Economic logic prevails

By Gérard Bérubé

This month Air Canada is celebrating the first anniversary of its emergence from bankruptcy protection. On September 30, 2004, the birth of ACE Aviation Holdings ended the complex restructuring of Canada’s major carrier. Initially, few believed that CEO Robert Milton and then executive VP Calin Rovinescu could save the airline. A year later, we can talk about a perfect takeoff in a still hostile environment.

For analysts and observers, bankruptcy seemed the only outcome of the court-protected restructuring process Air Canada initiated on April 1, 2003. They believed the strategy was overly ambitious and the obstacles insurmountable. At worst, they felt it would only duplicate a back-to-square-one exercise à la Swissair or, at best, replicate US Airways’ two rescue attempts. But most of all, they didn’t think Milton could pull off the restructuring.

After taking the helm, Milton had to learn to steer the company through some turbulent times. From 1999 to 2003, he had to fend off a hostile takeover bid by Onex-American Airlines, complete the forced acquisition of Canadian Airlines and attempt to reconcile the two clashing cultures. He had to weather the impact of the US recession, the September 11 terrorist attacks, the war in Iraq, soaring fuel prices and the SARS epidemic that was crippling Air Canada’s lucrative Asian routes. Despite it all, the airline managed to stay afloat and even improved its operating income by $500 million in 2001 and 2002, when the industry was facing losses of US$31 billion.

Milton had tough challenges to say the least. He had to defend the airline against a major offensive from Onex-American Airlines. The takeover bid was even more challenging because it had the blessing of the federal government and was backed by a board exclusively under the influence of Ottawa’s Liberal government.

The three-month battle could be described as one of the most ferocious in Canadian business history. But it ended suddenly when the Superior Court of Quebec ruled the Onex offer illegal.

At the end of the 18-month restructuring period, Milton published a book denouncing the close relationship between American Airlines and the federal government, through the latter’s interest in Canadian  Airlines. Ottawa’s attachment to the western carrier was reflected in a number of ways. For example, in 1991 the Conser vative government acquired three Canadian Airbuses for $195 million, even though their market value was only $60 million. This intimate relationship, which was fuelled by political interests, continued under Jean Chrétien’s government. But it really took flight when Gerald Schwartz, a good friend of the Liberals, launched a hostile bid for both Canadian and Air Canada, which would have put the two carriers firmly under the control of American Airlines.

Even when Schwartz had to abandon his plans, Ottawa still refused to consider bankruptcy as an option for Canadian Airlines. Air Canada was then  forced to acquire its competitor, under pressure from then Transport minister David Collenette, who threatened to transfer Canadian’s rights, slots and routes to Canada 3000.

All this is now part of Canada’s airline history. After the restructuring, Air Canada again began to gain altitude under its parent holding company, slashing its workforce by 25% and posting recurring savings of $2 billion in operating costs and a net market value of $4 billion, four times the previous capitalization estimates of $1 billion. The holding company, made up of seven subsidiaries, has net nonledger assets of at least $2 billion and an equivalent amount in the form of advantages tied to unused tax losses. But Air Canada especially benefits from cost structure and fleet renewal synergy that enables it to compete with WestJet on the domestic market. Its dominant position in Canada and on crossborder routes bolsters its unique world wide deployability. Its many assets can also be deployed across the Star Alliance, the world’s largest airline network.

Air Canada thus embarked on its new course having to cope with the destabilizing impact of the forced merger with Canadian Airlines. The obvious solution would have been for Canadian to declare bankruptcy. Under the terms of the merger, Air Canada had no choice but to pay out some $620 million, absorb $3 billion in additional debt with no offsetting assets, integrate aging aircraft into its fleet and take on Canadian’s 16,000 employees, 10,000 of whom it didn’t need. Economic logic prevailed and Air Canada has had to pay the price. As for Milton, he can no doubt look forward to a better future.

Gérard Bérubé is editor of the Économie et finance section of Le Devoir in Montreal