Why United Should Go for Broke


By Michael Arndt When Glenn F. Tilton took command of UAL Corp. (UAL) on Labor Day, he faced twin problems. With close to $1 billion in obligations due by yearend and little left in the airline's rainy-day fund, he needed to win loan guarantees from Washington to avoid Chapter 11 bankruptcy. That would require standing up to the unions at UAL's United Airlines division and wringing pay cuts from the carrier's 81,000-person workforce. Taking an ax to the outsize payroll would help solve problem No. 2: reducing expenses to the point where United could turn a profit post-September 11, with a stunted industry serving increasingly frugal flyers.

United's problems, however, may be bigger than Tilton realized. The first hurdle comes on Dec. 5, when the airline must convince its mechanics to overturn their decision last month to reject a pay-cut agreement. And although the odds still appear to be long, Tilton must secure a $1.8 billion loan package through the federal Air Transportation Stabilization Board (ATSB) before Dec. 16, when the airline's grace period on $875 million in overdue debt expires.

Even then, industry analysts and consultants say, the givebacks Tilton negotiated from United's unions likely won't come close to transforming the carrier into a consistent moneymaker. By its own reckoning, a restructured UAL won't turn a net profit until 2005, and a slower-than-assumed economic rebound could delay that turnaround for at least another year.

PAIN AND GAIN. Some analysts and consultants are now wondering if the UAL's best shot at long-term viability might be Chapter 11 protection, which would allow it to slash wages and other expenses with the support of a bankruptcy judge. That way, it could finally bring costs into line with low-fare competitors such as Southwest Airlines (LUV) and American Trans Air (ATAH). "The worst thing to do is reorganize now -- and then go through another one two years from now," says Darryl Jenkins, director of George Washington University's Aviation Institute and a veteran airline consultant. "United needs to take the pain all at once right now."

UAL's major rivals, including American Airlines' parent AMR (AMR), also are arguing that UAL would be better off in Chapter 11, as their lobbyists work to block a UAL bailout. If it's in bankruptcy, competitors have a better chance to cherry-pick United's best assets, perhaps grabbing prizes like the Pacific and Atlantic routes and its overseas and domestic gates. They might also nab more business travel if Corporate America steers clear of the wounded airline, the world's second-largest behind American.

More than that, however, United's rivals want to see the airline go first with pay cuts. That way, they might be able to manage a faster return to profitability by renegotiating their own costly labor pacts. "Unless they get their costs under control," notes an exec at another major airline, "we have continued upward pressure on our own costs." And that, the exec warns, could eventually push other airlines into bankruptcy. Adds the exec: "What we need are real concessions."

HARD SQUEEZE. Tilton has accomplished a lot in the three months since leaving ChevronTexaco to head United parent UAL in Elk Grove Township, Ill. He negotiated an 18% pay giveback from 8,600 pilots and imposed salary cuts of up to 11% on the 10,500 white-collar employees. He even persuaded the 20,000-member Flight Attendants Assn., to agree to reduced pay -- something the union refused to do when other employee groups traded wage concessions for a 55% equity interest in UAL through their landmark employee stock-ownership plan (ESOP) in 1994.

Altogether, United says it has achieved $5.2 billion in labor savings over 5 years and an additional $8.9 billion in lower expenses or new revenue in other areas. "We have turned over every rock," says Chief Financial Officer Frederick F. Brace. "We have done things that are truly transformational."

Tilton probably couldn't have squeezed much more from United's unions. Indeed, the 12,200 mechanics in the International Association of Machinists (IAM) stunned Tilton -- and their own leadership -- by rejecting pay cuts of 6% to 7% on Nov. 27 by a 57% to 43% margin. Mechanics explain the "no" vote by pointing out that they went without raises for eight years following the 1994 ESOP and feel they have sacrificed enough.

"BIG NUMBERS." The IAM unit is scheduled to reconsider the basic concessions in a second vote on Dec. 5. Management says another defeat would doom the airline's chances of obtaining loan guarantees. "I know, to the outside world, everyone wanted to see bigger numbers," says William Swelbar, managing director of Eclat Consulting, which advised the flight attendants in this fall's concessions talks. "But these," he adds, "are big numbers."

Big, yes. But the wage package falls well short of what the $14.4 billion outfit really needs, say those who follow it. Even before September 11, United was losing money, having chalked up only one profitable quarter since 1999. After losing a record $2.1 billion in 2001, it's expected to see as much as $2.3 billion worth of red ink this year, despite laying off 20,000 employees and a 12% reduction in operations. Moreover, the airline concedes it will lose money again in 2003 and 2004, even if it achieves all its savings.

The problem is labor costs. According to a new analysis from Unisys' R2A Transportation Management Consultants, these totaled about $5.5 billion in 2001. That represents 45% of total operating expenses -- more than any other carrier except US Airways Group (UAWGQ), which declared bankruptcy last August. And it's 68% higher than at Southwest, which has been the only big airline to remain profitable through the post-September 11 travel downturn. Crunching the numbers further, the R2A consultants point to United's pilot wages as the biggest burden: They soared by 29% in 2000 to exceed pay rates at all other airlines.

THE AMR MODEL? United's recovery plan wouldn't fundamentally alter the wage structure, however. True, the pilots have agreed to 18% reductions, retroactive to Dec. 1 if the airline gets its government-guaranteed loan. Still, analysts calculate that United pilots would be getting about the same pay as American pilots do today. On top of that, United's pay rates would begin climbing again in May, 2004, when the first 4.5% so-called snapback raise would take effect.

By 2008, when the loan guarantees would expire, pay for all of UAL's unionized employees would be back at today's levels. "Their cost structure ends up far more akin to American than Continental and Northwest, and even farther from true low-cost carriers like Southwest and JetBlue [JBLU

]," says Jamie N. Baker, an airline analyst at JP Morgan Chase. Noting that American is losing even more money than United, he adds: "The AMR business model is hardly worth aspiring to."

UAL management steadfastly believes its recovery plan will qualify it for loan guarantees from the three-member ATSB. As a safety measure, United and its allies, including House Speaker Dennis Hastert (R-Ill.), have been lobbying hard in Washington for the package. Their message: The airline is simply too big to be allowed to fail.

GRIM PRECEDENT. Most outsiders aren't so sanguine, however. Exhibit A, say skeptical analysts and consultants, is what has happened at US Airways, which secured $840 million in annual pay cuts from its workforce and was able to win conditional approval for a $900 million loan guarantee last July. Yet it couldn't secure so-called bridge financing and ended up in bankruptcy a month later. US Airways still hasn't received final approval from the loan board and in late November went back to its unions seeking further concessions.

If US Airways hasn't achieved a loan guarantee after lowering its labor expenses on a relative basis by nearly twice as much as United is proposing, the skeptics ask, why should United make the cut? "They still end up with a high-cost airline carrying a large amount of debt, which would leave them vulnerable to the next downturn," says Philip A. Baggaley, an airline analyst for Standard & Poor's. Adds Philip Roberts, managing principal of R2A: "The snapback is the Achilles' heel."

Today, United has about $1 billion in cash and is burning at least $5 million a day to cover expenses. It would be virtually penniless if it paid the obligations due in December. Also, all of the labor concessions will be voided if it fails to get a government-secured loan by Dec. 31.

So as a backup, UAL has readied a bankruptcy filing and has been lining up $1.5 billion in debtor-in-possession financing. Tilton has said a Chapter 11 filing would be risky: Management would have to answer to a bankruptcy judge, and some customers might avoid United, despite Tilton's assurances that day-to-day operations would be unaffected. But if a bankruptcy is what it takes for United to finally make its labor tab affordable, that may be the best course Tilton could set for his airline. Arndt is a correspondent for BusinessWeek in Chicago


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