BUSINESS WATCH

Airline message: merge or die

Peter C. Newman December 7 1992
BUSINESS WATCH

Airline message: merge or die

Peter C. Newman December 7 1992

Airline message: merge or die

BUSINESS WATCH

PETER C. NEWMAN

If God had meant us to fly he would never have created Canada’s airline policy. Most countries, some with twice our population, can no longer afford to keep two national airlines afloat. Even some of the world’s strongest carriers, such as Lufthansa, Alitalia and Air France, are searching for what they call “strategic alliances,” which really means ways of spreading their losses. The sad fact is that no matter what temporary solution is hammered out, in the long run there is no way we can afford two independent national airlines. Air Canada and Canadian Airlines must either amalgamate or become the northern juniors in a restructuring dominated by U.S. partners.

Although it appears to be the only way we can maintain at least one national airline, even the forced merger of the two carriers looks like a dubious proposition. Between them, Air Canada and Canadian carry a debt load of about $7 billion. That would burden the merged parent company with the third-highest debt level of any airline in the world, a just about untenable debt-equity ratio of nearly 30:1, and the highest debt-to-revenue ratio of any carrier still brave enough to fly. In other words, putting the two airlines together under their current operational codes is no solution.

The most helpful gesture Ottawa made last week was not the reluctant loan of $50 million to Canadian—which was like throwing a 21foot rope to a man drowning 40 feet from shore, while yelling, “I’ve met you more than half way!” Much more significant was the accompanying warning by Transport Minister Jean Corbeil that if the airlines don’t stop clobbering one another with seat sales, and if they refuse to cut back their unused capacities, Ottawa will step in to do it for them.

The current practice of double-tracking is bizarre. Between them, for example, the two airlines fly 30 times a day from Calgary to Vancouver and back again—with half-empty flights leaving and arriving within minutes of each other. The carriers’ overcapacity now

No matter what temporary solution is hammered out, in the long run there is no way we can afford two national airlines

amounts to nearly 30 per cent; that’s why be tween them, they are currently losing nearly $2 million a day. (PWA Corp., Canadian’s holding company, last week reported a 64-per-cent drop in the airline’s earnings for the year’s third quarter, traditionally its strongest.)

While the Calgary-based Canadian has had to go along with the charade of selling seats below cost, the price wars have almost always been triggered by Air Canada After its privatization in 1986, the former Crown corporation felt it had to emphasize its dominance by overstocking on new planes and artificially producing passenger loads through continual rounds of seat sales. Canadian understandably interpreted these tactics as the Montreal-based airline’s way of trying to drive it into the ground. “Air Canada’s focus,” Rhys Eyton, Canadian’s chairman, complained in an interview with Alberta Report, “is to put Canadian Airlines out of business.” He added, “They intend to accomplish this both by using their bigger bank accounts to outlast us and by threatening the government”

Eyton is running out of time in his desperate attempts to remain outside Air Canada’s clutches. His manoeuvring room in trying to put together a deal that might be acceptable to American Airlines is severely circumscribed

by the dispute over the Gemini reservation system he shares with Air Canada. One of American’s conditions for injecting $250 million into Canadian is that the airline switch to American’s computers, a step that has prompted Gemini to launch a $1.5-billion lawsuit against PWA and a $500-million lawsuit against American. (Air Canada’s litigious tendencies overstepped legitimate bounds when the airline threatened to sue Ottawa if it gave Canadian any money—this from an airline that during its 52 years as a Crown corporation happily accepted billions of dollars in government subsidies.)

One of the unknown factors in the whole equation is how long American itself can stay out of the bankruptcy courts. In terms of revenues, American is the largest airline in the United States. But last year, it managed to lose $290 million on revenues of $15.6 billion. The profit picture is even gloomier for this year, and American chairman Robert Crandall has already announced that with his airline facing extra 1993 expenditures of $1.4 billion, he will ground those airplanes in his fleet that are on short-term leases.

Ironically, one of the few airlines worse off than American is Continental, whose former president Hollis Harris, now runs Air Canada. Harris rescued Continental from 23 months of unsuccessful bankruptcy reorganization with a $280-million investment. The deal seems to make superficial sense because it would allow Air Canada to become a North American carrier. But Continental, which has been in bankruptcy courts twice before, is saddled with an aging fleet and low staff morale. Worse, the partnership’s potential synergies depend on Canada and the United States successfully negotiating their long-delayed “open skies” policy. One of the issues at dispute: Air Canada is not allowed to fly into Denver, one of Continental’s busiest hubs.

The toughest aspect of this cruel dilemma is the number of staff reductions that may be required if Canada’s airlines are ultimately merged. As many as one-third of their combined workforce of 35,000 could be laid off. The brave offer by Canadian employees to cut their salaries by up to 14 per cent and thus contribute about $200 million towards financing the American merger is a highly commendable move, but it may not be enough to turn the tide of red ink.

Hershel Hardin, the Vancouver-based author who has made a specialty of studying the effects of deregulation on Canadian airlines, last week suggested that the only solution may be “to buy up Air Canada and PWA, merge them, and create a single, publicly owned transcontinental carrier.” He’s probably right. The advantage of a monopoly (if its rate structures are tightly controlled) is that it allows for the optimum use of aircraft capacities and maximizes the economies of scale. Since Canada’s taxpayers are probably going to end up footing the bill for rescuing the airlines anyway, we may as well get something back for it.

Welcome to the upside-down world of the 1990s.