INCITE
Incite -- (v) 1: give an incentive; 2: provoke or stir up; "incite a riot"; 3: urge on; cause to act
Monday, July 26, 2004

 
UAL Needs to Hang it Up
Written by: Speculator

Sometimes it might be best to just call it a day.

Untied Airline's holding company, UAL, secured a new Debtor-in-Possession agreement on Friday that staves off the company's liquidation party until early 2005. 

Note: DIP, simply stated, is considered one of the last lending resources available for a distressed company.  What it effectively does is "transfer" most or all valuable (by that I mean assets that can be assigned an independent value by a third party) assets to a lender, or in UAL's case, a consortium of lenders, who monitor financial operations at the company with all the attentiveness of a sucrose-packed 5 year old at the base of a chimney on Christmas Eve.

The reward for the lenders is the front spot in the pay-me-line (per asset) should (when) things go awry.  So, when a company engages a DIP facility, it is effectively replicating the actions of a cash-strung, obligation-laden jackass at a pawn shop ("$500 for a '93 Rolex Daytona......I'll take it!").

So, what did Friday's agreement bring about?  Well, among other things, UAL essentially flung a mature hornets nest into each of their employees union camps.  UAL has announced that they intend to suspend all future funding of their pension plans.  The Wall St. Journal reports this morning:
The company said the terms of a new DIP financing arranged late last week to fund operations in Chapter 11 "effectively" prohibit it from making scheduled contributions to the plans.  UAL also said it hasn't decided whether it can sustain what it called "a huge financial burden" when it emerges from bankruptcy protection.
On July 15, UAL missed a $74.5 million contribution payment to the underfunded plan.  The company cited the need to "manage its resources".  Last year, UAL reported a top-line of $14.27 BB in revenues.  This missed payment represents 0.51% of last years annual cash generation.  This is a dire sign.  

By how much is the plan underfunded, you ask?  Depends upon who you consult.  UAL reported an underfunding of $6.2 BB on 31 Dec.  The Pension Benefit Guaranty Corp (PBGC), a quasi-federal agency that takes over plans when companies cancel them, finds the water-mark to be, as of 31 Dec, $7.5 BB.

Here is where the fun really starts.  Earlier this month, the feds gave UAL's chief Glen Tilton the finger by refusing his request for an additional $1.6 BB in lunch money (about time).  This left UAL reeling, and resulted in the consternation that surrounded UAL's attempt to secure further DIP arrangements.  Well, UAL in effect knocked the ball back into the government's court by announcing their intention to suspend pension funding.  If United terminates the pension plans, the PBGC gets to pick up the tab.  This would result in the largest financial loss in the history of PBGC, and the suffering of a great deal of pension recipients, as the PBGC is under no obligation to maintain the current level of payments.  UAL essentially told the government on Friday that they are going to pay, one way or another. 

This is when philosophical thoughts and arguments enter.  Maybe the use of Chapter 11 facilities are enjoying a little too much preference (as opposed to their Chapter 7 distant cousins) when a company who has been in Chapter 11 for over 12 months announces to the financial community that their scheduled emergence has been postponed for at least an additional 6 months because they could not secure the pinko-transfer of $1.6BB in government funds.  Granted, a company's ability to remain under Chapter 11 auspices is a direct function of the courts and financial markets' appetite for their story, and while this remains an efficient judgment-mechanism, it still raises questions.  Is UAL essentially committing financial destruction as it saps financial, capital, and human resources in its, in all likelihood, doomed attempt to reemerge as a fully functional, self-sustaining enterprise? 

There exists a truly artless statistic in the measurement of airline operating costs that facilitates effective comparison across all airline carriers.  It is a variable called Cost-per-Available-Seat-Mile, or CASM.  What it essentially communicates is an airline's total cost (sans fuel considerations) to move a seat, be it empty or occupado, one mile.  In 2003, the global industry average was around 9.50 cents.  The industry-leader, no surprise, was the perennial b-school case subject, Southwest Airlines, at 6.06 cents (others followed closely to SWA, including JetBlue at 6.18 cents.  Of all the airlines that were below the mean, only one was a non-low-fare carrier). 

United Airlines reported an 11.59-cents CASM in 2003. 

There is very little left to discuss. 

Over the past 20 years, "economy" airline travel has essentially become a commoditized business.  Outside of considerations surrounding unique city-pairs (e.g. Continental is the only airline that offers non-stop Tokyo-Houston service) and the airlines' attempt to forestall the forces of microeconomics by introducing the now ubiquitous frequent-flier programs, a flight from Chicago to New York is a flight from Chicago to New York is a flight from Chicago to New York.  The only differentiation point worthy of discussion is price.  And when your basic cost structure is 122% (this is following aggressive cost cutting, the likes of which are only reserved for Chapter 11 participants) of the industry average and 191% of the industry leader, it takes only a fundamental understanding of business to fashion a conclusion.

UAL needs to call it a day.  While the financial markets no doubt still find opportunity (which is a function of price and should NOT be construed as a collective statement of confidence), it would be prudent for the parent company of United Airlines to consider the fact that they are consuming finite resources in a bid that shares probability with Athens being crowned "Most Hospitable Olympic Host".


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John Beck

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