BUSINESS

CLOUDS IN ‘OPEN SKIES'

CANADA’S NUMBER 2 AIRLINE LOOKS FOR NEW WAYS TO SURVIVE TOUGHER COMPETITION

DEIRDRE McMURDY February 25 1991
BUSINESS

CLOUDS IN ‘OPEN SKIES'

CANADA’S NUMBER 2 AIRLINE LOOKS FOR NEW WAYS TO SURVIVE TOUGHER COMPETITION

DEIRDRE McMURDY February 25 1991

CLOUDS IN ‘OPEN SKIES'

CANADA’S NUMBER 2 AIRLINE LOOKS FOR NEW WAYS TO SURVIVE TOUGHER COMPETITION

BUSINESS

For Rhys Eyton, this week’s planned opening of the futuristic Terminal 3 at Toronto’s Lester B. Pearson International Airport is far more than a ribbon-cutting ceremony. It is an event that crowns years of effort to turn Canadian Airlines International Ltd., the Calgary-based company he heads, into a strong national carrier capable of challenging Air Canada’s dominant position as the country’s number 1 airline. And as Eyton, 56, himself acknowledges, Canadian Airlines faces serious problems. Like dozens of other airlines, the company is reeling from the combined effects of the economic recession, worldwide overcapacity and higher fuel prices caused by the Persian Gulf crisis. The heightened concern for security as a result of the Gulf War has even forced the airline to scale down its plans for a lavish opening-day party at the new terminal. “I’m frustrated— the whole company is frustrated,” Eyton told Maclean’s last week. “I’ve never seen anything like this in all my years in the business.”

Moreover, the pressures on Eyton are likely to increase dramatically in the coming months. Last week, Transport Minister Douglas Lewis vowed to press ahead with a plan to give U.S.

airlines full access to the Canadian market— despite warnings by an all-party parliamentary committee that the arrangement will devastate Canada’s airline industry. The prospect of a socalled open-skies agreement between Canada and the United States has fuelled speculation among analysts—and even among some Air Canada officials—that the two national carriers will be forced to merge in order to compete with larger U.S. airlines for international and domestic travellers. For his part, Eyton rejects out of hand the possibility of a merger. Instead,

he appears to be pursuing a bold new strategy: finding a foreign investor willing to buy a significant minority stake in the company.

Eyton gave few details of his airline’s plan to find a foreign partner. But he acknowledged that the company is counting on Ottawa to lift the permissible level of foreign ownership to 49 per cent from the current legal limit of 25 per cent. Foreign investors now own less than four per cent of Calgary-based PWA Corp., which is Canadian Airlines’ parent company. Explained Eyton, the airline’s president, chief executive officer and chairman: “We want access to global capital pools. Capital pools in Canada are just too small.”

Without an infusion of new money, Canadian Airlines will be hard pressed to cope with the wide-open competition in the North American market. In the past two years, the company has cut its workforce by 1,900 employees, to 16,100, and sold eight of its 97 aircraft. As a result, the airline reduced its total seat capacity last year by 10 per cent. Those measures helped to produce a profit of $19.4 million on revenues of $2.1 billion in the first nine months of 1990. Still, Eyton said that the airline lost so much money in the final quarter that it will post a loss when the full-year results are reported later this month. He added that the company is unlikely to return to profitability in 1991.

On top of those problems, Canadian Airlines is carrying almost $1 billion in long-term debt, much of which results from the company’s

takeover of Wardair Inc. in April, 1989. Company officials say that they had hoped to reduce the debt by selling eight of Wardair’s Airbus A310-300s for $547 million to a division of Montreal-based Lavalin Inc., which in turn planned to sell them to the Soviet airline Aeroflot. But that deal collapsed earlier this month when Aeroflot withdrew, citing a shortage of hard currency. Canadian Airlines is now searching for another buyer. Said Eyton: “We’ve discounted the aircraft to sell them quickly now. But it’s not a good time to sell.” Timing may also be a problem with Eyton’s plan to attract foreign investment. Last fall, representatives of both Canadian Airlines and Air Canada spoke in favor of raising the legal limit on foreign ownership during their submissions to the all-party parliamentary committee on transport. Last month, the United States raised its own limit on airline foreign investment to 49 per cent from 25 per cent. In Ottawa, a senior adviser to Lewis told Maclean’s last week that the transport minister sympathizes with the airlines’ desire to attract new capital. But he added that increasing the existing limit would likely require an amendment to the National Transportation Act—a decision that both the Liberals and the New Democratic Party would probably oppose. Said the adviser: “When we have to amend an act, we always bank on it taking at least six months.

Frankly, I can’t imagine that something like this would be tremendously popular.” Eyton’s other major difficulty is the prospect of unfettered competition between Canadian and U.S. carriers throughout North America. Currently, about 13 million passengers fly between Canada and the United States every year, generating $2.3 billion in annual revenues. Only about 35 per cent of that market is held by Canadian carriers. Under a bilateral agreement signed in 1966, the two national governments restrict each country’s airlines to specific cross-border routes. In addition, the airlines are denied the right to cabotage—the practice of picking up and flying passengers between cities in another country.

In Washington last week, Lewis reaffirmed plans to negotiate a new accord on cabotage when talks on a revised air agreement between the two countries begin next month. He added that a final agreement should be reached next year. Declared the minister: “A liberalized agreement, with cabotage, is essential for Canadian carriers

to access the U.S. market

fully and redress the structural imbalance.”

In fact, Maclean ’s has learned that Ottawa is seeking several key concessions from Washington that would make it easier for Canada’s two carriers to adjust to an open-skies agreement. According to a federal official who has taken part in the discussions, representatives of the two countries have already reviewed informally a proposal to allow Canadian airlines full cabotage rights in the U.S. market from as soon as the new agreement took effect. By contrast, U.S. airlines would gain cabotage rights in Canada only after the agreement had been in force for five years. During the first few years of the agreement, U.S. airlines might also face restrictions on the frequency of their daily flights to and from major Canadian airports. “Nothing is in writing yet, but the Americans have already accepted that there will have to be early advantages built into the agreement for Canadian carriers,” the official said. He added: “Our position is that if the U.S. negotiators don’t show a certain amount of maturity, there won’t be a deal.”

For the moment, however, Eyton appears skeptical about Ottawa’s ability to protect the interests of the Canadian airline industry. Industry analysts point out that Fort Worth, Tex.-based American Airlines, the largest U.S. carrier, has an estimated 556 aircraft, compared with 89 for Canadian Airlines and 107 for

Air Canada. “We want additional point-to-point access to the United States, but we are consistently against cabotage,” Eyton says. He adds that even if cabotage rights were phased in gradually, “it is a no-win situation for Canadian carriers.”

Fearing head-to-head competition with the giants of the U.S. industry, Canadian Airlines has drawn up a shopping list of conditions that it wants in a new bilateral air agreement. Topping the list is a provision that would require U.S. airlines to make available to Canadian carriers long-term gate leases and slot allocations at major airports, as well as access to their computerized reservation systems. Said Eyton:

“Every major U.S. centre has been transformed into a fortress by U.S. carriers. There is a problem with access.”

Another impediment, Eyton says, is that taxes on jet fuel in Canada are as much as 40 per cent higher than in the United States. Without that tax disadvantage, Canadian Airlines’ 1990 fuel bill of $450 million would have been about $150 million lower. Similarly, Ottawa’s 1987 decision to abolish special tax writeoffs for leased equipment makes financing costs for new aircraft about five per cent higher in Canada than in the United States.

Despite Eyton’s wary approach to the openskies negotiations, he says that he is determined to ensure that Canadian Airlines takes advantage of new opportunities in the international market by expanding the company’s

existing network of alliances with other carriers. Currently, Canadian Airlines has alliances with Lufthansa, Japan Airlines, Qantas and Air New Zealand. Under such agreements, airlines sell seats on each other’s aircraft and split the revenue from routes that both of them fly. The company hopes to announce several additional agreements in the near future, including one with a major U.S. carrier, Eyton says. Industry analysts say that American Airlines is the most obvious candidate for closer ties because it plans to share space with Canadian Airlines at Terminal 3 in Toronto.

At the same time, Eyton dismissed allegations by some Air Canada officials that his

company will be forced to merge with the Montrealbased airline. Declared Eyton: “They see how strong we are becoming at a time when they appear slow to react.” He adds that Air Canada’s failure so far to hire a new president and chief executive officer to replace Pierre Jeanniot, who resigned last August, is symptomatic of the company’s problems. “They have been talking about hiring a new CEO for six months now,” said Eyton, “but they haven’t done it.”

Still, Air Canada’s problems produce little comfort in Canadian ^lines’ headquarters. Communications director Jack Lawless, for one, said that last year’s announcement that the company had lost money for the first time in its history was “devastating internally,” particularly because it took place after the

airline had begun to implement a massive costcutting program. Since then, the recession and the Gulf War have added to the difficulties. Said Lawless: “We’ve finally seen the light at the end of the tunnel, only now it’s a train.” Eyton, meanwhile, appears to be taking a philosophical approach. “I worry about what I can control, not about what I can’t,” he says. “We can only batten down the hatches and hope we come through it.” The outcome of Eyton’s struggle will help to dictate the future shape of the Canadian airline industry.

DEIRDRE McMURDY

ROSS LAVER