U.S. Airlines Spent 96% of Free Cash Flow on Buybacks writes Brandon Kochkodin on Bloomberg
American Airlines Group Inc...led the pack, with negative cumulative free cash flow during the decade while it repurchased more than $12.5 billion of its shares. United Airlines Holdings Inc. used 80% of its free cash flow on buybacks, while the S&P 500 Index as a whole allocated about 50% for the purpose. As the industry reels under the weight of the coronavirus outbreak corporate leaders are seeking federal assistance to ease the burden.Let's be clear. It is a myth that buybacks are bad because they reduce investment. And free cash flow isn't a very interesting divisor. But buybacks do have a downside: they reduce equity and increase debt. Fine if you and the creditors are willing to take a bath in bad times. Not good if debt means taxpayers have to bail out in bad times. Too big to fail is spreading like a virus.
If airlines were financed by equity, they would have a natural shock absorber. They could just shut down, stop paying dividends, and then wake up on the other side. But they have debts to pay, and if they don't pay creditors will take them to bankruptcy court, seize assets, break them up and there won't be airlines when the virus is over.
Enter the federal bailout, as always really a bailout of the creditors.
Does this all sound like banks 2008? It is.
If we are going to bail out airlines then there needs to be subsequent capital regulation. Once bailed out you cannot finance yourself on a mountain of debt next time around. Issue equity, retain earnings.
Everyone is watching. If debts lead to bailouts with no consequences, there will be more debts and more bailouts. Yes, even now we have to watch moral hazard. We are setting precedents for the next larger pandemic.
The only reason the economy is in trouble is that not enough people and businesses kept cash reserves or plans to weather a shut down. If the ants bail out the grasshoppers without consequences, we will enter the next crisis with nothing but grasshoppers.
If there is going to be a bailout this consideration makes it ever more important that the government lends money, or invests, and is paid back first before any current creditors or stockholders. Don't just send a check.
If it's more efficient to put the airlines into hibernation and then revive them, why can't the creditors do that just like the equity holders would have? What do you see as the governance or coordination failures, and can they be fixed? In such a crash, the equity holders should be wiped out and likely the debt-holders take costs, too, but it doesn't make sense to break up the assets only to have someone try to re-construct a new airline with them later.
ReplyDeleteI've been wondering that same fact. I've always assumed there were tremendous legal consequences trying to restructure debt payments in a crisis. Why can't businesses justifiably defer payments once the crisis abates especially when the business model was functioning pre-crisis
DeleteAbsolutely! And not just for airlines. Lend to those in trouble on equal terms, lend, not give.
ReplyDeleteI think capital regulation is overkill. We have a good mechanism in the form of Chapter 11 to readjust the airlines capital structure on a retroactive basis. The Federal Government can come in as the DiP lender and be assured of cash back plus interest, plus some options. Current lenders can be subordinated and get cross put and call rights. The lenders could at some future date put for common stock or the airline could call for cash. No interest until the Government is paid off. The current common stock would get leftovers.
ReplyDeleteIt is important that as businesses the major airlines survive, it is not important that the current shareholders still own the company or that creditors be paid in full if they are indeed *bankrupt* companies. You're talking regulation coming after a bailout, fool me once shame on you. The only way to avoid the moral hazard is to avoid it now!
ReplyDeleteIn the event of a bankruptcy, completely wipe out shareholders, haircut creditors, and auction off shares in a new post-bankruptcy company with a guaranteed amount of government seed money exchanged for shares in the new company at the auction determined price. You could even make the government shares non-voting shares that convert to voting shares when sold to avoid government control of the new company.
This would require (a) authorizing of the funds and (b) bankruptcy reform to make it easy for a bankruptcy court to auction off shares in a post-bankruptcy company rather than make a piecemeal sale of assets in order to pay creditors. The new company would then be purchased by investors at a market price in an auction (the full amount going to creditors first, and then if any remaining to prior shareholders in the form of similarly priced shares). This would be done under the proviso that the government could then buy equity in the company at that same rate by putting up additional working capital for the new company in exchange for non-voting shares that convert to voting shares on sale. Let's call this a bail in and stop pretending that the only way to keep airlines running is to hand out government money to their creditors and shareholders.
Anonymous: What you propose about Bankruptcy is precisely the purpose of Chapter 11. The real issues n a Chapter 11 are financing and control.
DeleteQuestion: will one long-term consequence of this episode be the the average level of corporate gearing falls slightly?
ReplyDeleteSecond question: if debts lead to bailouts with the government taking equity stakes (to be sold after the crisis), will that be a sufficient consequence to caution businesses for the future?
Hi John Re: Your WSJ op-ed today. Thank you. One MAJOR error. The Federal Government DOES have infinite financial resources. This principle applies only to nations, such as the US, with their own free-floating currency and no debt denominated in a foreign currency. We can't run out of money any more than a scorekeeper can run out of points. There are limits, of course. But the limits are real, not financial. That is, if the private sector has and is spending more money than the economy can absorb, you create inflation. But it's not a financial resource issue. Understanding this would greatly impact your overall perspective. Pls consider. Thank you very much.
ReplyDeletePrecisely what the Wiemar Republic said in 1923. How did that workout for them?
DeleteThey printed more money than the real economy would absorb- which was my point. With the US economy sinking right now - there is room. Thanks.
DeleteEven if the result were bad - it is a fact that the Federal government does have infinite financial resources. They need not even "borrow" - they can simply write checks or have the Fed buy the bonds. Point - whether its good or bad is not the issue - just saying that John's statement is simply factually
Deleteincorrect. BTW, we used these "infinite" resources in WW2. We are in another war right now. thx
I'm not sure I understand your point. The fact that we can print any amount of currency enables what in this situation? What problem is this able to fix?
DeleteI'm also confused by your reference to world war II. are you saying during war times any amount of spending can be financed by the printing press?
I prefer letting people keep the money they earned and taxing it a lot less.
ReplyDeleteHow about a payroll tax holiday and a steep downward reduction in the federal withholding rates on income taxes?
As I understand it, in 2016 when the economy was strong, a capital gains tax was received with open arms. In 2020, when we are headed into a steep recession, we cannot seem to cut payroll taxes or reduce income taxes on wage earners.
Roger that.
For what it is worth, a quick look at AAL's 10-k, showed $7.3 billion of liquidity at year end. Interest payments + operating leases + capital lease payments = $3.2 billion, so a little over 2 years of liquidity if you literally shut everything down.
ReplyDeleteWages at $12.6 billion are the biggest operating expense by far and are the most fixed because of union contracts. Even if the Company had no debt and owned its planes and office space outright, AAL would still run out of cash in 6 months without the ability to layoff employees.
John, the problem is that stockholders are double taxed and bondholders are single taxed. There is an enormous tax incentive to debt financing over equity financing. This needs to be fixed. We should either end the deductibility of interest payments, or else abolish the corporate income tax entirely. Until you do one of those things, you will see a continual shift to debt financing.
ReplyDeleteBut even if we do nothing, the current system isn't as bad as you make it sound. If airlines can't make their debt payments, yes, they go bankrupt, but no, they do not cease to exist. If bondholders force the dissolution of the airline, then who will they sell the planes to? So, either a new airline gets created to acquire the assets of the old one, or the old airline continues to exist after renegotiating with creditors. Either way, air travel continues. Bankruptcy is really just part of a negotiation between the company's owners on how to split up lower-than-expected EBITDA, if one considers both equity and debt holders as "owners".
The main reason airlines have too much debt is the same reason the economy as a whole has too much debt -- interest rates have been kept artificially low for far too long. End the Fed!
ReplyDeleteDo I read in this essay (welcome) hints of Herbert Spencer's advocacy of how human society - and perforce the economy - goes?
ReplyDeleteSomeone, not Spencer, said "If you protect fools from their folly, you will populate the world with fools."
Recently we are talking about it as "the Darwin Principle."
Really? NO! Bailouts give lenders give every incentive to make loans that will someday non-perform. Once again the taxpayer is the victim of this moral hazard. Enough!!!
ReplyDeleteDelta Airlines reported a 4.77 BILLION dollar NET profit in 2019. This same carrier entered bankruptcy in 2005 as a method under the code of eliminating unsecured debt(like pilot pension/healthcare plans)and now they have their hands out again.
ReplyDelete