Western Airlines Back on a Smooth Course : But Improved Condition Makes It a Prime Candidate for a Takeover
For Michael H. Gable, a Western Airlines sheet metal mechanic, these have been unsettled times. Every morning he comes to work expecting to hear that the airline--his employer for 22 years--has been taken over by another carrier.
“You can see the handwriting on the wall,” Gable said the other day as he peered from the jet engine fan assembly that he was repairing. “It is happening all over the country. But Western is so small. I don’t think it can compete. I expect a merger or a takeover. I’ll hate to see Western go; it’s such a good company to work for.”
Gable isn’t alone in his nervousness. Tongues are wagging at Western’s headquarters at Los Angeles International Airport. And there’s only one subject: merger rumors.
Small wonder. Western Airlines, the nation’s 11th-largest carrier, which until recently was bleeding cash, has had a dramatic turnaround.
Now it is doing so well financially that its size, its young fleet, its greatly reduced debt and its dominance in the West have made it an attractive takeover candidate.
In the merger mania that has swept the airline industry, Western, the nation’s oldest air carrier, appears to be a logical takeover candidate and one of the last remaining brides that a suitor can go after.
“I liken Western to the prettiest girl in the school waiting for the homecoming dance to arrive,” said David G. Sylvester, airline analyst with Montgomery Securities in San Francisco. “I don’t think a takeover (of Western) is imminent. But I look at the trend in the industry, and I know that Western is the most attractive.”
It appears that Gable and his fellow employees can rest a bit easier. True, rumor has it that Delta Air Lines wants Western. But even if there have been overtures by Delta or anyone else--USAir and American Airlines have also been mentioned as interested parties--Western’s management, while admitting that it has held talks with other airlines, does not appear ready to throw in the towel.
Listening to Gerald Grinstein, Western’s affable chairman, one comes away with the distinct impression that the company is not up for grabs. “We’re masters of our own destiny,” he said in an interview. “Businesses in this industry which have improved their balance sheets and their liquidity have more than one option. They can pick and choose.” Options other than being taken over include acquiring another airline or merely arranging non-merger marketing agreements with other carriers. That is something that Western has just done with Japan Air Lines and Delta.
Whatever the future might bring for Western, the recent change in its financial picture has been phenomenal. Last year, the company reported a profit of $67.1 million, the highest in its 60-year history.
It is all the more startling since this was its first annual profit since 1979. The losses stemmed primarily from Western’s slow reaction to deregulation, which dramatically changed the face of the nation’s airline industry. The years after deregulation--when airlines were allowed to freely lower and raise fares, to enter and leave routes and to consolidate--were indeed stormy for Western.
Intensified competition from new low-cost carriers with whom it could not compete profitably, a poor economy, a slow-reacting management (it had five changes in top management in five years), too few business travelers and a mediocre consumer image all contributed to the five-year period of losses totaling almost $300 million. Between 1982 and 1984, in fact, Western was on the brink of bankruptcy.
Caught in the Middle
“We were caught between the mega-carriers that have . . . very, very strong balance sheets, computer reservation systems, very appealing frequent flyer programs,” Grinstein said. “And underneath us and nibbling at our more traditional leisure market were the new entrants that were siphoning off traffic.
Their advantage was that they had a totally different cost structure. They did not have organized employees. They hired people at what is known as the market rate. They bought their equipment on the used market as opposed to the new market . . . so their costs were totally different from ours. They targeted the leisure passenger by offering him price.”
Adam Aron, Western’s vice president for marketing programs, is somewhat more blunt. “There was a drive to save money at all costs because there was no money in the till,” he said. “This led to decisions that caused this airline to violate the old adage ‘You’ve got to spend money to make money.’ ”
But that’s largely history now. “Recently, a combination of positive factors has provided Western Airlines with the time and resources needed to pattern itself after other successful regional carriers such as Piedmont and USAir,” analyst Sylvester said. “Specifically, Western has lowered its costs, primarily through labor concessions, improved its mix of traffic to include more business travel, adjusted its fleet composition to include smaller, more-efficient planes, improved management and management controls and significantly reduced its debt burden.”
Western has reduced its debt to $378.9 million at the end of last year from $428.2 million at the end of 1984. That alone saves it $1 million a month in interest. Shareholders’ equity--or assets minus liabilities--has risen to $250 million from $62 million in 1984, the result of a conversion of debt into equity and a $30-million stock offering.
Liquidity Improved
“Financially, we are much more stable,” said Robin H. H. Wilson, Western’s president. “At the beginning of last year, we had a debt-to-equity ratio of 6.9 to 1. Now it is on the order of 1.6 to 1.
“Our liquidity has improved substantially. We can make decisions much more on a businesslike basis as opposed to having to concern ourselves with the short-term cash impact of that decision.”
One example of this, Wilson says, is that Western is currently redecorating the interiors of its entire fleet of planes at a cost of $15 million, putting in lighter, more comfortable seats with more legroom. Also, Western is acquiring more planes, investing in new computers for its reservation system and upgrading airplane engines. Not everybody agrees with Wilson’s assessment, though.
“Western is undoubtedly a stronger carrier today than at any time since deregulation,” said Scott Klinger, an analyst with Franklin Research & Development Corp. of Boston. “Still, there are risks. Long-term debts that exceed the industry average and continuing fare wars could pinch Western’s profits.”
Michael Derchin, airline analyst with First Boston Corp., a New York brokerage house, added that Western “has a highly leveraged balance sheet. Although its financial position has improved dramatically . . . it is still more vulnerable to economic recession and fare wars than companies with stronger balance sheets.”
While many of the nation’s other carriers are engaged in turbulent relationships with their unionized employees, Western enjoys excellent relations with its 10,000 employees. The first large airline to restructure its labor costs, its labor situation is quite tranquil.
During the same period, other airlines have laid people off. Some filed for bankruptcy to rid themselves of highly paid employees and then hired new people at greatly lower rates. Others endured lengthy, costly strikes.
Unions Aided Rescue
But Western’s unions played a big part in its rescue. In September, 1983, Western’s five unions, which represent 92% of its employees, took permanent 10% wage cuts in exchange for 7.8 million shares, or 32%, of the airline’s common stock (although a subsequent conversion of preferred stock and other securities to common stock has reduced the figure to 17%). They also got two seats on the 15-member board of directors. But the savings were not sufficient, and a year later the employees agreed to additional concessions. Wages were cut another 12.5%, and productivity was increased by between 8% and 12%. Newly hired workers started at a level 25% below the starting level of the 1983 agreement.
The concessions saved the airline $130 million annually, according to Grinstein, and have helped reduce the portion of Western’s overall operating expenses that is spent on labor to 31% from 36%.
In exchange for the concessions, Western employees received 20% of the first $75 million in profits and will get 35% of anything thereafter. (Recently, each employee got a check for $1,000 in that program.) The unions also were granted two more seats on the board of directors. The stock that individual employees received--the average worker got 780 shares at $4.125 each--have appreciated substantially. Western stock closed Friday at $11.125 a share, giving the average worker a potential capital gain of about $6,000.
“Having such a sizable exposure to the company’s fortunes has made an important impact on the work force,” Sylvester says. “When contract negotiating time rolls around again . . . we anticipate that the process will go smoothly for both sides.” (The company’s union contracts expire in December.)
Excellent Relations
“We have excellent relations with upper management,” says Dennis Johnson, recording secretary of Local 2707 of the Teamsters union, which represents mechanics, stock clerks and flight instructors at Western.
“We’re on a first-name basis with them. They are willing to cooperate in any problems we have. Before last year, no one had any way of knowing if he’d have a job the following week. Now everybody has job security.”
But more than help from employees was needed to pull Western’s foot out of the grave. It urgently needed to boost the proportion of business travelers on its flights, since they spend between 40% and 50% more on tickets than do leisure travelers. Western traditionally has been a leisure airline, largely because of its pleasure destinations--Hawaii, Mexico and Alaska. Because it could not sell all of its seats, it sold many to tour wholesalers at deep discounts. At one point, it was selling such seats at 3.5 cents per mile when its own costs were 8 cents.
But last year, the airline began to improve its schedule, providing more same-day round trips that allow businessmen to return home at night. It installed first-class sections on all of its aircraft that did not have them and improved its meals and its frequent flyer programs. As a result, Western has improved the mix of its passengers. Its percentage of business travelers, as low as 25% in 1984, has risen to about 48%, according to Aron. Western hopes soon to increase that to more than half “without sacrificing the leisure traveler,” Grinstein says.
It could not have achieved this if it had not set up a major hub in Salt Lake City in 1982. Western has 70% of the traffic in and out of Salt Lake City, representing 43% of the airline’s total capacity. It controls half of the airport’s 48 gates, operating 118 flights a day, an increase from 29 in April, 1982. In June, it plans to boost that number to 136.
Lures United’s Customers
Western says it is attracting lucrative business from United Airlines, which operates a hub in Denver, due to Salt Lake City’s better weather and less crowded conditions. Western says it also capitalized on the 29-day United strike last summer, luring away some of its traffic permanently.
Western is also well on the way to reducing significantly the cost of operating its fleet. Most of the planes that the airline buys in the future will be 110- to 130-seat Boeing 737s, which are better utilized in small markets connected to Western’s big hub at Salt Lake City. The shift away from the 727-200s, which have made up the bulk Western’s planes, to 737s as the foundation of the fleet greatly reduces costs. There is a 40% saving in fuel alone.
The smaller aircraft will also allow Western to increase its service to cities where there is less passenger traffic and less competition. Observers say this will lead to dominance in the cities that Western serves, especially through its hubs in Salt Lake City and Los Angeles.
Grinstein said that by next year, Western will be operating 37 of the 737s, more than twice the number that it had in 1983. At the same time, it will decrease the number of 727s to 33 from 47 in 1983.
Such savings will allow Western to greatly reduce the cost of operations and boost profit margins. Its present operating cost is 6.9 cents per available seat mile, allowing it to remain very competitive with other trunk carriers, which have costs ranging between 7 cents and 9 cents per ASM. (An “available seat mile” is one passenger seat--occupied or not--flown one mile.)
But Western must bring such costs down further to compete effectively with discount carriers such as Continental Airlines, which has a cost per ASM of 5 cents.
The plunge in fuel prices is also helping Western. Grinstein said every 1-cent decrease in the price of a gallon of aviation fuel decreases Western’s expenses by $3.6 million annually. And all of this, naturally, only increases Western’s attractiveness as a target of the takeover plans of the suitors in the industry.
