AMR's Chapter 11 may foreshadow both the best and worst of times ahead
It is hardly the first time an airline has sought protection under U.S. bankruptcy law in order to formulate—or at least fine-tune—a new business plan. Some carriers are even recidivists in bankruptcy court. But AMR Corp. had striven proudly to restructure its high cost base on its own. Now that it has thrown in the towel and headed down the path trodden by all the other remaining U.S. legacy carriers, it is at least hoping for the smoothest trip yet through the courthouse and vowing to “kick some ass” when it comes out of Chapter 11.
There are, rightly, questions about the timing of this filing just days after the busiest travel period of the year and weeks before yet another rush of holiday travelers push load factors past 90%. Times had been bad for so long for AMR—so why would the board of directors be called to an unscheduled meeting late on a Monday evening to issue an edict that could just as easily have been delivered during one of the many recent rushes on the company's shares or held until the more sober winter months?
As with any decision of this magnitude, the answer is complicated, and only those few at the top of AMR's corporate ladder know all the reasons. But in the past weeks, it was becoming clear the voluntary reorganization hoped for by Chairman and CEO Gerard Arpey was failing and that momentum was shifting to a philosophy championing Chapter 11, led by Thomas Horton, who has assumed Arpey's responsibilities.
Stalled negotiations with the Allied Pilots Association (APA), to many observers, was the catalyst for change, and there is no doubt that the union leadership's avoidance in the past weeks of any meaningful contact with management did little to help those who favored a voluntary option. Staffing pressures caused by an exodus of' senior pilots added to AMR's pains, but by Nov. 28 these had passed, as the incentive to leave (a 60-90-day retroactive share price on part of their retirement package) was all but irrelevant.
On top of this, AMR had been in that position many times before with several of its unions and, as APA points out, the monetary value of its contract talks alone was not sufficient to push a company into court protection when it already knew it had $24.7 billion in assets and $29.5 billion in liabilities.
No, something else was wrong and a likely contributor was AMR's forecast for the coming months. It is no secret that the airline industry is bracing for a tough 2012, and since the end of the third quarter most of the U.S. major airlines had issued revisions to their revenue, cost and capacity forecasts into next year. AMR was the one notable exception.
The company was already under scrutiny by investors who, while empathizing with AMR's attempts to address its labor costs, attacked it for unremarkable single-digit revenue growth while the likes of, United Continental Holdings and powered ahead with double-digit gains. Critics also questioned the so-called “cornerstone” strategy that focuses AMR's operations on five key cities, noting that the airline had no commanding hold on most of those hubs.
Time was running out for AMR. With no guidance and a continuing sense of ill-feeling toward its management, there was an inevitable dip in the company's market capitalization, even though it was trailing its peers. Eventually, the depressed stock could have fallen too far behind the airline industry's already poor standards, and in that situation the company had little recourse but to approach the courts.
It also is now apparent that AMR wanted to avoid the limitations of debtor-in-possession financing by funding this reorganization with the $4.1 billion its holds in cash and (mostly) short-term investments. If the forecast was bad enough (and a few poor months can cost hundreds of million of dollars), AMR's management would have seen an already tight budget potentially depleted beyond usefulness, and yet another opportunity would have been lost.
The slickness with which AMR handled the first few hours of its Chapter 11 filing belies the surprise of the announcement. Professional, efficient and succinct, the carrier controlled its message in a way it had failed to do for months and, apart from a distinctly noncommittal public denial of possible mergers, seemed to appease most of the concerns about its immediate future.
It also appears that Horton and his team have a clear understanding of what they want from court protection; and for the most part we already know what it is.
Initial comments from Horton and Chief Financial Officer Isabella Goren reiterate the company's commitment to July's order for 460and narrowbodies that at the time was heralded as AMR's savior. There are still doubters, especially about the pending order for MAX aircraft, but the two manufacturers offered up public reassurances during the Credit Suisse-Aviation Week Aerospace and Defense Finance conference in New York last week.
This was unnecessary. The narrowbody deal was brokered by Horton, not Arpey, and the pique with which he responds to criticism of the order just illustrates his commitment, not only to Airbus and Boeing but to the strategy the order embodies. Unfortunately for American Airlines' mechanics, that also seems to include considerable outsourcing of AMR's maintenance.
So far, the company has avoided inflammatory remarks about its maintenance, repair and overhaul facilities, choosing instead to issue boilerplate statements about the need to evaluate all eventualities. But, in light of the bankruptcy, the decision to split the engine choice for the first batch of Airbus single-aisles between International Aero Engines and CFM indicates that American's maintenance strategy has changed since Arpey's reorganization plan from 2003.
The facilities were intended to become revenue centers, according to that plan, but AMR's comments at the time of the engine order noting the financial as well as operational benefits of the deals only fueled rumors of a major change for the company's maintenance division. The unrestrained attack by the mechanics' union, the Transport Workers Union, that it “will fight like hell” does little to stop speculation that the end of in-house maintenance beckons.
While thoseengines will power Airbus set to replace at least part of the company's -200 operation, the new -5Bs are destined for an entirely new A319 operation that essentially will be a low-cost carrier (LCC) within the mainline operation (AW&ST Nov. 26 p. 19). This LCC was a core tenet of the AMR contract proposal that coincided with APA's withdrawal from formal talks. Given the clarity with which AMR chose to present the concept, it is certain Horton will, at least in the initial phases of his reorganization, want to keep this intact, especially as AMR proceeds with an expedited reduction of its MD-80 fleet.
This should placate many critics on Wall Street, who have openly berated AMR's leadership for failing to address shifts in North American demand as quickly, or as widely, as their competitors. The cuts in the MD-80 fleet, if deep enough, should also satisfy those who believe AMR's domestic operation is still bloated, though initial comments indicate the company is holding back from any commitment beyond “modest” reductions. Unfortunately for AMR, and its staff in particular, analysts are calling for capacity cuts of 10%, all of which will have to come from the home market.
There are still questions about AMR's “cornerstone” strategy, which pulls most of its capacity into hubs at Dallas/Fort Worth International, Chicago O'Hare, Los Angeles International, New York's John F. Kennedy and Miami International airports, but Horton is intransigent on this: this is the future, he has regularly said, noting that once costs are addressed, the benefit of this strategy will become clear.
This should also help dismiss rumors of a pending merger, especially with US Airways, which would dilute benefits of the cornerstone approach. Despite AMR's incessant inability to deny merger speculation, it has pointedly avoided the influence of outsiders by funding the bankruptcy itself. Horton himself rallied the troops at headquarters Nov. 29 with calls to “kick some ass” when the airline emerges from Chapter 11.
That is not to say a merger is not planned, but both Delta and United waited to restructure their operations through bankruptcy courts before approaching their respective targets. It should also be noted that AMR has approached both US Airways andto place its designator code on a U.S. East Coast shuttle; code-sharing could negate many of the problems associated with mergers.
All of this comes at a cost, and while creditors will take a hit, AMR's labor groups should expect some pain. Job losses are inevitable, and the defined benefit pension plans Arpey so jealously guarded are also likely to be terminated. In fact, the Pension Benefit Guaranty Corp. is preparing the ground work by warning AMR workers they should expect to lose $1 billion, should responsibility for the massively underfunded pensions be transferred to the already stretched U.S. government agency.
Workers atAirlines should also prepare for a shock. The reorganization suspends a divestiture plan that proposed drastic cuts to Eagle's fleet, but even with new concessions it may be unable to be competitive with third-party operators such as SkyWest and Trans State Airlines.
The coming months will be tiresome for all involved, and the outcome will ultimately be disappointing for some. But for now, AMR has taken a major step to stem the flow of red ink from its balance sheet. Only time will tell if it can achieve profitability.
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|Source: Aviation Week Intelligence Network|