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Airline Industry

United Airlines and other US carriers cope with a cash squeeze.

Jul 06, 2009

The next few months will be crucial for United Airlines as it and other U.S. airlines cope with a cash squeeze.

The global recession has caused airline ticket sales to plunge deeper than anyone -- carriers or analysts -- anticipated.

Rather than banking cash from peak-season flying this summer as they normally do, United and its peers are paying a king's ransom to borrow money to get them through the winter months, when demand for air travel usually chills.

But after leveraging everything from frequent-flier miles to spare jet engines, United is running low on assets that it can use as collateral for debt or sell to raise cash. That limits the Chicago carrier's options as it faces new requirements by its credit card processors to keep unrestricted cash near the present level of $2.5 billion, analysts said.

The prospect of another lean winter for U.S. carriers could spur more consolidation, analysts said, with United and Houston-based Continental Airlines as the likeliest carriers to head back into merger negotiations.

After talks failed in 2008, the two created a close partnership, or virtual merger, which has recently drawn scrutiny from the Justice Department, potentially making the venture less attractive than a full combination.

"I think that merger makes a lot of sense," said Roger King, airline analyst for CreditSights Inc.

Cash is tight across the airline industry, and Ft. Worth-based American Airlines and Tempe, Ariz.-based US Airways could also face liquidity crises if conditions deteriorate, analysts warned. American faces steep debt payments over the next year and pressure from a credit card processor. US Airways has little debt but thin cash reserves.

"The whole industry is looking at an erosion of liquidity and cash flow," said Bill Warlick, senior director and lead airline analyst with Fitch Ratings. "It's a very grim revenue picture."

The need for action is especially pressing for United. If its cash holdings decline, two major credit card processors, JPMorgan Chase & Co. and American Express, could require it to set aside hundreds of millions of dollars to safeguard advance bookings in case the company folds.

Under an agreement that took effect March 1, American Express requires United to pony up money on a sliding scale if its unrestricted cash falls below $2.4 billion. The lower United's cash, the greater the amount it must set aside. United may also pledge aircraft, real estate and other assets as collateral.

As of January 2010, Chase will require United to hold at least $2.5 billion, a provision that would have cost United $134 million had it been effective in May. If United's cash falls to $1 billion, Chase would require it to set aside half of its monthly credit card charges, according to a Securities and Exchange Commission filing.

While credit card firms pushed Frontier Airlines into bankruptcy last year, analysts think it very unlikely that they'd pursue similar drastic measures with United unless operations deteriorate to the point where the airline isn't viable.

Chase, in particular, has a deep partnership with United that gives it a vested interest in keeping the carrier aloft. Chase's Mileage Plus affinity card is one of its most popular credit cards, while the bank last year gave United $600 million for the advance purchase of frequent-flier miles. A Chase spokesman declined to comment.

"When you have big boys at the table like credit card companies, and a big airline like United, nobody is going to throw anybody into bankruptcy," King said. "They're going to find a way around it, unless there's no way around it."

United's fortunes could improve if the economy improves, business travel recovers or airline prices start rising in earnest. The nation's third-largest carrier cut earlier and deeper than rivals, positioning it to weather the 15 percent to 20 percent drop in revenues that airlines are likely to see this year.

"We are already benefiting from the cost reductions under way as demonstrated by our strong cost performance over the past several quarters," United spokeswoman Jean Medina said. "Per our second-quarter guidance, we are positioned to gain further competitive advantage in this area, positioning us to get back to profitability as the economy rebounds and for the long term."

United also stands to gain hundreds of millions of dollars related to its fuel hedges if oil prices stay close to current levels.

Still, United's margin to maneuver is slim, analysts said, and could be narrowed further by a number of factors, from another oil spike to a renewed, deadlier outbreak of the swine flu.

"Certainly, they would benefit from any recovery," said Philip Baggaley, managing director and senior credit analyst with Standard & Poor's. "Unfortunately most observers, including Standard & Poor's economists, believe it will be a pretty weak recovery. But anything helps at this point."

United also needs to regain Wall Street's confidence. As of Thursday, its stock had declined 70 percent since January, to $3.31 per share, leaving United with a market capitalization of $476.4 million. That's paltry for one of the world's largest airlines, a carrier that generated $20.2 billion in sales last year.

Another sign of United's tenuous standing on Wall Street: It agreed to pay 17 percent interest on $175 million in debt in late June that was secured by $583 million worth of spare parts.

Lenders aren't fond of such financing because it would be onerous to collect jet engines and the like from warehouses around the world if the airline folded. That fact and the perception of United as a weaker player likely forced United to pay high rates to complete the financing in a market that is wary of airline deals, analysts said.

"This is a trying time," former Continental CEO Gordon Bethune said. "Their cost of debt indicates their weakness in a down market. I'm sure there's a lot of uncertainty out there, not only for employees, but for the public and shareholders."

United did not do the deal out of desperation as some have claimed, Medina said. The transaction "was oversubscribed with terms that reflect the structure, the nature of collateral used and the tight credit market and will further boost our liquidity as we continue to take the right actions in response to the difficult environment."

United has $1.1 billion in unencumbered assets that it could use to raise money, including 63 older aircraft and real estate. The carrier is looking for buyers for the Elk Grove Township campus that serves as its operations center and its pilot training center in Denver, sources said.

But United's classic Boeing 737s are a tough sell in a market glutted with used, parked jets, noted Fitch's Warlick. "They have $1 billion left in assets, but how much could they borrow, how much could they raise in cash? It's nowhere near $1 billion. How much emergency liquidity could they have left? It's probably near $500 million in my opinion."

Cash isn't United's only concern. The carrier has been dinged by consumers in recent satisfaction studies, while its efforts to closely link operations with Continental on international flying have been hung up by last-minute antitrust objections raised by the Justice Department.

The cascading issues, analysts think, could force United to again attempt to merge with Continental, a combination that would create the world's largest airline. Finding financing remains a major obstacle to a merger, although Chase has financial ties to both carriers and could play matchmaker, sources said.

Neither airline would address the renewed merger talk.

With passenger demand in the doldrums and oil prices on the rise, the merger would provide a new source of revenues at a time when pressure on United is growing.

"They're getting the worst of both worlds," Baggaley said of United, American and US Airways. "There certainly is some bankruptcy risk, and those negative external trends are increasing pressure."

United Airlines and other US carriers cope with a cash squeeze.
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