Northwest Starts Trans-Pacific Power Struggle

Events during that six week period before the Gulf war reveal much about the interplay between the domestic rivalry and international expansion of US carriers, and how that interplay can affect the rest of the world. It was a time of stress throughout the aviation industry. Some treated it as a period simply to survive; others saw it as a time of opportunity.

Route purchases have become the standard technique for overseas expansion by US airlines. Rather than await the outcome of bilateral negotiations and route awards, the biggest carriers have gone out and bought routes from their weaker rivals. United set the pattern when it bought PanAm’s Pacific division in 1985, a move that brought it to Australia. The recent sales of prime US/London routes and American’s takeover of Eastern Airlines’ routes in South America have given these carriers instant international networks.

Northwest’s acquisition of Hawaiian’s route was simply part of that trend. But two things made it notable: – it was Northwest’s first route purchase, and it is a wonder someone else did not buy it sooner.

Hawaiian had been in terrible shape for some time. Despite an ownership change, its financial results for the first half of 1990 were quite disappointing. It lost three times as much as in the first half of the previous year. By last September, Hawaiian had suspended its Sydney service, citing an uneconomical DC-8 operation and poor loads. While reluctant to admit it, Hawaiian had found that it could make more money ferrying US troops to Saudi Arabia under military charter.

Northwest had been one of three US carriers turned down in the 1988 award of Australian routes. When Hawaiian suspended services to Sydney, Northwest saw its chance and promptly made an emergency request to the US Department of Transportation to replace Hawaiian. But then John Ueberroth, Hawaiian’s president, announced that his airline had refinanced its debt, reached an accord with its unions, and would restore Sydney services by mid-January. Faced with that news, Northwest knew that DOT was unlikely to replace Hawaiian, so it withdrew its request.

That was late September. What no one else knew was that Northwest then entered into negotiations to take an equity stake in cash strapped Hawaiian in exchange for some of Hawaiian’s international routes. It was a gamble because Northwest could lose its investment if Hawaiian collapsed, a prospect many regarded as likely.

Northwest unveiled that deal in early December. It agreed to buy 25% of Hawaiian for $US20 million, including a $US? million secured loan, in exchange for the Sydney route and Hawaiian’s routes between Micronesia and Japan. Thus, Northwest came to Australia.

Two weeks before the announcement of this deal, an even bigger deal fell through. Had it succeeded, Delta Airlines, the third largest US carrier, might have replaced Continental Airlines across the South Pacific. Had that happened, the four largest US airlines would have been fighting for market share in the South Pacific, with potent consequences for everyone.

Delta, unlike United or American Airlines, had never bought an international route. Some claim it will always rank third or lower because it is too cautious. Delta is as well capitalised as its bigger rivals, but it seems unwilling to take the initiative required to grow through route acquisitions. Typically, it reacts to proposed purchases by others, arguing – so far, unsuccessfully – that authorities should open a route case allowing all applicants to compete rather than approve a proposed route sale.

Late last year Delta was considering an uncharacteristic move. It was negotiating with Continental Airlines to buy Continental’s entire Pacific division. But the deal collapsed because Delta’s management developed cold feet.

(Refer P. 81, July 91 AA)lt is unclear who initiated these talks, but it seems likely that Continental first approached Delta. Continental was desperately trying to raise cash to avoid bankruptcy. Fuel costs were out of control and Frank Lorenzo had left the airline with long term debt totalling more than 78% of its assets. Continental’s parent held uncollectible notes from Eastern Airlines, which was already in bankruptcy, and owed large pension liabilities on Eastern’s employees.

Delta was interested in Continental’s proposal. Like Northwest, it had applied without success for an Australian route in 1988. Delta had a modest network in north Asia that Continental’s routes would nicely complement. Even though Delta faced the same fuel costs hurting the entire industry, it also had some reason for optimism. Arch-rival Eastern Airlines, which shared its Atlanta hub, was in bankruptcy and industry observers predicted Eastern would be insolvent by December.

But the combined impact of three events frightened Delta’s management. First, its accountants reported a stunning third quarter loss of $US51. 6 million. Second, Moody’s Investors Service announced in early November that it was lowering Delta’s debt rating due to higher fuel prices, softening domestic traffic, and the airline’s substantial capital commitments for new planes. That affected about $US2. 4 billion of Delta’s debt.

The straw that broke its resolve, however, was a·decision by the judge in Eastern Airlines’ bankruptcy authorising the bankruptcy trustee, Martin Shugre, to spend $US135 million from cash reserves to keep that airline afloat. Creditors howled that this was simply throwing good money after bad, but the judge was convinced that Eastern would never survive without a substantial commitment of cash.

So, instead of an insolvent competitor, Delta suddenly could foresee a cut-throat fare war at its key Atlanta hub with a rival who knew no tomorrow. It called off talks with Continental. Continental promptly sold its Seattle/Tokyo route to American Airlines and filed for bankruptcy the next week.

A week later, Northwest announced its deal with Hawaiian. Australia was to host only one new megacarrier instead of two. Characteristically, Delta, along with America West Airlines, opposed Hawaiian’s route sale to Northwest and called on DOT to hold a new route case. As before, DOT rejected that request. The only other US airlines strong enough to buy Continental’s Australian routes already had their own. If Continental failed, Washington faced the prospect of making a new award. For the first month after Continental filed bankruptcy, that looked like a possibility. Continental’s future seemed bleak. Its pilots agreed to a wage freeze; there were rumours of merger talks with American Airlines and Northwest.

By February, however, Continental’s outlook was improving. Eastern had exhausted its cash infusion and shut down. Continental moved quickly to fill the vacuum, adding 32 daily flights in less than a month. By March, Continental’s president, Hollis Harris, was optimistic that his airline would emerge successfully from bankruptcy, possibly before the end of this year. “I am really excited,” Harris said, “about getting Continental back on course and becoming a world class airline. ”

Continental still needs cash, but a number of creditors and suppliers have offered interim financing, and discussions are underway on an equity for debt swap. During mid June a consortium of US banks agreed to debtor-in-possession finance of $120m for Continental. Talk persists about a sale of Continental’s stake in Air Micronesia, but the South Pacific routes are apparently off the block. According to one analyst, “the current view is that the South Pacific is crucial to their route structure. ”

This synergism between domestic and international routes is well understood in the US. Airlines know that each type of route feeds the other. A gap in a carrier’s international routes means a loss of both domestic and foreign traffic. Megacarriers see their competition in global terms. It is no accident that the five largest US carriers are amongst the ten largest carriers in the world.

Yet, the rivalry over US/Australia routes is more than a matter of drawing routes in empty spaces on a map. If capacity matches demand, the Australian Tourism Research Institute picks the United States as the fastest growing source of visitors to Australia between now and 2000 – with an annual growth rate of 14. 2% compared to 12. 5% growth in Japanese arrivals. Moreover, Australia/US traffic is growing in both directions. The US Travel and Tourism Administration sees Australian visitors to the US climbing at 11 to 13% annually. USTTA also notices a clear shift in Australian travel patterns away from traditional UK/ Europe destinations to North America.

Despite the short term problems that compelled Canadian International to withdraw flights south of Hawaii, and American Airlines for a seat purchase agreement on Air New Zealand flights to Auckland, capacity between Australia and North America is still climbing. United’s business grew 32% last year, and it will add more flights next month. Starting 17 August, it will extend its Los Angeles/Auckland route to Melbourne, and its Los Angeles/Sydney route to Brisbane. By September, it will be using 747-400s on all segments. Before year’s end, American will also increase its Australian frequencies from four weekly flights to daily. Brisbane has been mooted as a gateway for some of them. Even though Continental remains in bankruptcy, it recently added flights between Melbourne and Honolulu. With Northwest now arriving four times weekly,the presence of US carriers continues to grow.

Qantas lacks the muscle to match this combined onslaught.

With a debt-to-equity ratio that is already too high at 78:22, it is committed to spend $950m on new aircraft over the next eight years. Faced with growth in the number and size of US competitors, its alliance with Air New Zealand was inevitable. As Jim Scott, Air New Zealand’s then chief Executive Officer, put it, it was “crazy” for Qantas and Air New Zealand to compete on trans-Pacific flights when shared aircraft could offer the same frequency and service at half the cost.

Richard Porter, Qantas senior vice president for the US, Canada, and Latin America, sees the benefits of theQantas-Air New Zealand alliance not in terms of cost savings,but rather in increased capacity. “In effect, we have gone from 21 frequencies to North America to 41 frequencies. That’s a big increase in service. ” But the question no one can answer is whether Qantas and Air New Zealand combined can continue to hold their share of the trans-Pacific market against the arrival of yet another US megacarrier. Qantas and Air New Zealand rank 21st and 38th in the world based on sales. Continental, their smallest US rival, ranks 11th. When some of the world’s biggest airlines start jockeying amongst themselves for position, smaller rivals could face some daunting challenges.