Even with fading memories of school physics, most of us would be hard put to explain the dynamics of how hundreds of tons of Jumbo jet can remain airborne without plummeting to destruction.
But it’s equally mysterious that so many airline companies manage to fly through an atmosphere of insolvency, laden with debts and liabilities heavy enough to sink an aircraft carrier. As no one else was putting money into US airlines, British Airways’ $450 mn investment in US Air was considered to be very bold at the time. And the UK carrier has paid dearly for it, since it is now 50 per cent written off.
Of course, BA had strategic reasons for its move, which gave it access to codesharing benefits across the Atlantic. But one wonders what could have possessed it to boldly go where so many had gone before. America’s airlines have run up a loss of $13 bn in the last five years – and they were already in a weakened, debt-ridden state before that.
As Joe-Victor Shammas of Standard & Poor’s says bluntly, ‘None of them are investment grade.’ He points out that they carry certain items off-book – such as aircraft leases, which should technically count as debt – and notes that this reflects their chronic undercapitalisation. That, in turn, produces an understandable reluctance on the part of most investors to scatter their money in the jet stream at 30,000 feet. Airline stock is still traded, however: ‘It moves, but who’d want to buy it?’ asks Shammas. ‘I wouldn’t,’ he adds.
Moody’s puts the industry’s overall indebtedness at a staggering 96 per cent of capital, despite the fact that last year was what passes for a good one for airlines. For the first time in years, their aggregate loss only amounted to $860 mn; and in the second quarter of this year they even made a billion dollars worth of profits. ‘But it’s a very volatile industry,’ cautions Shammas. ‘It is going up now – but it will inevitably go down.’
Even so, for once none of the nine major carriers was cruising in Chapter 11, although US Air did seem as though it could dive in any moment to replace them.
Ironically, some carriers cringe at the thought of a profitable quarter, since it disarms management’s efforts to cut pay and perks for employees. But the stated profits may not be what they seem. The industry’s special blend of imaginative accountancy and dubious finances could be even more dire if airlines had to carry the cost of their frequent flyer miles in their accounts. Passengers now have claims on trillions of free airmiles (and that doesn’t include the art buyer at Sotheby’s who recently chalked up 2.5 mn of them for one painting he bought with an American Express Card).
Airlines have usually accounted for the miles, if at all, by ‘incremental cost.’ That means they assume that every seat redeemed from award miles would otherwise be empty, so they only count the cost of extra fuel for the extra weight, and the even more negligible cost of that necessary evil, the airline meal.
Only 28 out of a thousand US airline passengers in 1993 redeemed their air miles at all, but the number is rising and the liability mounting. In practice, passengers are typically finding it harder and harder to redeem their free miles, especially from those airlines with over-high redemption rates.
So what are frequent flyer miles? To those of us who hoard them, they are, psychologically at least, a store of wealth, like money. Even if we never actually use them, most of us can testify that there is indeed a feeling of well-being from sitting atop a heap of various airlines’ free miles, not least since they are often amassed at the expense of our employers.
But, like money, they are suffering from inflation. As travellers, credit card users, car-hirers, and sojourners in hotels all collect them together in anally retentive heaps, the airlines who issue them, like profligate central banks, have fuelled inflation. They have been upping the ‘prices’ of their ‘free tickets,’ and restricting their availability, so far confident that what an airline frequent flyer programme giveth, it taketh away – whenever the management wants.
In Britain domestic appliance manufacturer Hoover found itself in extremely deep financial and legal trouble when its special offer of free trans-atlantic flights produced an unexpectedly enthusiastic response. Similarly, this January the US Supreme Court ruled that frequent flyer award holders could sue for retrospective changes in eligibility.
The case was against American Airlines but the decision unlocked other suits. The airlines argued successfully that the 1978 law deregulating air services protected them from suits under state laws on deceptive advertising – but the court ruled that this did not protect them against breach of contract. What the law brings together, let no amount of deregulation put asunder.
In token of the seriousness of all this, a lawyer for the industry warned the Wall Street Journal at the time that the result could be ‘saddling the industry with enormous new unforeseen liabilities’ – a tactful way of describing being forced to live up to one’s promises. The ruling came just as interest among the accounting profession for new rules for the industry seems to have died down. ‘It’s a shame,’ says Shammas. ‘With more accurate accountancy they might have been forced to run more soundly.’
