Delta, Northwest Sink Into Chapter 11

Nearly simultaneous bankruptcy filings yesterday by Delta Air Lines and Northwest Airlines marked a watershed moment for a chronically dysfunctional industry. Despite travel demand nearing peak levels of 2000, more than 40 percent of domestic industry capacity now is operated by insolvent companies. A long-predicted shakeout in the commercial aviation sector may well be underway.

With additional fuel price pressures in the wake of Hurricane Katrina seen as the tipping point, Delta and Northwest joined United and US Airways under court protection. Despite the new filings, both carriers committed to maintain uninterrupted operations--including flight schedules, ticketing policies and frequent flyer programs--though many changes ultimately are expected within their networks, including the potential for a merger with one another.

Citing excess capacity, Northwest president and CEO Doug Steenland last night on a media conference call said, "it is reasonable to expect that consolidation could take place," but that a merger specifically involving Northwest had not been forwarded as part of the bankruptcy filing. When pressed further, Steenland said, "we do not comment or speculate" on potential future transactions.

The fact that both cases were filed within minutes in U.S. Bankruptcy Court for the Southern District of New York was "completely coincidental," Steenland added. "It was not orchestrated."

Should consolidation eventually take hold, it could "benefit pricing and capacity dynamics, though applying longer-term pressure on American and Continental," according to J.P. Morgan Securities analyst Jamie Baker.

Squared off against a combined Delta-Northwest entity, UAL and its stakeholders also would likely reassess United's competitive positioning. In fact, United already contemplated such a scenario in a recent filing to the U.S. Department of Transportation, opposing SkyTeam alliance antitrust immunity.

Additional industry consolidation also would impact the competitive dynamic for corporate travel buyers in the domestic market, as networks, airline sales strategies and products continue to transform. On a multinational scale, airline corporate clients likely would have even greater reason to consider global alliance contracts.

Before any potential merger would take place, both Delta and Northwest are expected to shrink by reducing domestic capacity. Both likely will deploy more regional jets on more North American routes while emphasizing growth in international networks.

Both airlines also will pursue additional labor costs, including job cuts and compensation reductions. They also said they would seek federal pension relief.

In Delta's case, Judge Prudence Beatty ordered the airline to continue normal operations ahead of a first-day motion scheduled for this afternoon. The company said it has arranged a debtor-in-possession financing package backed by GE Commercial Finance and Morgan Stanley, with additional funding from American Express. It intends to use Chapter 11 "to reconfigure its fleet and network footprint."

Delta also told customers that it would "utilize the Chapter 11 process as long as necessary to implement a successful plan of reorganization," a strategy not available to companies filing for bankruptcy after new rules take effect in October (BTN, Aug. 16).

"Delta's financial problems are severe, but by no means insurmountable,'' said CEO Gerald Grinstein.

The airline this year already eliminated its Dallas/Fort Worth hub and announced a 26 percent reduction at its Cincinnati hub.

Further retreat is likely. "We expect little reduction by Delta in its overseas markets, whereas domestic capacity is expected to decline by a healthy 17 percent," said J.P. Morgan's Baker. He also suggested that Song operations "stick around" because "Song is pretty spiffy and customers like it, something that one doesn't hear-or, in fairness, hears far less often-regarding Big Delta."

Unlike Delta, Northwest stated its intentions to "expeditiously" complete the restructuring. "We certainly would not expect the process to come anywhere near the three-year process that has occurred at United," Steenland said.

Also unlike Delta, Northwest did not line up DIP financing ahead of its bankruptcy declaration. Steeland said the carrier believes it has sufficient cash to handle the restructuring, but also noted that "we are no longer an asset-rich company."

Meanwhile, Northwest has not specified capacity reductions beyond a previously announced suspension of New York JFK-Tokyo Narita service, which will eliminate 2 percent of the carrier's systemwide capacity.

"We clearly anticipate returning aircraft to our lessors and operating a somewhat smaller airline," Steenland said. "In the weeks ahead, that will be an element of our restructuring that will get a particular focus." He did not provide any guidance beyond saying, "if anything, frequencies might be somewhat less."

Steenland also stressed that an ongoing strike by the Aircraft Mechanics Fraternal Association did not prompt the filing nor does it complicate it, as the company and the union currently have no collective bargaining agreement in place. Northwest continues to use replacement workers.