The airline industry has been hard hit by the COVID-19 pandemic, which globally is expected to cost the carriers more than $100 billion in lost revenue. The transportation grid has come to a near halt: Flights are cancelled, vacations are on hold, and businesses are banning travel.
In response, airlines are seeking government assistance, with U.S. executives in Washington seeking about $50 billion in grants and loan guarantees designed to help prevent layoffs and stabilize balance sheets until demand recovers.
However, that request has been met with pushback, both from labor leaders who advocate direct assistance for workers instead of corporate funds and by critics who note that airlines have for years been allocating funds to stock buybacks and dividends instead of building up their savings.
The biggest U.S. airlines spent 96% of free cash flow over the last decade to buy back shares of their own stock in order to boost executive bonuses and please wealthy investors.— Robert Reich (@RBReich) March 17, 2020
Now, they expect taxpayers to bail them out to the tune of $50 billion. It's the same old story.
Lawmakers have pounced, delaying what earlier in the week seemed likely to be a quick process to provide airlines relief. In the process, markets have questioned the viability of some airlines. The critics have a point, but as usual there is a lot more to this story than one tweetable headline number.
The danger of painting with a broad brush
It's worth mentioning that the 96% figure is largely due to American Airlines Group, (AAL 4.75%) which spent more than $12 billion on buybacks while generating negative cumulative free cash flow, and United Airlines Holdings, (UAL 2.13%) which spent about 80% of its free cash flow on buybacks.
Other airlines were much more conservative, with Delta Air Lines (DAL 3.03%) for example spending about half of its free cash flow on share repurchases and Alaska Air Group (ALK 5.08%) about one-third of its free cash flow. By comparison, S&P 500 index members on average spent about half of free cash flow on buybacks during that period.
Nevertheless, it is still a bad look for an industry now coming hat-in-hand to Washington.
Diving deeper into those numbers, American did do substantial buybacks. However, free cash was also depressed because the airline was engaged in massive capital expenditures (capex) that were investments in the future, including new facilities and expanding the fleet. Absent that capex American's buyback ratio would likely look a lot better, but the company would be in much poorer shape.
Critics have complained the airlines weren't preparing for a rainy day. But this is no rainy day, this is a 1,000 year flood. The airlines say the current situation is worse than post-9/11, a time when total U.S. capacity shrunk by nearly one-third in a single month and took nearly four years to recover.
All of the major airlines have reserves and billions in unencumbered assets that can be used for collateral in the event of a downturn. Even smaller airlines like Alaska had nearly $2 billion in cash on hand, but this is no ordinary downturn.
Delta expects March revenue to fall by $2 billion year over year and has warned it expects April to be worse. As of last week, JetBlue (JBLU 4.75%) was taking in $4 million in new bookings daily while issuing more than $20 million per day in credits. This isn't just an economic slowdown, this is a national call to shelter in place and close borders.
No major U.S. industry was prepared for this scenario. The airlines just happen to be in the bulls-eye.
It sounds good in hindsight to say the airlines should have been pouring all of their free cash into an online savings account for the better part of the last decade, but is it realistic? Airlines were hardly alone in embracing buybacks, as the S&P 500 figure above shows. And shareholders have demanded it.
In 2013, Delta broke with recent industry tradition and instituted a dividend. It was viewed as a sign of confidence by the markets, and the beginning of a new era in the industry that transformed investors, including Warren Buffett, from a vocal critic of airlines to a long-term investor.
Suppose that, instead of announcing the dividend, Delta had instead told shareholders that due to fears that some unforeseen future event could overnight wipe out demand for travel it was planning to horde its cash in liquid investments. Would the industry have enjoyed the sort of renaissance that got Buffett interested and attracted billions in additional private capital?
Even if an airline wanted to store all its free cash in a vault, it would likely have been unable. The first step in the activist investor playbook in recent years has been to demand increased payouts to shareholders. A management team that was going all-in on building a reserve while not returning cash to shareholders would have likely been shown the door.
United Airlines was the target of activist pressure in 2016, despite its cash return policies. The airline won over shareholders in part by doubling the size of its planned share buyback.
This is a moment for pragmatism
It pains me to stick my neck out as the defender of corporate welfare and ignorer of moral hazards. In hindsight, the buybacks were regrettable, and I would hope whatever bailout the airlines get is heavy on loans or provides the government with equity, as well as limitations on executive bonuses until the loans are repaid and the stock is sold.
But now is not the time for scolding, it is time for pragmatism. This is a vital U.S. industry in a dire position due to an incident few, if any, in corporate America were prepared for, with hundreds of thousands of employees and support jobs on the line and huge ramifications for cities if they fail. Ask St. Louis what happens to nonstop options when your home-town airline goes bankrupt.
Ironically, a strong show of government support would also likely help the airlines to secure more private assistance by giving creditors, lenders, and counterparties more confidence to do business with them, which perhaps could minimize the total bailout needed.
The bailout cannot come with an attempt to put permanent restrictions on stock buybacks or dividends. It is hypocritical to both demand these companies turn to the private sector for their capital needs, and then neuter that effort by denying them the tools that the rest of the S&P 500 use to attract capital investment.
Now is not the time to let perfection be the enemy of the good. This is a systemically important industry in a desperate situation. Washington needs to get the bailout done, post haste.