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Stocks D / Delta Air Lines, Inc.


Subject:  Re: Buying Delta? Date:  9/19/2005  12:30 PM
Author:  rev2217 Number:  670 of 699


Would this mean that once they come out of Chapter 11 proceedings then buying stock again would be an option? If so, how prudent would that be?

Yes, buying the company's stock after it emerges from Chapter 11 is certainly an option -- but one that warrants caution and due dilligence.

Let me amplify on that. When companies reorganize via a Chapter 11 bankruptcy proceeding, they attempt to shed the parts of their business that are liabilities (that is, the source of red ink) so that what remains is a profitable business. The bankruptcy code allows a company in Chapter 11 to terminate leases and other contracts that it would not be able to terminate otherwise. By way of example, a company that operates department stores may close stores that are not netting enough profit to cover their rent. The bankruptcy code allows the company to terminate the leases on such stores as soon as it vacates the building, with the court's approval, so the rent and other fixed costs associated with that location cease to be red ink on the balance sheet. The owner gets the building back and may rent it to another tenant to make up the lost rent from the termiated lease.

Now, bankruptcy reorganization is a very tricky process. Continuing the previous example, a retailer who closes a several stores in a geographical area may discover that the warehouse or distribution center serving that geographical area is too big for the remaining stores in that area, and thus has to realign its distribution network (and there are several options for doing so -- leasing or subleasing part of the building, moving the facility to a smaller building and terminating the lease or selling the vacated building, or closing the facility completely and reassigining the remaining stores to adjacent distribution areas, potentially with higher costs for trucking longer distances). At the end of the day, though, there may be some stores that were profitable but that are not within the range of any warehouses or distribution centers that can remain open. The company may well end up closing those stores, too. At the end of the day, what emerges might not look anything like the original company.

An airline tends to have two major assets -- (1) aircraft and (2) ground facilities to support the operation of aircraft. The latter includes terminal facilities (gates, check-in counters, baggage claims, etc.), hangars, and training centers. It also owns ground handling equipment (baggage carts and tractors, tugs to handle aircraft on the ground, and service other vehicles), but that is a very small piece of the pie. Thus, options for restructuring are pretty limited.

>> An airline can on surplis ground facilities, but sacrifices planned growth for which it procured those facilities by doing so.

>> An airline can terminate orders for new aircraft, but such terminations often result in forfeitures of deposits and require continued operation of older aircraft that are less efficient than the newer models.

>> An airline can reduce or realign capacity, but typically not without loss of business due to lost connections and lack of flights at times that would be convenient for potential customers.

Note, BTW, that reductions in service can have a major ripple effect because potential connecting customers no longer fly on the routes that connect to the affected route, either. It's also important to remember that an airline may need just as many ground staff and the same ground facilities at an airport to handle ten flights per day as to handle five flights per day, so long as the times of the flights do not coincide. Elimination of a flight does not guarantee a proportionate reduction in cost.

The bottom line is that a restructuring that's done well can cut a lot of fat out of the company but a restructuring by incompetent management can leave a company that can't succeed. Note that US Airways emerged from Chapter 11, then landed in another Chapter 11 bankruptcy only a year later because the company's management did not "get it right" on the first try. The second try looks more promising, but we'll see -- merger partner America West (NYSE: AWA) is not exactly the strongest company in the industry. I have not studied the details, but I'm seeing indications from several sources that the present management United Airlines is not "getting it right," either. OTOH, there are many instances of companies that have used Chapter 11 to shed dead weight and emerged as very strong competitors in their industry. I think that Delta's present management will do a better job, but there may be some dramatic changes in the company before the dust settles. My recommendation is to take a fresh look at the compnay when it emerges from Chapter 11 and assess, at that time, whether or not it's a business that you want to own.


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