellner With Michael Arndt
Business Week


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 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, Delta, and Northwest 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. 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, JetBlue, and AirTran, 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. More pain and
turmoil clearly are on the horizon. And, as United is discovering, time
is running out.


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