Delta Air's Revival Plan Preaches Austerity

The struggling carrier's turnaround plan may emphasize the role of its low-cost unit Song.
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Updated from 12:26 a.m. EDT

Delta Air Lines

(DAL) - Get Report

will cut employees and benefits but give a bigger-than-expected role to Song, its low-cost unit, in a widely anticipated but still unannounced overhaul,

TheStreet.com

has learned.

In a memo to employees sent Wednesday, Delta CEO Gerald Grinstein said the company will have to eliminate jobs, slash benefits and cut paychecks in order to reduce costs and avoid filing for bankruptcy. The nation's third-largest carrier is asking 6,900 unionized pilots represented by the Air Line Pilots Association for $1 billion in annual wage concessions. The union, whose contract is not amendable until mid-2005, has offered a package worth about $700 million.

"When our plan is successfully implemented, we will be the leaner, simplified, more productive airline we must be in order for us to survive and compete," said Grinstein, in his memo. "Regrettably, one of the consequences will be fewer jobs and additional changes to pay and benefits for all of our employees as we make operational changes to achieve the necessary cost savings."

More speculation surrounds the fate of its low-cost startup, Song, which Delta launched 19 months ago as a response to

AirTran

(AAI)

, a low-cost carrier who shares Delta's hub in Atlanta, and

JetBlue

(JBLU) - Get Report

, which flies lucrative north-south routes on the Eastern seaboard. Many on Wall Street have said the restructuring could spell the end of Song, but two sources close to the company said this view is incorrect. In fact, the well-branded unit may provide inspiration for the rest of Delta to follow, because it is more efficient and cheaper to run, despite the fact its pilots are paid the same wages as Delta's regular Boeing 757 pilots.

"Wall Street has it wrong," said the source. "Song is doing just fine. Song is growing. John Selvaggio

head of Song knows what he's doing. And good things are coming down the pike in the coming weeks."

On Thursday, Delta shares were unchanged at $4.07, coughing up earlier gains of 9% after oil hit $48.75 a barrel midafternoon and Standard & Poor's cut Delta's corporate credit rating again, citing bankruptcy risk. On Wednesday, Delta gained 16%.

But in order to win deeper concessions from pilots, the company's only unionized work force, Delta will have to give something up as well. With time running out, ALPA has said it won't come to the negotiating table unless the union is given an equity stake in the revitalized Delta. In his memo to employees, Grinstein said the company's board was reviewing such a step after receiving the Delta Solution on Wednesday.

"The people of Delta must have the opportunity to share in any success their sacrifice helps make possible," he said. "Today, the board reviewed the employee reward plans we are now developing. A combination of equity, profit sharing and incentive payouts tied to performance and productivity is being designed."

While company officials would not comment when the plan would be made public, a source close to the company said to expect a public announcement after Labor Day. For the last eight months, Delta's management has been working on the plan, which was delayed by two months after a number of key executives left the company.

This week, speculation about Delta's future has hit a fever pitch, with analysts predicting the company will stick to long-haul and international routes, while jettisoning less profitable point-to-point routes and smaller hubs. Over the last year,

AMR

(AMR)

unit American Airlines has taken similar steps, downsizing nonessential hubs like St. Louis, while adding a number of international flights, where there is no low-cost competition.

Rumors that Song would be shut down appear to stem from a negative comment about the unit made by Grinstein early in his tenure. Speculation remains that the unit could be sold for cash, but insiders say Grinstein has changed his tune while working on the Delta Solution. And while Delta does not break out numbers for Song, whose planned expansion has been frozen while the carrier tries to restructure, the unit has been performing better than many expect and may even expand again.

If Song is expanded, JetBlue is likely to feel the heat. In the coming years, Delta will be adding a massive new terminal in Boston, where it will consolidate its operations and potentially add more Song flights, forming a beach head against JetBlue, which debuted service there this year. And in New York, the carrier will be renovating a terminal at the John F. Kennedy Airport, JetBlue's hub.

Peggy Estes, a spokesperson for the company, said part of the Delta Solution has, in fact, already been revealed; on Thursday the carrier announced SimpliFares, a new program to simplify fares at its Cincinnati hub which will be rolled out into other markets. Under the new pricing scheme, similar to those employed by low-cost carriers, Delta will cap prices, lower ticket change fees and end certain restrictions, like the mandatory Saturday-night stayover.

Analysts said the new pricing scheme, which reduces ticket prices by as much as 60% on some flights, will have a negative impact on revenue but not profits, given Cincinnati's small size.

"

The Cincinnati hub represents a more modest 4.5% to 5.5% of revenue," said William Greene, analyst at Morgan Stanley, in a note. "Thus ... the impact on system-wide profitability should be more limited. That said, anything that exacerbates Delta's losses cannot be a positive for the company's restructuring efforts." (Morgan Stanley does and seeks to do business with the companies covered in research reports.)

But deep sacrifices and painful decisions loom and those restructuring plans are a ways off. Management and labor will have scheduled a negotiating session on Thursday, but an ALPA spokesperson said the union did not expect any major developments and was unlikely to release any details.

With fuel costs, Delta's second-largest expense, skyrocketing as the price of oil approaches $50 a barrel and airlines helpless to add fuel surcharges, the restructuring plan is the carrier's last hope to avoid Chapter 11.

If unsuccessful, Delta could join

UAL

(UALAQ.OB)

-unit United Airlines in Chapter 11. United has been operating under Chapter 11 for a year-and-a-half and seems likely to spend at least two years before even coming up with a plan to reorganize. Elsewhere,

US Airways

(UAIR)

seems likely to re-enter bankruptcy protection just 17 months after emerging from it, because it didn't cut costs deep enough -- a mistake that the Delta's deliberate CEO vows not to repeat.

"The motivation behind Delta's bold response has been to 'do it once and do it right'," Grinstein said.