American seeks future profitability through Chapter 11 bankruptcy reorganization It was an odd distinction of honor, yet one to which venerable American Airlines and Gerard Arpey, its chairman and CEO from 2003-2011, proudly clung: The Dallas-based carrier was the only US legacy airline that had never declared bankruptcy The company’s roots go all the way back to the pioneering days of the 1920s, when Charles Lindbergh piloted DH-4 biplane flights carrying mail between Chicago and St. Louis for Missouri-based Robertson Aircraft Corp. , one of a number of early airlines that consolidated in 1930 under the banner of American Airways Inc. , the precursor to American Airlines (AA), by which name the carrier has been known since 1934. As time went on, the company discovered what other US legacy airlines did, particularly post-1979 deregulation: It is extremely difficult to earn consistent profits operating a major international airline based in the US.
The aircraft are expensive; workers through the years have been represented by unions that have collectively bargained (often during rare periods of industry strength) for muscular benefits; the market is ultra-competitive and, until the recent consolidation push, has been fragmented; serving both short-haul domestic markets and long-haul international destinations creates tremendous complexity and can be at cross-purposes; the government is wary of providing financial assistance to airlines in trouble and, in fact, taxes the industry heavily; and, finally, carriers must contend with numerous factors over which they have little-to-no control, such as global economic disruptions, severe weather events and volatile fuel prices. As a result, every US legacy airline has gone through periods of financial hardship. Some didn’t make it despite having iconic brands (Pan Am, TWA, Eastern), and even the survivors were forced to operate for stretches under the supervision of a US bankruptcy court, with Continental Airlines (CO) and US Airways (US) even filing for Chapter 11 twice each. All, that is, except for AA.
No matter what, from the Depression-era days of the 1930s (it had carried 1 million passengers by February 1937) through 9/11 and the 2008-09 financial crisis, AA and its parent company, AMR Corp. , avoided bankruptcy. But, in the end, that strange bit of nobility may have been its costliest legacy burden. Seeking Protection AMR finally took the plunge and filed for Chapter 11 bankruptcy protection in a New York court on Nov. 29, 2011, and announced the resignation of Arpey, who had long resisted the move as he endeavored to reduce costs outside of the Chapter 11 process. President Tom Horton assumed the roles of chairman and CEO and is overseeing the company’s reorganization.
AA’s remaining legacy rivals—United Airlines (UA), Delta Air Lines (DL) and US had all filed for bankruptcy in the tumultuous four-year period following 9/11, and Horton said AA has been at a cost disadvantage ever since. While UA, DL and US returned to profitability in 2010 and 2011, AA continued to swim in huge amounts of red ink quarter after quarter. It was the only US major to post a net deficit in 2010 ($471 million) and it incurred losses in four straight quarters leading up to the Chapter 11 filing. It did earn more than $640 million in 2006 and 2007 combined, but has posted a loss in every other year since 2000, including annual deficits exceeding $1 billion in 2001, 2002, 2003, 2008, 2009 and most likely 2011. The “very substantial” cost disadvantage had become “increasingly untenable,” Horton declared on the day AA entered bankruptcy.
Arpey, Horton and other AA executives declined to comment for this article. While AA had never actually declared bankruptcy prior to last November, it had come close. In the waning days of former chief executive Don Carty’s tenure in 2003, AA employees accepted $1. 8 billion in annual wage and benefit givebacks and the elimination of 9,300 jobs. The airline squeezed vendors, lessors, lenders and suppliers for a further $200 million in yearly savings. These actions enabled AA to narrowly escape Chapter 11, and Arpey ascended to the airline’s top spot and let it be known that he thought bankruptcy represented a “failure” that should be avoided.
But he watched as UA, DL, US and Northwest Airlines (now part of DL) used the bankruptcy process to achieve deeper cost cuts and secure more labor concessions than AA. In May 2006, he told a Bear Stearns conference that the rival airlines had “leveraged marketplace failure to reduce their costs . . . We now find ourselves with relatively high costs among our peers. Each additional dollar of savings becomes harder to come by but we are looking under every rock. ” Last October, when discussing AA’s $162 million third-quarter 2011 net loss, Arpey told analysts and reporters, “It’s no secret that the court restructuring process used by our competitors . . . as intensified our competitive challenge. ” He maintained that AA had “put in place building blocks which . . . build a strong foundation for future success. ” But, he added, the company needed to tackle a key remaining “structural” impediment: the lack of “next generation labor contracts . . . more in line with the competitive market realities. In many respects, what we’re talking about . . . are transformational kinds of [collective bargaining] agreements. ” To that end, airline management throughout the autumn engaged in “very focused and intensive dialogue” with the Allied Pilots Assn. representing AA flight deck crew, according to Arpey.
But Arpey’s inability to strike a concessionary deal with the pilots finally convinced the AMR board that restructuring through bankruptcy was necessary. Horton has said AA spends about $800 million more annually on labor than it would if its worker agreements had similar terms to those of its largest competitors. In a letter sent to AA employees explaining his resignation, Arpey wrote, “It’s no secret that we have tried exceptionally hard over the last decade to avoid this outcome. But the [Chapter 11] process also represents an opportunity to rebuild AA in a way that assures it will not just survive, but thrive and win in the global marketplace. ” It was clear, however, that filing for bankruptcy was not Arpey’s preferred option. I respect the decision of the board of directors to take this path,” he said, noting that the board asked him to remain at the helm during the reorganization but he declined. Instead, he joined former CO CEO Larry Kellner’s Houston based investment firm Emerald Creek Group.
Cash Available That leaves Horton, AA’s onetime CFO, with the task of guiding the company through bankruptcy and beyond. “The future on the other side of this restructuring we think is very bright,” he has said. As Horton is the first to point out, AA is not the typical bankrupt airline, in terms of both short-term financial stability (unprecedented for a bankrupt US carrier) and having several unique “assets” that Horton believes provide a foundation for long-term prosperity. For starters, AMR has approximately $4. billion in unrestricted cash and short-term investments available, a very high amount for a bankrupt company in general and an unheard of amount for a US airline operating under Chapter 11. Coupled with revenue from continuing operations (more than $6 billion per quarter), the cash “is anticipated to be more than sufficient to assure that [AA’s] vendors, suppliers and other business partners will be paid timely and in full for goods and services,” the airline stated. “Because of the company’s current cash position, the need for debtor-in-possession financing is neither considered necessary nor anticipated. ” In other words, filing for Chapter 11 was a carefully plotted strategic decision, not a desperate play for survival.
AA views the process as a way to get its cost base more in line with competitors that have already utilized bankruptcy reorganization to lower their debts and expenses (especially labor costs), not as a means of avoiding imminent collapse—or anything close. (The company probably could have carried on outside of bankruptcy for some time, albeit while likely continuing to incur big losses. ) Passengers, partners and vendors shouldn’t worry that the company won’t be able to meet its obligations, AA has assured, eliminating what would be a serious concern in most bankruptcy cases. According to the Chapter 11 filing, AMR has total debts of $29. 55 billion including nearly $8 billion in underfunded pension benefits. But it also has $24. 7 billion in total assets. Horton said AA has “great assets” that will enable profitability if it can lower its cost structure.
Among these, he said, are hubs in key US markets (Dallas, Chicago O’Hare, Miami, New York JFK and Los Angeles) and a range of international partnerships, most prominently its membership in the one world alliance and antitrust-immunized joint ventures with British Airways and Iberia on transatlantic flights and with Japan Airlines on transpacific flying. “Most importantly,” he made a point of saying on the day of the filing, is the massive order announced last July (the largest ever for any airline) for 130 Airbus A320 family aircraft (to be split between A319s and A321s), 130 re-engined A320neos, 100 Boeing 737NGs and 100 re-engined 737 MAX aircraft. “That deal gives us enormous flexibility to grow the company as we get our costs and capital in line,” Horton said. Nearly one-third of the carrier’s fleet of more than 600 aircraft is comprised of aging MD-80s (even with AA retiring about 100 of the type over the last four years), a serious weak spot in a high fuel cost environment.
Replacing those aircraft with a slew of brand new narrow bodies will greatly boost the carrier’s operational efficiency. But how can a bankrupt carrier have so many new planes on order? Horton has called the blockbuster split order the “envy of the industry,” and the deal’s financing terms certainly are creating jealousy in airline board rooms. Both Airbus and Boeing, fearful of not being a part of AA’s fleet modernization, agreed to finance at least the first 230 of the 460 aircraft to begin delivering in 2013. In essence, the manufacturers will lease those aircraft to AA, taking care of about $13 billion in financing that the airline would have been hard-pressed to find independently.
Bernstein Research said in a recent report that AA was fully aware of its tenuous financial situation when the order was announced, and will likely be able to take delivery of the aircraft despite its Chapter 11 status, which could extend into next year. “We believe that this large order was the perfect approach for American management whether or not the airline was to eventually enter bankruptcy,” it stated. “At the time of the order, the company’s financial condition was much as it is today. But this deal meant that the airline would have a valuable asset: a huge number of delivery slots from both Airbus and Boeing at a time when both manufacturers were sold out of narrow body airplanes into 2016. ” Bernstein added, “We believe that the financing arrangements also minimized cash outflows from American.
Such a deal could not be done after a bankruptcy filing because the airline would then be prevented from spending any money on new airplanes. ” ‘Twists and Turns’ Even though AA is in a relatively strong position for a bankrupt airline, Horton acknowledged that the Chapter 11 process is “complex,” warning the company’s employees in a Dec. 15 letter that “it will undoubtedly be a path with many twists and turns— much will be unpredictable. ” Horton told the workers that AA “will have to change the way we do business,” necessitating “very tough and sometimes unpopular decisions that will impact people’s lives . . . and, regrettably, we will most certainly end the process with fewer people than we have today. AA entered into Chapter 11 with about 80,000 employees. For the most part, though, Horton appears to believe that AA has the correct basic platform and will largely look the same when it emerges from bankruptcy, just slightly smaller with lower costs and less debt.
“Level the playing field [with other US legacy airlines] and American will win,” he said. But, he cautioned in his letter, “outside parties . . . may try to knock us off our path . . . There may be opportunists who wish to acquire our company while we are in this situation . . . Internal discord will not serve us well. ” AA lost its status as the world’s largest airline after the DL-Northwest and UA-CO mergers. Size is not the issue,” Arpey said in 2008 when discussing one of the carrier’s steep quarterly losses. “The real factor is being profitable. We’ve got to get supply and demand to the point where we recover our costs. ” Arpey fervently believed—or, perhaps, hoped— that AA could be the one US legacy carrier to prove that profitability could be achieved through shrewd management that eliminated the need to seek the protection of US bankruptcy law. Now AA has reluctantly become the latest to conclude that the legacy burdens carried by a major international US airline are too costly to be competitive, and simply can’t be offloaded absent a Chapter 11 filing.