In search of a safe landing

Deirdre McMurdy August 30 1999

In search of a safe landing

Deirdre McMurdy August 30 1999

In search of a safe landing


Deirdre McMurdy

It would be hard to find two companies with a more open dislike of each other than Canadian Airlines and Air Canada. In addition to competing for passengers and routes, they have very different histories, corporate cultures and management styles. But this week, for the second time this decade, a financial crisis at Canadian will bring the two rivals—and their separate agendas —to one negotiating table.

Late last week, an opening foray aimed at salvaging Canadian in some form got off to an inauspicious, if predictable, start: Air Canada made an opening bid, and Canadian rejected it. Without attaching a price tag, Air Canada wants certain international routes—to Asia, in particular—currently controlled by Canadian. Air Canada is also willing to acquire certain unspecified “associated assets” and to share ticket codes, which would allow passengers to move freely between the airlines. Another key aspect of the proposal was a pledge to preserve jobs for a significant number of Canadian’s 16,000 workers.

The promise to save jobs is critical to win Ottawa’s approval for a rescue plan for Canadian. The Liberals are well aware that the bulk of jobs—along with Canadian’s headquarters—are in British Columbia and Alberta, where Liberal support is weak.

In fact, Air Canada played a key role in the federal government’s decision on Aug. 13 to suspend competition rules for 90 days to allow the two companies to talk freely. Ottawa made the move at the request of Canadian. It, in turn, was responding to overtures made by Air Canada. In an interview with Macleans before the proposal to Canadian was announced, Robert Milton,

the newly appointed chief executive of Air Canada, said the airline watches Canadians situation closely. “We operate on a planning basis that they will continue to be around,” he added. “[But] the fact of the matter is there is considerable competition in Canada whether it’s Westjet, charter airlines or transborder routes.”

Air Canada may face other competi-

Canadian needs a partner to stay aloft— and that has brought Air Canada calling

tion for Canadian’s assets. The financial community has been buzzing with speculation that Onex Corp., a cashrich leveraged buyout firm headed by Toronto financier Gerry Schwartz, may engineer a deal in which Onex would merge and control both airlines. Vancouver financier Jimmy Pattison and Calgary-based Westjet have also been tagged as possible bidders for parts of Canadian’s portfolio.

While the federal government clearly favours a made-in-Canada solution, there have also been suggestions that Ottawa might ease foreign ownership limits from the present maximum of 25 per cent to help woo an international investor. The Con-

sumers’ Association of Canada sees that as the preferred solution. “We’d rather see a foreign venture come in to keep competition lively,” says spokeswoman Jennifer Hillard. “Why should we just let these airlines carve things up to suit themselves?”

But despite the urgency of Canadian’s plight—and despite the federal Liberals’ own aspirations in Western Canada— there is no discussion of federal fund-

ing. “Regional pressures,” says one Liberal strategist, “are not so deep that the government would participate in a bailout.”

With a $500-million cash infusion needed to survive the winter, Canadian may soon have to lower its expecta-

Operating an expensive fleet of ‘oddballs and orphans’

tions. It lost another $107.8 million in the first quarter of this year and is on track for another losing year in 1999. For the moment, management is sticking with its strategy of trying to preserve foreign routes while forging a domestic market-sharing alliance with no overlapping service.

But Canadian faces other steep hurdles. Its problems are rooted in low revenues rather than excessive operating

costs. That leaves little opportunity to rebuild its finances through cost cutting, Previous cuts—along with the recession in Asia—have already damaged Cana-

dian’s lucrative business-class passenger base. In Canadians 1998 annual report, chief executive Kevin Benson wrote that

business traffic was down “due to many years of capital restrictions and cost reductions resulting in a product that was simply not compa-

comparable to that of the competition.” Already, the investment community has lost interest in Canadian’s fate. The company has market capitalization of under $80 million, and over the past five years the stock has dropped 90 per cent in value. Airline analyst Jacques Kavafian of Yorkton Securities Inc. in Toronto says: “I don’t know any analysts that seriously follow Canadian anymore. It’s

not a ‘buy’ story, so why bother?”

The inability to control costs affects vital areas of operation. Canadian’s balance sheet is vulnerable because of extreme leverage to currency exchange rates and rising fuel costs. Every onecent drop in the value of the Canadian dollar against the U.S. dollar costs the airline $11.7 million in operating and interest expenses. That is exacerbated by a 1998 issue of $270 million (U.S.) in senior debt notes, with interest payable in American dollars. And rising jet fuel costs exact a stiff price: every one-cent per litre rise costs the airline $16 million a year.

Other factors make Canadian a relatively dismal investment or merger partner. It has a 20-year deal with the Sabre reservation system that was negotiated in 1994 as part of American Airlines’ rescue package and would be cosdy to break. The company’s union contracts would raise tricky issues of seniority and staff integration in the event of a merger.

Canadian’s aging fleet is also a drawback. It relies heavily on fuel-inefficient Boeing 737s, which also need costly “hush-kit” upgrades to meet new world standards for noise emissions by 2002. Because Canadian has grown through a series of corporate mergers, it flies a hodgepodge of different aircraft—so it must spend more on pilot training, maintenance and parts inventory. “It’s a fleet of oddballs and orphans,” says Michael Murphy, director of Transport 2000 Canada, the Ottawa-based lobby group. “That’s always more of a challenge than uniformity.” He adds that while Canadian has a “remarkable, exemplary” safety record, the advanced age of its aircraft—especially its DC-10s— is a subject of discussion.

Another concern is the toll that perpetual financial crises have taken on employees and morale. In 1993, Canadian staffers contributed $200 million in wage and pension benefits to save the airline. In 1996, they took another $70 million in wage rollbacks. This time, workers have been silent. Just like the airline itself, they, too, find they are running on empty.

John Geddes

Ross Laver