A Delta Deal Buys Some Time


By Brian Grow After more than a year of bargaining and some very high-pressure negotiating sessions, Delta Airlines (DAL) staved off bankruptcy during the evening of Oct. 27, scoring huge pay and benefit cuts from its 6,900 pilots, the highest-paid in the industry. Now, Delta hopes to use the financial breathing room to restructure its costly operations and survive in the cutthroat airline business. The stock jumped 16.2%, to close at $5.74 on Oct. 28, on news of Delta's deal with its pilots.

The tentative accord that the nation's third-largest airline reached with its pilot union, if approved, will deliver an estimated $1 billion in annual savings through a combination of wage cuts, pension restructuring, and work-rule changes. Fortunately for Delta, the deal was struck just hours before the board was prepared to approve a bankruptcy filing.

Under the deal, Delta will cut pilots' pay 32.5% from May, 2004, levels, beginning on Dec. 1, and will not raise wages for five years. It will also freeze pilots' defined-benefit retirement plan and give them a new defined-contribution plan, akin to a 401(k) program. Pilots will also receive about 30 million shares of common stock, representing a 15% equity stake in the company. "The pilot agreement is one very important and necessary piece of a complex puzzle," says Delta CEO Gerald Grinstein.

NECESSARY RELIEF. For months, Delta management and its pilot union have traded demands as the airline fought to avoid joining two other legacy carriers, USAirways (US) and UAL Corp.'s United Airlines (UAL) in Chapter 11. Delta management had demanded $1 billion in givebacks, while the pilots offered $705 million.

The eleventh-hour deal underscored union leaders' fears that the airline's bankruptcy would be more costly for the pilots than pay cuts. "It pained me to see such drastic changes made to almost every section of our contract. They are significant and will affect each of us and our families," says John Malone, head of the pilots' union at Delta. "However, [we] were convinced that immediate relief was necessary to prevent a bankruptcy filing in light of the company's economic condition." Union members will vote on the proposal beginning Nov. 1. Voting will end on Nov. 11.

Delta pilots reacted to the deal with a combination of trepidation and relief. On the way to visit his retirement adviser, Capt. Richard Columbia, a Boeing 767 pilot and 25-year Delta veteran, says news of the deal is likely to cause him to cancel his Dec. 1 retirement plans, assuming the new terms mean he can keep his accrued benefits.

Hundreds of Delta pilots retired early this year out of fear that the airline would terminate its pilot-pension plan. If it had done so, the carrier likely would have turned over management of the pilots' pensions to the federal government's Pension Benefit Guarantee Corp., which would have provided far lower retirement benefits than the company plan. Columbia and his wife, a Boeing 737 pilot for Delta, have cancelled plans to buy a new car this year and intend to reduce spending on home-improvement projects. "This is a deal that had to be done," says Columbia. "But everyone is going to have to cut back."

FUEL CRUNCH. Still, the pilots' agreement is the binding thread in a crazy quilt of new financing and debt relief that's likely to keep Delta out of bankruptcy -- at least for now. On Oct. 26, Delta said it had bulked up its balance sheet with $600 million in new financing from American Express (AMEX), but the deal was contingent upon an agreement with pilots. Delta was also able to defer $135 million in debt due in 2005. In addition, analysts believe the airline has received a positive response to an exchange offering to holders of Delta's $20 billion in debt. If successful, the exchange could reduce Delta's total debt by $607 million, according to Standard & Poor's Ratings Services.

The upshot: with a deal in hand, Delta says it's on track to deliver approximately $2.4 billion of its targeted $5 billion in costs savings by yearend, with a further $5 billion anticipated by 2006.

Hit by the triple-whammy of high fuel costs, brutal competition from low-cost carriers, and the industry's highest costs per available seat, Delta has lost more than $6 billion in the last three years. Low-cost carriers such as AirTran Airways (ATA) and Southwest Airlines (LUV) compete head-on with Delta on more than 70% of its routes. With oil at close to $55 per barrel, Delta estimates that fuel costs will rise by $950 million this year.

As a result, Delta's cash reserves dwindled by September to $1.45 billion, down from $2.7 billion in January, and the airline has been burning more than $400 million in cash per quarter this year. On Oct. 20, Delta reported a $641 billion third-quarter loss -- and the specter of bankruptcy still looms. "While there can be no guarantees, the people of Delta are diligently and collaboratively making every effort to avoid bankruptcy," Grinstein wrote in an internal memo to employees on Oct. 28.

SIMPLER FARES. Now Grinstein aims to fill in the blanks in his restructuring puzzle, dubbed "The Delta Solution," and halt the airline's financial hemorrhage. In August, he announced plans to slash flights and gates at Delta's hub in Dallas/Ft. Worth, while streamlining operations at three other hubs, Atlanta, Cincinnati, and Salt Lake City. Delta is also likely to increase international flying and, domestically, plans to add 12 new planes to its perky, lower-fare carrier, Song.

To fend off low-cost carriers and attract new passengers, the airline plans to simplify and cut prices. For instance, unrestricted fares from Greater Cincinnati/Northern Kentucky International Airport, one of the most expensive airports to fly from in the country, have already dropped by as much as 60%. Flights from that airport now have just two first-class and six economy-class prices -- a structure that could migrate to other hubs. "Our transformation is well underway," Grinstein says.

Analysts see progress. If Delta is able to achieve all of the $2.7 billion in cost cuts that it says it needs, it could reduce its cost per available seat mile, a standard measure of operating efficiency, to 8.5 cents, down from 11 cents as of Sept. 30. But digging out completely from its $20 billion in debt will continue to be tough. On Oct. 28, S&P reaffirmed its "CC" rating with a negative outlook, citing concerns about the possibility of an out-of-court restructuring of the airline's debt and its inability to operate profitably despite substantial cost cuts. "The fact that Delta is still incurring heavy losses despite these savings highlights the severity of the challenge facing the airline," wrote S&P credit analyst Phillip Baggaley.

Still, Delta avoided becoming the latest legacy carrier forced to operate under the debilitating cloud of Chapter 11. That, in itself, is no mean feat. Grow is a BusinessWeek correspondent in Atlanta


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