For Canadian Airlines, More Money Isn't the Answer; New Management Is
It has been some time since we checked in with our friends across the border. And last time we took a look at both Air Canada (ACNAF) and Canadian Airlines (CA:Toronto), neither looked very much like an airline we would want to put our hard-earned money into.
But money is exactly what Canadian Airlines is looking for, in the version of more foreign investment money.
According to several reports out today, the airline has asked the Canadian Department of Transportation to consider relaxing the rules that limit foreign ownership of Canadian airlines to 25%. And guess who is No. 1 on the foreign investor hit list?
AMR Corp. (AMR), parent of American Airlines.While both major Canadian airlines have struggled with eroding yields, too much capacity and a crippling Canadian dollar/U.S. dollar exchange rate over the last couple of years, the situation with Canadian is different for one very important reason -- its very close ties to AMR. How close? Don Carty, CEO of American and chairman of AMR, is Canadian, and his brother, Doug Carty, is Canadian Airlines' CFO. Five years ago, mainly at the urging of then-American CFO Don Carty, AMR put roughly $220 million into the struggling airline -- an investment that American then wrote off when the stock of Canadian plunged two years ago. But American still controls 25% of the stock -- the maximum amount allowable under Canadian law. At the time that the investment in Canadian was written off, American said publicly that it would not invest any further money into the airline. However, there was a difference then. Robert Crandall was running the show. Now he's gone.
Lifeboat ProvisionIn addition, last week we ran across a very interesting clause that is included in the current Allied Pilots Association contract with American Airlines. Needless to say, the situation with Canadian has been a sore point with the pilots at American for years, as the pilots have contended that the codesharing agreements that American struck with Canadian years ago were detrimental to the pilots at American. Their reasoning? The agreements effectively slowed further expansion by American. As a result, there is a fairly large section in the contract that deals specifically with Canadian, titled "Economic Support to Canadian."
Neither the company [American] nor an affiliate shall transfer or provide to Canadian, at below market rates, any aircraft assets, loan guarantees or other forms of economic support that could directly or indirectly be used for aircraft purchases or leases, except that nothing in this provision shall prevent the company or an affiliate from infusing operating capital into Canadian for the sole purpose of keeping Canadian solvent.So, the question becomes -- when is it a matter of keeping Canadian solvent? In our opinion, that point could be coming sooner rather than later. And we think AMR shareholders should sit up and take note. Because we don't think the airline needs more money. It needs new management. At PlaneBusiness, when we see that an airline is in trouble financially or when we think a stock could be problematic for an investor, we place the airline on PlaneBusiness Titanic Watch. (This was before the movie.) We placed Canadian on the Watch early last year -- long before the airline lost $150 million in the last quarter of 1998. Since then, earnings have continued to worsen quarter after quarter, yields have continue to drop, costs have continued to increase and we see nothing in management's actions that indicate to us that anything is likely to improve. In fact, management at the airline continues to blame its troubles on a revenue problem. It doesn't have a revenue problem. It has a cost problem. Meanwhile, competitor Air Canada has been busy at work not only increasing its yields, but also cutting its costs. Air Canada has also been working with a number of regional Canadian carriers to build symbiotic feeder relationships, including talks that are going on now with WestJet, the low-fare Western Canadian carrier that we are so enamored with. WestJet is one very well-managed and profitable little airline -- and from what I understand, Canadian was "not interested" in talking to them about an alliance. Yesterday, analyst Jacques Kavafian with Yorkton Securities issued a research report on Air Canada, which was important primarily because of its damning assessment of where he sees Canadian headed. In his research report, Kavafian says he thinks the market doesn't recognize the severity of the problems at Canadian, and that the airline could significantly deplete its cash position this year, even though it had a $302 million cash balance at the end of 1998. Kavafian is estimating the first-quarter loss for Canadian to be $140-$150 million. We think this figure is accurate.
Grasping at StrawsSo, we find it most interesting that Canadian has now appealed for relaxation of the foreign ownership rules. I think they know the severity of the problem. The airline has now been through four so-called restructurings, and is going nowhere financially. The latest "business plan" is a failure. Concessions that the airline had received from employees and suppliers in 1996 expire in less than two years, at which time costs will increase 20% overnight. But Canadian is an important part of the oneworld alliance. It is American Airlines' Canadian codeshare partner. And, American Airlines owns 25% of the airline. And yep, then there is that little matter of family ties. If I were an AMR shareholder, I'd be watchful of what transpires north of the border.
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