Out of Chapter 11 but not out of trouble

by Caroline Daniel (Financial Times)

This Monday offered a tale of two airlines. As executives at American Airlines spent the day hammering out 11th hour deals with its unions to avoid a bankruptcy filing, US Airways executives were busy signing the final slew of some 700 documents needed to make their exit from Chapter 11.

The exit of US Airways is a significant event. If the restructuring proves to have put the carrier on a sustainable footing, it would mark only the third time in recent history that a carrier has been able to re-emerge successfully.

Of the seven airlines that entered Chapter 11 in the early 1990s, only Continental and America West are still airborne. But US Airways will be having to trial its restructuring in an environment radically worse than the mid-1990s.

US Airways entered Chapter 11 in August, with some of the highest labour costs in the industry at 12.2 cents per available seat mile.

Under the leadership of David Siegel, the airline has reduced that to an estimated 10.5 cents for 2003, and a projected 9.9 cents after that.

It has done this by shedding about 35 per cent of its workforce, or 16,000 employees, dumping hundreds of aircraft, scaling back international routes, and strategically repositioning around regional jets.

John Luth, chairman and president of the Seabury Group, a boutique investment bank that advised US Airways on its restructuring, says a central change has been improving relations between labour and management. In addition, the airline has cut its fleet from 412 to 270.

"No other major carrier has done that kind of downsizing," says Mr Luth.

But more than cost-cutting, the restructuring has been unusual in two ways.

First, US Airways looked aggressively at its pension underfunding. The wider industry, according to Fitch, the credit ratings agency, has not yet tackled its $18bn pension underfunding.

When US Airways' revenue projections sank further in November, it turned to its pension plan to cut costs further. After failing to get support for an alternative proposal, it was forced to terminate some of its pensions, which have now been taken over by the Pension Benefit Guaranty Corporation, leaving some pilots facing far lower pensions.

Second, its restructuring has attracted an unusual lead investor: the Retirement Systems of Alabama, which controls about $20bn of pension assets. The fund was US Airways' second biggest creditor, holding about $340m of aircraft-backed debt.

RSA, partly advised by Rono Dutta, formerly president at United Airlines, made the decision to take a more active role after Texas Pacific Group, the private equity group with a reputation for airline turnrounds, made an offer to become the majority investor.

RSA thought TPG's offer restricted competing bids, and so made its own, of $240m, in hopes of sparking a bidding war.

It never came. Instead the market took another nosedive, forcing US Airways to rethink the amount of cuts it needed to return to profit. RSA stuck with the management team, taking a largely hands-off role in the restructuring. With the airline's exit from bankruptcy, RSA's investment translates into a 37 percent equity stake and eight board seats.

Darren Schulz, acting chief investment officer at RSA, says RSA has no intention of selling that down quickly. "The investment represents about 1 per cent of our total assets. We have a long-term investment horizon and RSA is a patient investor."

It will need to be. While US Airways has cut $1.9bn from its annual costs - with $1bn from labour savings and $500m from renegotiating leases - it still expects to report losses until 2004.

And even its reduced unit costs of 10.5 cents per available seat mile in 2003 are still a third more than JetBlue's 6.32 cents and Southwest's 7.5 cents.

Unfortunately, US Airways did not have the option of sitting out the next few weeks until the dust settles in Iraq under the protection of Chapter 11.

Instead, the threat that its credit card operator would pull the plug on trans-actions if it failed to leave Chapter 11 by March 31, and doubts about RSA and the federal body that is providing $900m of loan guarantees to support the carrier, created pressure to meet the deadline.

As one employee reflects. "Monday was a milestone, but there was not the sense it was a moment for great celebration . .. The [exit] still represented a lot of discarded pensions, employees have made significant financial sacrifices and then we face the uncertainty of war, which still looms large on every decision we make every day."