The Dangerous Cost of Airline Deregulation
THE latest chapter in airline deregulation is a prescription for disaster. Most airlines are saddling themselves with enormous debt and fleet capacity. Watch out if recession rears its ugly head. Two reasons account for the sudden surge of interest in airline acquisitions. First, after more than 150 bankruptcies and 50 mergers, the industry has become an oligopoly. Eight megacarriers dominate 94 percent of the domestic passenger market. With fortress hubs and shared monopolies, ticket prices are ascending into the heavens. Now that airlines are becoming money machines, they have become targets for leveraged buyouts (LBOs).
Second, the glamor of the industry has always attracted men with huge egos. In the old days, it was buccaneers like Howard Hughes, Eddie Rickenbacker, and Juan Trippe. These days it is Marvin Davis, Donald Trump, and Peter Ueberroth. Owning an airline is more prestigious than owning an NFL franchise, for there are fewer of them. Owning an airline also means becoming emperor of several fiefdoms, for the fortress hubs have a stranglehold on the cities they serve.
Prior LBOs reveal that raiders leverage airlines to the teeth to pay for acquisitions. In the mid-1980s, Frank Lorenzo gobbled up Eastern, while Carl Icahn grabbed TWA and Ozark. They added millions in indebtedness to these once proud airlines, while stripping them of assets. Before Eastern fell into bankruptcy, it carried $2.5 billion in long-term debt; its debt service was a crushing $575 million a year. TWA carries $2.4 billion in debt and lease obligations, and has a negative net worth of $30 million.
Not only are LBOs burying airlines in debt, new aircraft acquisitions are as well. Media attention has focused on the geriatric jets - the peeling skin and the exploding doors. The fear of flying has prompted airlines to order huge new fleets of aircraft. The conventional wisdom also identifies fleet mass as a key ingredient of survival. So fleets grow.
Adding new jets will reduce the average age of the nation's fleet. That will increase the margin of safety, but it saddles the industry with even more debt.
What's worse, unlike the days before deregulation when airlines actually owned most of their aircraft, today they lease them. For example, American Airlines owns only about a third of its 476 aircraft outright. Even solid carriers like Delta have sold large numbers of aircraft only to lease them back. That increases debt, but decreases value. Potential and successful LBOs will accelerate this trend.
Lease obligations usually don't show up on balance sheets as debt, but like accumulated frequent-flyer mileage, they should. When these obligations are included, the industry's debt-to-equity ratio is significantly worse than it was in the mid-1980s, although industry performance has dramatically improved.
Whether purchased outright or leased, new aircraft not only impose tremendous debt, they also flood the market with capacity. For example, American Airlines may have a fleet of more than 800 aircraft by the late 1990s. If we learned nothing else from deregulation, we should have learned that excess capacity causes prices to spiral downward, and leaves the airlines afloat in red ink. A soft economy may dissuade the airlines from retiring the geriatric jets.
So now the wild cards - fuel prices, air terrorism, or recession. The former will raise industry costs, as they did in the 1970s and 1980s; the latter two will curtail demand. Few industries are as susceptible to downward turns in the economy as are airlines. Recessions prompt travelers to cancel their vacations and businessmen to tighten their belts. Passenger demand plummets.
Couple a prolonged recession with excess capacity and high debt service, and we will see another round of bankruptcies and mergers like the one in the early 1980s. When the dust settles, the industry will be even more concentrated than it is now. As the economy improves, surviving megacarriers will raise prices more ruthlessly.
Sooner or later, we will reregulate the airlines. Better for government to jump in sooner rather than later to halt widespread failures in an industry so important to the nation's commerce, communications, and national defense, and to preserve what little competition remains.
There are more important interests than the greed of a small and exclusive club of corporate robber barons. America needs a safe and dependable transportation network, providing decent service at a fair price. Responsible government oversight of this important infrastructure industry is essential to restore its position as a servant of the public interest.