United May Get Lift by Dumping Collective Failure
Will it be safe to invest in United Airlines if the employees get to own it? Sure, it could even be smart because odds are that short-term the new United would be an attractive prospect.
In the proposed United buyout, which still must be approved by union members and company directors, employees would acquire 53% of the airline in return for wage concessions--and a hefty company payout to existing shareholders. The immediate effect would be that employees will cut United’s labor costs up to 20%--thus boosting earnings--in hopes of a reward six years or so down the road. In essence, they are taking greater risk for a potential but uncertain long-term reward.
Meanwhile control would remain with institutional shareholders and creditors. Under terms of the deal announced last week, existing shareholders will get money out now and leave workers with more direct responsibility for success of the business or liability for failure.
The idea of of a huge employee stock ownership plan at United is many things, depending on your perspective. For shareholders, it’s an attempt to make the company competitive in a crowded industry. For employees, it’s an attempt to gain a measure of control over their working lives. For the Clinton Administration and Labor Secretary Robert B. Reich it’s an admirable model “for all industries.” But it should not be overlooked that the buyout results from labor and management failure.
The extent of United’s uncompetitiveness is astounding. In the buyout, the company will issue stock in exchange for employees taking wage cuts, forgoing contracted wage increases and making changes in work rules sufficient to cut United’s labor costs by $700 million to $800 million.
That’s a sum roughly equal to United’s losses in the last two years or, put another way, far more than the company earned in any year in the last decade.
And that begs the question. If costs can be reduced so readily today, why weren’t employees ordered to do so before? The answer is inefficiency was protected by union contracts no longer suited to the current business environment, when airlines such as Southwest are beating the pants off the big carriers.
But why didn’t management fight, take a strike if necessary, to change those contracts? Because a long strike might have bankrupted United and its parent company UAL Inc. The company has $3.6 billion in long-term debt and only $706 million in stockholders’ equity. It wouldn’t take much to topple a structure like that.
United’s management led by Chairman Stephen M. Wolf contemplated splitting the company into several regional airlines and contracting out maintenance and other services as an end run around the unions. But such tactics would have produced a bitter strike and probably met with White House disapproval.
So Wolf has decided to bow out, cashing in stock holdings and options possibly worth more than $30 million if the buyout is approved by union memberships and the UAL board of directors.
Existing shareholders will get a payment of $88 in cash, preferred stock and senior debt securities--and shares of common stock in the new United as well. If preferred dividends and interest payments on the senior bonds are not made, existing shareholders could take the airline back--just as your mortgage lender could take your house if you missed monthly payments.
“That new stock will be a good investment,” says Prof. Joseph Blasi of Rutgers University, an expert in employee ownership. Blasi and others have produced studies showing that stocks of companies with sizable employee ownership perform as well as any others on the Wilshire index of 5,000 publicly traded companies.
Ultimately United’s stock performance will depend on profitable management of a difficult business. Lower wages may not be enough. Southwest’s success stems from operations, not wages. It flies short hops, lands and takes off planes within 20 minutes, and has well-paid employees who work longer and at more tasks than those on other airlines.
Even on the international front, where United has an edge on government-owned foreign airlines, things are changing. British entrepreneur Richard Branson’s Virgin Airways has grown into a worldwide carrier. So Branson is splitting the company into Virginia Atlantic and Virgin Pacific because he doesn’t want it to get big and bureaucratic.
On the brighter side, the airline business which depends on employees skillfully handling stressful customers, should benefit from committed owner-workers. And United’s employees are buying at a good time. “The industry collectively should earn $1 billion this year, compared to a loss of $2 billion last year,” says Lee Howard, president of Airline Economics, a Washington research firm.
The overriding significance of United’s buyout is that if it succeeds, it could set a useful precedent of a way to dispense with rigid labor contracts or practices that make firms unresponsive to a changing world.
To succeed, United’s employees will have to think and act like small business owners--which means working long hours and weekends and worrying all the time about the business. “And pilots, machinists and flight attendants will have to work with one purpose,” notes Henry Hansmann, a Yale law school professor who has studied management systems around the world.
But there’s a reward for employee effort. Ultimately, after roughly six years--in which their concessions would earn them stock--the employees would own equity in the business.
Traditional thinking saw ownership as less secure than union contracts, but union contracts didn’t protect United and its employees from change and competition in today’s world.
So in a sense United’s employees have no choice but to take the risks of ownership. And for the good of U.S. business, we should hope they reap the rewards of ownership as well.
