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The Daily Interview: Airlines Could Be Headed for a Grounding

The U.S. airline industry will be crippled if the government does not provide relief on an order never before seen in the private sector, says Scott Gibson, a senior vice president with Simat, Helliesen & Eichner, a company that provides consulting to the airline industry.

Scott Gibson
Senior Vice President,
Simat, Helliesen & Eichner
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Gibson, who testified before the House Transportation Committee this week, says that not only does the government need to provide immediate relief and loan guarantees to the airline industry, it also will have to underwrite insurance for cataclysmic events and restore public confidence in air travel by helping to police commercial travel. Even if these measures are taken, Gibson says, the crisis facing the airline industry is so great that it's almost certain a number of airlines will go out of business.

TSC: What did the House Transportation Committee ask you as you testified before them Wednesday?

Gibson: They are looking at a bill to help the airline industry. This is such a cataclysmic event, akin to an act of war, that it threatens the entire airline industry. Government has an essential role here to keep this key infrastructure business up and going. Were they not to do that, I don't think there is any other party out there who could help preserve this industry.

Aside from financial aid, which needs to happen very quickly, the first thing that the government needs to do is to restore confidence in the air transport system, and that may involve federalization of security and other measures. That is the most essential thing. Absent that, this business is dead.

TSC: Do you believe that the $24 billion that the airline industry is seeking from the government is sufficient?

Gibson: They are now seeking nearly $18 billion. None of us knows for sure. All of us are making projections based on past events -- the Gulf War, Pan Am 103. While they help give us an indication, none of them are comparable to the events that happened last week. Certainly the airlines' traffic results since the system started up again are much more depressed than one might have expected.

TSC: What about the $5 billion that President Bush is giving to the industry in immediate cash? Is that sufficient?

Gibson: It's sufficient to stabilize the airlines for today, yes. The airlines have a very specific problem today, and that is cash. American, held by AMR (AMR), and United, held by UAL (UAL - Get Report), will run out of cash. The financial markets are closed to them because of the liability issue now facing the entire airline industry. Unless there is some kind of shield provided by the government to protect airlines from third-party claims, no one in their right mind would lend money to the airlines.

The second problem you've got is confidence in the business going forward. We don't know when passengers will return. It may not be soon enough. So every airline in the nation is at risk of going bankrupt. Given the fiduciary responsibility of a lending institution, who in their right mind would lend money to a business that they can't predict will be around a month from now? The answer is, they won't.

That's where the loan guarantees are needed. There is no private company that can afford the risk, because the risk is unknown.

TSC: What's going to happen to the aircraft that are in production now at Boeing(BA - Get Report) and Airbus? Who is going to buy those?

Gibson: The airlines have probably started negotiations with the aircraft manufacturers. It is inconceivable to me that in a world when you have 20%-25% of the current fleet grounded that you have an ability to afford the new deliveries. There are 930 aircraft on order by U.S. passenger carriers.

The airlines can cancel and not take an aircraft, but they will incur penalties. And most airlines make big predelivery payments. They get that money back when they are in receipt of the plane through financing, but the markets today are not functioning.

TSC: What about insurance? How much aid might American Airlines and United Airlines hope to receive? And what kind of protection against lawsuits might they seek?

Gibson: The airlines generally have coverage for an accident that includes a terrorist event. I have never heard of coverage greater than $1 billion per event, and the $1 billion rule of thumb is designed to cover 500 injuries or fatalities, damage to the aircraft and property.

Certainly something of the order of magnitude of the World Trade Center goes far beyond the insurance coverage that is in place. Historically, this goes far beyond the ability of American or United to absorb. This basically kills those companies -- the liability that stems from the two crashes into the World Trade Center.

As far as whether the other airlines' loss of business due to this event is covered by insurance, I do not know.

TSC: So are you saying that American and United are going to go out of business?

Gibson: Yes, it could jeopardize their survival, but what I think they will do, absent protection from Congress, is go into bankruptcy and say this is a pre-petition claim.

As far are the lawsuits are concerned, there is a ceiling on the total amount that they can be sued for. If you had an aircraft accident that injured people on the ground, this historically has covered them. I don't think any insurer or airline ever envisaged an event where an aircraft accident might result in the collapse of a huge building and 5,000 fatalities.

TSC: Do you think a rash of bankruptcies is inevitable?

Gibson: Yes. Even before the events last week, with Midway (MDWYQ) already filing bankruptcy, there were many other airlines on watch that were at risk of bankruptcy. The monies we are talking about giving the airlines are for making them whole, for covering the days of the shutdown and the expected shortfall of revenues as a result of people not flying.

TSC: Do you expect there to be layoffs in addition to the 100,000 the airlines have recently announced?

Gibson: Certainly there are several airlines that have not yet announced layoffs, so I certainly do expect more. Even the numbers we are already seeing, while substantial, might not be enough. So much of this depends on whether people start flying again.

TSC: In sum, what is your general outlook for the industry and for investors?

Gibson: I think things are about as bad as they are going to get today in terms of the impact on traffic and revenues going forward. One would like to believe that as people start to feel the system is safe, they will return to flying. That's an issue of confidence, and time will tell how quickly that is restored.

A lot of this depends on what Congress does. In a world of no Congressional action, it is highly likely that we will see many airlines going into bankruptcy, and many of those that go into it will fail. What this means for investors is unclear. Bankruptcy can wipe out the equity and often does. It does not automatically do that. The real question is why does equity get wiped out.

The airlines' argument, which I think is a fair argument, is these are acts of terror. These are not normal business events. They are not something to do with the companies themselves. The companies were just a vehicle through which these acts were perpetrated. Thus, they should not be the ones to bear responsibility.

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