Others Might Climb Aboard United’s Plan
Keep your eye on the offer by United Airlines’ pilots to buy Allegis Corp., United’s parent and the company they work for. Because if they succeed, their venture into high finance may well suggest a solution to a problem shared by many U.S. companies: How to cut costs and get competitive yet avoid layoffs or destructive strikes.
The United pilots, in a bid announced last week, propose to purchase all of Allegis, then sell the non-airline parts of the $10-billion (revenue) company (Hertz car rentals, Westin and Hilton International hotels) and retain ownership of 80% of the remaining airline company through an Employee Stock Ownership Plan, or ESOP. The total value of their offer comes to approximately $5.5 billion. Of that, the pilots and other employees will have to come up with roughly $2 billion in cash. They propose to borrow $1.5 billion and kick in the remaining $500 million by taking money from their pension funds and cutting their own pay.
Situation Confused
The situation at Allegis is confused. The management is proposing a $3-billion restructuring of the company while the Coniston Partners investment group, which owns 13% of Allegis, wants to replace the management and board of directors. But the pilots’ offer is no mere labor maneuver. Rather it is the richest bid so far to Allegis shareholders, and is backed by two of Wall Street’s smartest investment banking houses, Lazard Freres and Salomon Brothers--which would raise the $1.5-billion debt financing from investors.
The pilots and other employees would then pay back that debt through pay cuts. The pilots propose to cut their pay by 25% and to try to get the other employees to reduce their pay by 15%. A rough estimate says that would reduce United’s labor costs (and thus increase its cash flow) by $400 million a year. Some of that extra cash flow would help United operate more competitively, and some would pay off the debt. In about seven years, says a pilots union spokesman, the employees would own 80% of the airline’s equity.
In one sense, the pilots are only recognizing reality. Their pay is about to be cut anyway because whoever wins the current takeover tussle is sure to move quickly to slash United’s costs, which are higher than those of its chief competitors, American and Continental airlines. United’s pilots, for example, make $120,000 a year compared to $60,000 a year for Continental pilots. So the pilots moved to get something for their pay concessions by proposing an employee version of the leveraged buyout--the technique by which managements buy out shareholders with borrowed money and then use the company’s cash flow to pay off the debt.
But the pilots didn’t get the idea from management manuals. They got it from Louis Kelso, the 73-year old original thinker who devised the ESOP many years ago as a way of giving wage earners an additional stake, a slice of capital ownership, in the U.S. economy.
Jobs Preserved
Kelso, a lawyer by training who now runs his own investment banking firm in San Francisco, has seen his idea preserve jobs at troubled companies such as Weirton Steel, which would have shut down in 1983 if its employees hadn’t been able to buy it.
He has also seen the idea used to the disadvantage of employees, either as a financing tool by managements or as the basis for the leveraged buyout, which Kelso denounces for concentrating wealth instead of spreading it. “I explained the idea to George Roberts,” says Kelso, “and he went ahead and founded Kohlberg Kravis Roberts (a Wall Street firm specializing in leveraged buyouts) and distorted it.”
Kelso met with United’s pilots three years ago and the idea of their buying the airline has been percolating ever since. If they can bring it off--and Salomon Brothers is certainly confident of raising the financing--United Airlines would become the largest ESOP to date.
And perhaps a significant precedent. Because United, the largest domestic airline, is a profitable firm--a going concern, that is, not a failing company as was Weirton Steel. Cutting labor costs is often easier at troubled firms, where workers and managers are willing to make sacrifices in their common peril, than at profitable companies, where labor costs are cut through layoffs or at the expense of bitter strikes--such as the one at United Airlines last year.
A United ESOP would provide a different model--one of employees taking less in wages in return for an offsetting ownership stake that could pay a tax-exempt dividend on capital.
Kelso has spread that idea to some 9,000 firms in the last half century, and even proposed a $20-billion ESOP in 1981 to General Motors and its union, the United Auto Workers.
But neither the giant auto company nor the union--nor the investment community--was ready for the idea back then. Times have changed though and there is a need for fresh thinking at GM today. Which is why it’s a good bet that a big ESOP will be on the agenda when GM and the UAW go into crucial contract negotiations this summer.
