What Now?


Airlines



What Now?

Bullets on Airline Restructuring in Canada after the Onex Withdrawal

November 8, 1999


Lesson #1: Public Policy Should be Set in Parliament, not in Boardrooms

  • The governmentÕs invocation of Section 47 measures this summer was a welcome acknowledgment that CanadaÕs airline industry was broken, and that so-called "free competition" on the U.S. model was not working.
  • But by abandoning the leadership of the restructuring process exclusively to existing airline executives and financial investors, this restructuring process was diverted in directions that maximized the actual and potential profits of shareholders, rather than toward solutions which would make the most sense from a public policy perspective.
  • Even if and when a private restructuring plan is implemented, it is not at all clear that the fundamental problems underlying CanadaÕs airline crisis will have been solved. In particular, the problems posed by the wasteful expansion of capacity in the domestic market may not be adequately addressed through private initiatives (such as Air CanadaÕs current plan, which actually calls for the creation of another domestic airline).
  • The CAW has been arguing for a decade that airline deregulation has created an unstable economic environment in which a very small number of firms challenge each other for market share, with negative long-run implications for stability, profitability, efficiency, and even consumer welfare. The structural difficulties in the domestic market must be addressed in the course of this restructuring, or else the current crisis will inevitably reappear in future years. The federal government must take the lead in tackling these problems through regulatory reforms.

Lesson #2: "Saving" Air Canada is not a Solution for the Industry

  • Air Canada executives, and many Air Canada employees, have directed most of their energies in the last three months into opposing and defeating the Onex bid to buy the company. This effort, thanks to the Quebec court decision, was ultimately successful, and Air Canada executives and many employees are now relieved.
  • But merely protecting Air Canada against a hostile takeover bid does not in itself resolve any of the fundamental problems of the industry.
  • Though Air Canada is the seeming "winner" of the Great Canadian Airline Wars, it suffers from important financial problems of its own. Profits have been lackluster at best over the long-run, its share price has languished (until the speculation associated with the current restructuring), and it is heavily indebted as a result of its fruitless decade-long war of attrition with Canadian Airlines in the domestic market. The upcoming payment to shareholders of a significant portion of the companyÕs cash reserve can hardly strengthen the companyÕs balance sheet.
  • Sensing that the federal government would not approve any restructuring unless the survival of Canadian Airlines was addressed, Air CanadaÕs response to the Onex bid included a plan to acquire and continue operating Canadian Airlines as a separate subsidiary.
  • It remains to be seen whether this offer is a genuine effort to ensure the long-run viability of Canadian Airlines, or was instead a cosmetic concession to political realityÐnamely, the fact that the federal government will not allow Canadian Airlines (and its 16,000 jobs) to simply disappear.
  • The effort of Air Canada executives to seize on the current insecurity of its employees, to demand major concessions (most importantly a six-year contract) is deplorable, and proves forcefully that this companyÕs leadership is not really acting to "defend" their employees. Similarly, the proposal to establish a new low-fare airline operating within the Air Canada family also reflects an opportunistic attempt to take advantage of the current economic and regulatory flux to undermine, in the long-term, the wages and working conditions of all Air Canada workers.
  • In this sense, it is not at all clear that the supposed "victory" of Air Canada executives last week is in any way a victory for Air Canada employees.
  • If the Air Canada restructuring proposal is to be implemented, the federal government (in its capacity as the ultimate regulator of the restructuring process) must ensure that the interests of all affected airline workers (including those at the present Air Canada, at Canadian Airlines, and at the respective regional carriers) are protected.

Who Profits? Who Pays?

  • Onex and Air Canada spent an estimated minimum of $100 million on their battle for the allegiance of shareholders (legal and underwriting fees, advertizing costs, etc.).
  • Much or all of OnexÕs costs in the aborted takeover will be offset by a gain of an estimated $50 million or more on its own holdings of Air Canada shares.
  • Air CanadaÕs shareholders will receive a "gift", or one-time-special dividend, of over $1 billion through the $16 partial share buyback offer. A full $300 million of this one-time payment will be paid for through the depletion of Air CanadaÕs internal cash reserves. [For comparison purposes, at the end of the first quarter of this year, Air Canada had total cash reserves of $450 minimum; two-thirds of the companyÕs low-point cash stock is thus being paid out to shareholders.]
  • In short, shareholders have already done well for themselves thanks to the machinations of the financiers and buyout specialists.
  • The sums of money required to adequately protect airline employees through this restructuring process are not large, in relation to the profits that have already been earned by investors.
  • As a very tentative estimate, assume that early retirement and voluntary severance packages will be offered to 5000 airline employees, costing an average of $150,000 per employee. This would almost certainly be more than adequate to ensure a required downsizing of the workforces at the two airlines, without involuntary layoffs or forced relocations.
  • The total cost of this buyout packageÐ$750 million, spread over two or more yearsÐis considerably smaller than the amount of cash that is already being paid out to Air Canada shareholders.
  • Airline employees have suffered incredible insecurity and dislocation in the turbulent decade; on pure ethical grounds alone, they clearly deserve to be at least as well protected as shareholders through the restructuring process.
  • And it can certainly be argued that investing in the voluntary restructuring of the airline workforce would have a far more beneficial long-run impact on the operational efficiency of the industry (by considerably reducing the fear-level of individual workers, and calming the current antagonisms between workers at the competing airlines), than will the special one-time handout to Air Canada shareholders.

Back to Basics: The Fundamental Problem and How to Solve It

  • The Onex bid for Air Canada, and the subsequent Air Canada responses, focused attention on the possibility of a corporate merger as the solution to the problems of CanadaÕs airline industry.
  • But a merger is not the only option. And the complete merger of operating airlines poses daunting financial and operational difficulties that must be carefully considered. Not the least of these is the huge task of integrating two distinct workforces with distinct histories and cultures, and separate seniority structures, into a single unified workforce.
  • The CAW views the chronic financial weakness of the entire Canadian industry (including Air Canada) as being rooted in the nature of unregulated competition in the domestic market, which has produced a cyclical and unstable pattern of overcapacity, large losses, followed by crisis and retrenchment.
  • "Wingtip-to-wingtip" competition between major airlines has not benefitted consumers: fares remain high (to cover the huge costs of wasteful duplication), and schedules are less convenient than they could be. Airline investors have lost big, as have airline employees. Both companies have foregone key opportunities to expand their more profitable international business (where the market share of Canadian carriers has fallen to 35% from 50% since domestic deregulation), because of the financial and capital resources tied up in the money-losing battle for domestic dominance. The chronic maintenance of excess domestic capacity is economically irrational and hugely expensive.
  • The major airlines must step back from their competition in the domestic market. This "rapprochement" could occur in one of several ways:
  1. streamlined reregulation of domestic capacity growth

ii) private, cooperative agreement between the major airlines regarding their domestic capacity strategies (allowable under Section 47)

iii) the outright merger of the two airlines into one dominant carrier

iv) some form of cooperative financial arrangement between the major carriers (up to and including a full merger at the corporate or financial level), while preserving separate airlines at the operational level

  • The Onex proposal fell within category (iii) of these options, while the Air Canada counterproposal (on the surface, anyway) falls into category (iv). In the wake of the withdrawal of the Onex offer, the federal government now has the opportunity to more carefully consider the full range of policy options at its disposal. The current Air Canada proposal may or may not be the most feasible and beneficial of those options.
  • In any of the four categories of policy options listed above, a greater role for government oversight and planning in the airline industry is clearly suggested. A relaxation of domestic competition is necessary for the reallocation of financial, physical, and human resources in a more efficient and sustainable manner. But that relaxation also requires more government oversight to ensure that the interests of airline workers and the traveling public are well-served, both during and after the restructuring.
  • It is also necessary to learn from the debacle of the past decade to ensure that the problem of chronic overcapacity and unstable oligopolistic competition does not reappear several years down the road. In particular, the government ultimately needs to address the problem of limiting the expansion of airline capacity in core domestic markets.
  • Existing "low-fare" competitors to Air Canada and Canadian Airlines do not as yet constitute a major factor in the industryÐeven the much-vaunted WestJet, the only survivor of the numerous start-up airlines which have come and gone under deregulation, accounts for just a tiny fraction of Canadian airline capacity. But the problems posed by the expansion of capacity of new entrants could become significant in the long-term.
  • The government needs to learn from the mistakes of the past decade, and begin to consider ways in which the growth of domestic capacity can be rationally limited. In this regard, we invite the government to look again at proposals which were presented to the MinisterÕs Special Committee on Air Policy in 1997, such as the CAWÕs proposal to establish auctionable quotas that would regulate aggregate passenger capacity on major domestic routes.

Federal Responsibilities

  • The interests of airline workers have so far taken a back seat to those of financial investors during the present restructuring process.
  • As the representative of the public interest, the federal government needs to ensure that airline workers are fairly protected during and after the coming restructuring.
  • We fully recognize that the reduction of domestic airline capacityÐwhich we view as a necessary and valuable element of restructuringÐimplies a reduction of employment in the domestic segment of the industry. We expect that much of that reduction will be offset by normal retirement and attrition, and by future growth in the international side of the business.
  • Additional downsizing must be achieved through voluntary early retirement and severance packages. No airline employee should involuntarily lose their job through this processÐworkers have already sacrificed enough for their employers and for this industry.
  • In addition, no worker should be forced to relocate to another part of the country as a condition of keeping their job. Given the reality of two-career families and other personal responsibilities, telling someone that they must move across the country to keep their job, is tantamount to telling them they do not have a job.
  • The Onex investor group was willing to recognize a package of worker protectionsÐ including no forced lay-offs, no involuntary relocation, normal collective bargaining rights, and the provision of extensive early retirement and voluntary severance packages Ðas part of its restructuring proposal. This recognition sets a standard which other investor groupsÐincluding Air CanadaÕsÐmust be expected to meet in their own restructuring initiatives.


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