America’sairlinesarestrugglingagain,andsomearealreadyfilingforChapter11bankruptcyprotection。

Butwouldn’titbebettertoletthemdie,asksSimonWilsonWhydosomanyUSairlinesgobust?

Inpart,becausecommercialaviationisahigh-riskbusinesswithhighfixedcosts(expensiveaircraft,hundredsofspecialistworkers,lotsoffuel)thatishardtogetright。

Theindustryisalsoparticularlyvulnerabletobigswingsindemandandexternalshocksoverwhichithasnocontrol。

Inthepastfouryears,USairlineshavelost$32bnastheycopedwithasuccessionofshocksincludingtheSeptember11thterroristattacks,thecollapseofthemillennialstockmarketbubble,theIraqwar,andtheSarsepidemic。

ThereweresignsofhopeearlierthisyearthattheworstwasoverforUSairlines。

Inthesecondquarter(April-June),AmericanAirlinesmadeitsfirstnetprofitinfiveyears($58m)andContinentalsawrevenuesup12%andanetprofitof$100m。

Butsincethenthesoaringoilpricehashadtheindustryonitskneesonceagain。

Thesixbigairlinesarenowexpectedtomakelossesof$10bnthisyear。

Anyotherreasons?

Inrecentdecadesthebigairlineshavehadtodealwiththeriseoflow-cost,low-farecompetitors,suchasSouthwestandJetBlueintheUS。

Themajorplayers,knownasthe‘legacy’carriers,typicallyhaveexpensive,‘hub-and-spoke’businessmodelsbasedonhugeinvestmentsininfrastructure–alegacyfromthehighlyregulatedpre-1978era,whenairlineswereeachrequiredbylawtohandledesignateddomesticroutesandsocentredthemselvesaroundparticularairports。

Theyalsohavematureandheavilyunionisedworkforcesandhighpensioncosts。

Bycontrast,thenew,smalleroperatorshavebuiltnimblebusinessesbasedoncherry-pickingprofitableroutesandlowfixedcosts。

Who’sdisappearedsofar?

FamousnamessuchasPanAmandTWAhavedisappeared。

ButoutrightliquidationistheexceptionratherthantheruleintheUS。

Inpractice,theairlinesareusuallyallowedtostruggleonunderChapter11ofthefederalbankruptcylaw,whichgivesthemabreathingspacetoworkthingsoutwiththeircreditors。

Sincethederegulationoftheairlineindustryinthe1970s,morethan20airlineshavefiledforChapter11,butthesituationisnowsobadthataroundhalfofAmericanairpassengersarenowflyingwithairlinesthataretechnicallybankrupt。

Lastweek’sChapter11declarationsfromDelta,thethird-biggestUScarrier,andNorthwestern,thenumberfour,meanthatfourofAmerica’ssixmaincarriersareunderChapter11protection。

United(second-biggest)hasbeeninbankruptcysince2002andUSAirways(sixth)willshortlycomeoutofbankruptcyprotectionbymergingwithAmericaWest。

HowdoesChapter11operateIt’salast-chancesaloon–aformoflegalprotectiondesignedtogivestrugglingbusinessesachancetogetbackontheirfeet。

Itgivesfirmstemporaryprotectionfromcreditors,andthechancetorenegotiatecontractsandrestructurethebusinessasagoingconcern,avoidingliquidation。

UnderChapter11,afirm’sexistingmanagersareallowedtostayinchargeofrunningthebusinessandhavetherighttotearupwageagreements,selloffassets,renegotiateleasesandtermsofbusinessand–crucially–scrapexpensivedefinedbenefitpensionschemesandhandoverpensionliabilitiestothestate-runPensionBenefitGuarantyCorporation(whichgetsastakeinthebusinessinreturn)。

What’swrongwithChapter11?

Itmaykeepailingbusinessesgoing,butitdistortstheairlineindustry:Chapter11businessesendupwithunfaircompetitiveadvantagesovercompetitors,thankstotheirabilitytorenegotiatecontracts,cutcostsanddumpdebts。

Worse,themostbasicproblemintheindustryisexcesscapacity–toomanyseatsandtoofewcustomers,somethingChapter11doesn’thelp:alltoooftenitletsairlinesrestructurewithoutcuttingbackcapacity。

Thismeansthecoreproblemisneverresolved。

InternationalcompetitorsbelieveChapter11bankruptcyisaformofdefactoprotectionbytheUSgovernment,allowingUSairlinestokeepcostsartificiallylowandsodistortingthelong-haulmarket。

Itisaway,saysBritishAirwayschairmanMartinBroughton,ofproppingupthewalkingdeadateveryoneelse’sexpense。

Andthere’sreasontothinkthat,insomeinstances,Chapter11hasbecomeastrategictoolratherthanalastresort。

Forexample?

NorthwestAirlinesisnotbroke,orevenclosetoit:ithas$1bnincashorcreditlines。

Onthesamedayitfiledforbankruptcylastweek,fiveWallStreetbankspublishedresearchscoffingattheideathatNorthwestwouldgobankruptandreiteratedtheir‘buy’recommendations。

CynicssayitjustwantedtomakesureofChapter11statusbeforetherulesgoverningwhocandeclarebankruptcyaretightenedupnextmonth。

IsChapter11reallysuchaneasyoption?

TakingChapter11bankruptcydoesn’talwaysmeanthatabusinesssurvives。

OfthesevencarriersthatfiledforChapter11intheearly1990s,onlytwoarestillinbusiness–AmericaWestandContinental。

Norisitcheap。

UnitedAirlines,whichhasjustannouncedafurtherdelayincomingoutofbankruptcyuntilnextspring,hasspentmorethan$250minrelatedprofessionalfeessince2002。

ThebiggestChapter11successstoryisContinental,whichspentmorethanfouryearsinbankruptcyinthe1980sand1990s,andnowhasthelowestcostsofanyofthebighub-and-spokeairlines。

EvenContinental,however,isonceagainlosingmoney–nearly$1。

1bnsincemid-2001。

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