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An Airline Bailout--with Strings Attached


Less than two weeks after terrorists hijacked and crashed four commercial jets on Sept. 11, Congress opened up the Treasury to the airline industry. Lawmakers coughed up $5 billion in emergency aid and agreed to guarantee up to $10 billion in borrowings. The government had shut down the airlines for nearly three days, so it's only fair that it provide compensation, the thinking in Washington went. The bailout was aimed at making the airlines whole--in effect, turning back the clock to Sept. 10.

But for airlines, Sept. 10 wasn't such a great time, either. The emergency legislation didn't touch some fundamental problems. Airlines are a cyclical business, not unlike commodity manufacturing or commercial real estate, swinging from boom to bust. Like many old-line industries, airlines have huge fixed costs; a single airliner can cost as much as a factory, so debt levels are high. And their workforces are highly unionized and highly paid. Pilots and mechanics, especially, hold enormous clout over management because their specialized skills are tough to replace.

"BANKRUPTCIES." Even so, how did such a relatively brief shutdown threaten to ground the entire industry? Even before the terrorists attacked, analysts expected the airlines to lose $2 billion this year. Now, with fearful tourists and business travelers avoiding flights, that could turn into a $5 billion loss. "Even if the aid package could get them back to the status quo, the status quo is not a good place to be," says Morgan Stanley Dean Witter analyst Kevin C. Murphy. "Some carriers are mortally wounded."

Free-market advocates in Congress insisted that any airline vulnerable to bankruptcy on Sept. 10 will still face that possibility when the $15 billion runs out. "We believe in markets, not Marxism. We have taken corrective action at the top, and we would expect that the falling of the dominoes has slowed," says Senator Charles E. Grassley (R-Iowa). But if traffic doesn't pick up enough and a bunch of airlines file for bankruptcy in the months ahead, some of those same congressmen might have to decide whether to step in again, and the precedent could be hard to ignore.

Even if Congress remains hands-off, regulators will likely face the thorny issue of how to manage an inevitable consolidation. Just months after antitrust officials blocked United Airlines Parent UAL Corp. (UAL) from buying US Airways Group Inc. (U) for fear that it would crimp competition, they may have no choice but to act as referees as surviving airlines snap up routes and airport gates from dying carriers. Already, industry analysts are predicting a shift in policy to let even blockbuster deals go through.

The bailout comes with strings that give the government more say in basic business decisions. For one, airline executives who earned at least $300,000 last year can't be paid more this year or next. And their severance pay can't be more than two years' salary. That's likely to draw cheers from union workers, but a second condition has larger implications: In return for guaranteeing an airline's debts, the government will get warrants, stock, or stock options in the airlines; the details aren't worked out yet. "There will be greater government involvement and influence," says Standard & Poor's Corp. analyst Philip Baggaley. "Money doesn't come without strings."

The weakest players aren't likely to change post-bailout. Topping the critical list are US Airways (U) and America West Airlines Inc. (AWA). US Airways, the nation's No. 6 carrier, has long been in trouble because of its high operating costs and small reach, which was why it solicited a takeover offer from UAL last year. The airline had a debt-to-capital ratio of nearly 92% at the end of 2000, while anything above 50% is considered unhealthy. US Airways has been hurt further by the indefinite shutdown of Ronald Reagan Washington National Airport near Washington, where it had been the biggest carrier. No. 8 America West, which came back from bankruptcy a decade ago in the last recession, is also getting dragged down by a millstone of debt and had less than $200 million in cash and credit before the bailout. Neither airline would comment on its financial condition. But Peter Walsh, chief of Mercer Management Consulting's aviation unit, predicts: "Even with this aid package, there still will be bankruptcies."

WAR-RISK INSURANCE. Continental Airlines Inc. and Northwest Airlines Corp. (NWAC) were in slightly less trouble before the rescue. If the airlines had remained grounded, Continental had enough cash to survive for only 39 days, according to Salomon Smith Barney Inc. Northwest's debt ratio was 96%. But analysts say the money and loan guarantees likely will see them through the next few months, and both could regain altitude quickly next year if traffic comes back as expected. Already, No. 4 Northwest says its flights are more than 50% full, a big improvement over the nearly empty planes after flying resumed, though far from the 65% to 70% that airlines need to break even.

Even AMR (AMR), parent of American Airlines and Trans World Airlines (TWA), and UAL had seemed vulnerable. While they rank first and second in the world in traffic, the airlines faced ruinous claims if they had been forced to reimburse people and businesses for losses on the ground when the hijackers crashed their planes. But Congress shielded them from those liabilities.

The handouts will go a long way toward patching the financial hole that the terrorists tore in the industry. AMR will receive the most aid, an estimated $915 million, followed by UAL, at $804 million. No. 5 Continental gets $396 million, while American Trans Air Inc. (AMT), which ranks 10th, will get $51 million. All told, passenger airlines will get an estimated $4.5 billion, while cargo-only carriers will receive $500 million.

Still, the airlines don't expect a rapid return to normal traffic levels. Aside from Southwest Airlines Co. (LUV), the major carriers have announced service and payroll cuts of roughly 20%. Altogether, the industry is expected to shuck 110,000 employees and up to 900 no-longer-needed planes, as airlines downsize to levels of the mid-1990s. Most of the planes will be parked in deserts in the West. Even before the hijackings, four small carriers had filed for Chapter 11 protection; one, Midway Airlines Corp., has shut down.

PLUNGING TICKET SALES. Eventually, of course, people will return to the skies. Already, there are some signs of normalcy. Southwest is again promoting its low fares on TV, and United has resumed emphasizing ticket sales on its Web site. At Minneapolis-based Carlson Wagonlit Travel, travel agents report few cancellations over the upcoming yearend holidays. And one by one, corporations are lifting their bans on travel.

Still, it took more than a full year for travel to get back to normal following the Persian Gulf War in 1991. And analysts and industry executives say the coordinated hijackings of four jets inside the U.S. could spook travelers for even longer. The Air Transport Assn. forecasts that ticket sales will be off 40% in the fourth quarter and won't rebound to year-earlier levels until next year's third quarter. "There is no business unless people feel secure. Period," notes Philip M. Condit, Boeing Co.'s chairman and CEO.

In some ways, the industry is stronger than it was going into 1991, when a war and a recession conspired to drop airlines into the tank. Even before the hijackings, some carriers were speeding up the retirement of old planes, postponing purchases of new ones, and imposing hiring freezes. But the nation's fear of flying is much more intense today than it was a decade ago. And a full-blown recession appears to be just starting. The bailout and the airlines' aggressive cost-cutting should get most of them into the new year. But 2002 will almost certainly bring more financial crisis. Look for the government to be right in the thick of it. By Michael Arndt in Chicago, with Nanette Byrnes in New York and Lorraine Woellert in Washington


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