There’s a nasty virus going around that seems to be infecting people at a rapid rate. I’m not talking about COVID-19; I’m talking about “airlines-suck-itis.” This latest resurgence of the virus is currently best embodied by the rantings of Tim Wu, a Columbia law professor and New York Times opinion columnist who has written a book on antitrust issues. Sadly, this virus seems to thrive on misinformation. Let’s set the record straight and see if we can make it disappear before it becomes a pandemic.
In a PBS Newshour story, Tim said this right before I was interviewed.
[Airlines] have been running their businesses completely recklessly. They have been running a game where they squeeze people into tiny seats, do everything they can to extract every last dollar out of everybody, to make the most profit they could, and then thrown that all into stock buybacks. And to realize, after all those billions being spent, they didn’t keep anything for a predictable event like this.
This general vein has been echoed in many other places, including in Tim’s March 16 op-ed in the New York Times. In fact, this belief received so much traction that restrictions worked their way into the CARES Act stimulus requirements. It’s also completely false.
Part I: Airlines Have Been Profitable, But Not Insanely So
Compared to the period before 9/11, airlines are now (or were before this month) in much better financial shape, are more consistently profitable, and have far more cash on hand or available through credit lines. Let’s start with profitability.
To make things easy, I’ll focus on American Airlines, because that’s the one that Tim targets in his op-ed. It’s also the airline most widely considered to be the weakest of the big three thanks to its high debt load, and it has the highest bankruptcy risk of any of them. To tear the airline down, Tim had to start by making it a corporate villain.
…American began reaching stunning levels of financial success. In 2015, it posted a $7.6 billion profit — compared, for example, to profits of about $500 million in 2007 and less than $250 million in 2006.
This was cherry-picked to make the numbers look as evil as possible. Here’s a chart to help put this in context.
Yes, American did have net income of $7.6 billion in 2015, but as you can see that is quite the anomaly that hardly represents the business overall. It’s also obviously including one-time benefits that boosted the net profit above the operating profit. Still, let’s stick with that number for demonstration purposes. Or really, let’s take that number as a percent of revenue, because the raw number means nothing without knowing the size of the business. It translates to an 18.5 percent net margin. That is a healthy profit. Is that insanely good for the airline industry? Oh, heck yeah. But in the scheme of things, there’s nothing out-sized about this.
For comparison, Apple posted a 24.2 percent net margin in its most recent quarter. Coca Cola was at 24.1 percent for the previous year. Alphabet (Google’s parent) was at 21.8 percent. I could go on, but you get the point. (For the record, excluding a one-time tax benefit in 2013, Delta never passed 20 percent.)
The ability to earn “stunning” profit is more a way to set the stage than a central criticism. The next step is to chastise the airlines for how they spend that money. So, we move on….
Part II: Airlines Actually Have Done Good Things for Passengers and Employees
With all this money flowing in from profits, Tim asserts that “at no time during its years of plenty did American improve how it treats its customers.” Further, he says American has done nothing to help its employees, saying “[American] might have tried to decisively settle its continuing contract disputes with pilots, flight attendants and mechanics.” If PolitiFact were rating these statements, they’d belong in the “Pants on Fire!” camp.
The industry at large has made massive improvements over the last several years. Airlines have invested in fast internet, added power outlets (except for you, Southwest), and provided a massive entertainment library for free. They’ve bought new aircraft that are better for the environment and, as in the case of the 787, have a better cabin environment. All of this has been done while keeping fares in check. Several airlines have invested in technology to track checked baggage. Baggage-handling rates have improved. Denied boardings have plummeted. And airline operations have improved overall, though there are obviously some notable hiccups.
I’m not suggesting airlines have done nothing bad here. Have airlines increased the number of seats on airplanes and ripped out seatback screens? Yes. But until the feds decide there is a safety issue here, this is simply a business decision. Critics may not like it, but that doesn’t mean it’s reckless by any stretch.
On the flip side, employees have seen dramatic improvements. Pilots and flight attendants are making far more than they were during their bankruptcy contracts at all airlines. Take a look at total salaries/benefits per employee from the DOT Form 41 data.
Just look at that growth, and it doesn’t include any work rule gains that are non-economic. Further, we had entered the pattern-bargaining stage where employees were seeing their wages and benefits improve significantly as each contract came up. The most recent contract for American’s maintenance and ramp workers was outstanding from an employee perspective to the point that it had me wondering whether American could even support it in the long run.
If someone wants to make the argument that American gave TOO much to employees, that would hold more water than saying it gave nothing. I would think even the most hardened, angry front line workers would begrudgingly admit that to be true.
Part III: Hate the Stock Buyback Game, Not the Player
The argument, however, is not just that the airlines failed to invest in their people and customers but rather it’s about exactly what the money was spent on. The current bogeyman is the dreaded stock buyback. This is the trendiest rallying cry against corporate America today.
The idea is that companies can buy back shares using their own cash or debt to help prop up stock prices. Like it or not, companies are beholden to their owners. You have shareholders who want higher returns. You have Wall Street analysts banging the drum on how important buybacks are. And you have executives who are compensated on rising share prices. Put it all together, and stock buybacks have infected most big companies.
The most hated move isn’t just buying back stock; it’s taking out debt to do those buy backs. See, money has been cheap for a long time. With low interest rates, that means companies find it appealing to borrow cheap money to improve shareholder returns. It’s a calculated risk, but that obviously carries more risk than just using cash from operations… or not doing it at all.
I’m not here to support stock buybacks. I tend to think companies put more money into these than they should. This would be really blatant if, as Tim noted, airlines have done nothing for customers or employees. That’s not true, but it also misses the point.
This isn’t an airline problem. This is something that major companies do all over. For example, at the end of 2014, Apple had 5.9b shares outstanding. By the end of 2019, it was down to 4.5b.
If there is action to be taken here, it should be broadly against all of corporate America. Ban buybacks, ban borrowing for buybacks, or put restrictions on if you want, but if you just single out one industry, you’re hurting that industry’s ability to become an attractive investment compared to other companies.
What we have here is an airline industry that’s generally following what other companies are doing. And to that, I’m sure the response is, “but airlines are different.” Yes, they are. They are very capital-intensive with, for the most part, high fixed costs. They should have more cash on hand in general, so if they’re spending on employees and customers, should they not buy back stock and instead just sit on cash?
Part IV: When Is Your Cash Balance Not Enough?
Figuring out the right amount of cash to have on hand isn’t easy. Ever since 9/11, airlines have bulked up their cash positions to create more cushion.
For example, back in the second quarter of 2001, the last normal quarter before 9/11, American had operating expenses of $5.1b and cash/short-term investments of $1.4b. In the third quarter of 2019 (the last quarter DOT currently reports), American had operating expenses of $11.3b with cash/short-term investments of $5.2b. That is a far higher amount of cash on hand, and it’s double the percent of expenses. But that doesn’t even tell the whole liquidity story. American also had undrawn lines of credit as well as enough mojo to enter into a new line. As it reported last month, it had $8.4b of liquidity available on March 18.
That is a lot of cash, but it’s not enough to survive a year without any revenue. If Delta’s burning through $60m a day, that’s more than $20b a year. Tim seems to argue that its irresponsible for airlines to not have cash on hand to be able to weather this storm. He says this was entirely forseeable and in fact, some airlines warned of a possible pandemic in their financial statements. Yes, they did, but that’s because it’s their job to think about all possible disruptions. There have been pandemics in the past, but no pandemic has ever come remotely close to having this kind of impact on the airline industry.
United said demand is down 97 percent. Delta is burning through $60m a day. No amount of rational preparation can get you ready for that kind of loss. Could you hold on to $20b in cash to get you through a year with no revenue? In theory, but you don’t build the church for Easter Sunday, right? In the same vein, you don’t hold on to cash for the worst possible scenario.
If owners see an airline holding on to more than $20b in cash, they’ll assume the company is being mismanaged. Even if they don’t, it won’t matter. A company with that much cash is ripe to be taken over using a leveraged buyout.
So what is the right amount? There isn’t a hard and fast rule, but there’s a good chance that those numbers will change once this crisis is over, just as they did after the last one.
Part V: Wrapping It Up
What we have here is an industry that has been making healthy profits. It has invested that money into employees, customer improvements, and yes, stock buybacks. It has bulked up on cash over the years, and it could have weathered a storm like the aftermath that occurred on 9/11 without outside assistance. This pandemic is so much further beyond what happened after 9/11 that it makes it hard to suggest any company should or even could prepare for this.
Certainly in the future, airlines will likely shift how they build their balance sheets once again, now that they’ve gone through this. That doesn’t mean they were reckless up until now. It just means they’ll be reckless going forward if they don’t adapt. But holding on to enough cash for a full year of no revenue is just not realistic either. We’ll see how this shakes out.
In the meantime, this “airlines-suck-itis” has already made the government do strange things in the CARES Act. As a condition of receiving the grants, airlines can’t buy back stock or issue dividends for a period of time. I don’t think this will be an actual problem since it’s unlikely airlines will be in a position to do either of those in the near future anyway. But that misses the bigger point.
When investors are looking at where to put their money, they want companies that are going to provide the best return. Airlines had been creeping up on to the radar of people who wouldn’t have touched them previously. But now, if some companies are allowed to do buybacks while airlines aren’t, then that hamstrings the airlines. They aren’t as attractive. This is particularly strange since the government has warrants to purchase stock as part of this airline stimulus. The taxpayers make more money back the higher stock prices rise. It’s strange to single out one industry, especially one that wasn’t being run recklessly but rather was thrust into an impossible situation.
Let’s all just sit back and hope the “airlines-suck-itis” virus disappears soon. It doesn’t make much sense that it’s around now.