The Merger and Acquisition Phenomena

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By: Mark H. Goodrich – Copyright © 2012

To many, acquisition and merger are among the most puzzling actions taken by airlines, joining a list of decisions by modern executives that reflect an absence of knowledgeable and reasoned analysis. From the inside of the company, employees hear rumors about an acquisition or merger, wonder at the ignorance of management concerning practical issues and effects, and try to make sense of the corporate gamesmanship, knowing that continued employment, professional status and retirement security are at stake.

It will be of little consolation to learn that lawyers and business consultants are also puzzled by the lengths to which airline executives will go in pursuit of what is often little more than a mutual suicide pact. As a lawyer, advisor and consultant over the past several decades to airlines and other aviation businesses, I have been witness to a repeating scenario in which client managers contort the facts, economics, laws and logic in attempts to convince themselves, shareholders, banks, lessors, justice department officials and customers that black is white, and night is day where acquisitions and mergers are concerned.

Whether trying to reconcile the positive and negative synergies between red and blue in Toronto, red and green in Minneapolis, or the myriad other professional marriages in the worldwide airline business, understanding the folly that acquisition and merger have become requires first that one understand the basics.

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Acquisition has been a part of corporate maneuvering as long as there have been businesses, and has been used most often as a way for self-described capitalists to evade the competitive forces of the marketplace. When smaller or weaker businesses try to compete, the larger or stronger often find it more profitable to buy up and absorb or kill off the competitor, rather than fairly competing in the free market they pretend to love. This is little more than business as usual in the normal growth cycle of corporations and industries, which inexorably moves towards monopoly as so-called “free markets” are consolidated by acquisition. The trick for an acquiring entity is to evade any harsh light of scrutiny from anti-trust officials, shareholders and employees, usually through misrepresentation. For example, press releases talk about “synergies”, “economies of scale”, and “consolidation to enhance competition and reduce fares” as though such things are real, will reduce costs, and will benefit the marketplace. The facts are that seldom is any of that true.

Synergies imply that, by combining telephone systems, computer networks, reservations centers, training facilities, maintenance and inspection programs, employee groups, fleets and management structures, redundancy can be eliminated and costs thus reduced. The truth is that few endeavors are more expensive than consolidating resources and facilities. Administrative systems are seldom compatible, which means the physical resources of one entity are discarded at fire-sale prices or worse, while similar resources of the other are expanded through new purchases. Training costs skyrocket as personnel are trained on new equipment and procedures. Facilities are closed and opened. Enormous costs are incurred to bridge airplane maintenance programs, expand operating manuals to include differences between dissimilar fleet components, and recertify. Litigation costs arise, due to cancelled leases, other contracts issues, and employee buyouts. Airplanes too expensive to bridge into a new system are sold for twenty-one cents a pound, and the process of re-branding and re-painting overwhelms balance sheets expected to suddenly and magically reflect efficiency. And, none of this addresses the direct and indirect costs of trying to pour oil on the waters of discontent within the corporate cultures. The professional damage to careers, income and pensions invariably affects corporate efficiency for decades following an acquisition or merger under the best of circumstances.

Most distressing to professional advisors is the regularity with which clients refuse to listen when cautioned about the realities of acquisition or merger. Potential benefits are seen as certainties. Potential risks are downplayed. Executives see everything through a prism of unreasonable expectations. Some years ago, an airline client was advised as to the full spectrum of acquisition costs, and chose to ignore all recommendations, including a forecast of several hundred million dollars to recertify under one operating certificate. Unable to later afford the acquisition to which it had committed, “the airline” operated under two separate operating certificates for years. Crews and airplanes could not be cross-utilized. Manuals could not be combined. Maintenance required separate facilities and personnel. Only negative synergies were ever realized, and the certain path to bankruptcy was accelerated.

Economies of scale imply that large organizations are more efficient, despite all evidence to the contrary. While it is true that larger organizations could save money in the purchase of common supply items – toilet paper, copy machine ink and yellow pads – the increases in money required for additional layers of middle management and the inefficiencies that are inherent with increased size overwhelm any and all economies gained. That increases in size of an organization create efficiency is a “factoid” – that is, an unsubstantiated assertion that has been repeated so often by so many that it is now easily accepted as fact.

Consolidation through acquisition and merger is sold by the corporatocracy as a way in which costs are reduced through synergies and economies of scale, and thus resulting in lower costs to the consumer. If the airline industry were a cattle ranch, this theory would be scraped up every spring from the feed lot, and spread on the fields as fertilizer. For all of the reasons described above, consolidation increases real costs. Most often, consolidation is used as a “misdirection play” by industry to focus attention away from reality. When two airlines with no individual net worth consolidate through acquisition or merger, stock analysts often talk up the result in hopes that share price and trading activity will be enhanced to their benefit. Anti-trust officials are lulled into dropping price-fixing or predatory-pricing cases under investigation, since all concerned are now the “same company”. When combined with a bankruptcy filing, the corporations score a “hat trick”. By pushing for tax breaks in the salad days of profitability, they have privatized profit. When seeking bankruptcy relief after looting the company and mismanaging badly, they have socialized losses by sloughing off enormous amounts of legitimate debt, leaving vendors, suppliers, employees, shareholders, and taxpayers with the tab. And, by merging with another carrier, they have created the appearance of future strength to a marketplace ignorant regarding the realities. As a bonus, senior executives know the current operating profiles under economic deregulation are not sustainable, and that a larger merged entity will, as one “too big to fail”, more likely be on a list of surviving airlines when governments ultimately step in to bail out the industry at taxpayer expense.

The folly of acquisition and merger is not unknown to legislators and regulators, but political forces do not want to admit the failure of economic deregulation. Aviation – even at large hubs – is seldom concentrated enough for the forces of free markets to work well. When looking at smaller airports and route structures that will support only one or two carriers, it is simply wishful thinking to believe that deregulation can work at all. Yet, the idea that all will prosper absent government regulation is popular, especially among those who see such issues emotionally, rather than intellectually based on facts – that is, average voters.

And so, despite that deregulation has been messy, inefficient, and fraught with degradations in safety and service, governments world-wide promote the idea that acquisition and merger work to the benefit of all concerned. Until the reality becomes an unavoidable consequence, we will continue to read news reports that two more bankrupt carriers have merged, without expenses and somehow creating value from whole cloth. It must be magic.

Mark H. Goodrich – Copyright © 2012

“The Merger and Acquisition Phenomena” was first published in the June 2012 Issue (Vol 9 No 2) of Position Report magazine.