Texas Air Corporation
Texas Air Corporation
Incorporated: June 11,1980
Sales: $4.407 billion
Market value: $1.272 billion
Stock Index: American
The Texas Air Corporation is not an airline, it is an airline holding company. In the decade after deregulation Texas Air has challenged many rules in the airline industry. A relatively young company, the story of Texas Air parallels the story of its founder Frank Lorenzo.
Frank Lorenzo was born and raised in New York City. He graduated from Columbia and received his MBA from Harvard. Due to his life-long fascination with aviation, he spent the next three years working in the financial departments of TWA and Eastern Airlines. In 1966 he and a colleague from Harvard, Robert J. Carney, established an airline consulting firm. In 1971 their company was appointed by the Chase Manhattan Bank to arrange a complex $35 million refinancing for the troubled Texas International Airlines. Lorenzo and Carney established a second company in 1969 called the Jet Capital Corporation, an aircraft clearing house and leasing organization. By 1971 Jet Capital had amassed $1.5 billion in equity, an amount sufficient to afford Lorenzo the opportunity to acquire Texas International, or “TXI.”
In 1972 Jet Capital, which was largely owned by Lorenzo and Carney, absorbed Texas International. Lorenzo was named president and chief executive officer while Carney became chief financial officer. In 1977 a TXI vice president named Donald C. Burr introduced a new low-cost “peanut fare” to attract more passengers. The cut-rate scheme temporarily revived the airline and increased the cash flow, but it also invited challenges from competing airlines.
The following year Congress passed the Airline Deregulation Act which effectively eliminated government control over airline markets and fares. Donald Burr, who had recently been named president of TXI, resigned from the company along with several associates and established an airline called People Express. Based in Newark, New Jersey, People Express became synonomous with cut-rate air fares and no-frills service.
Meanwhile, Texas International initiated a cost-cutting campaign. Through Jet Capital the company replaced its older Convair jets with durable and efficient DC-9s. In addition, TXI eliminated cross subsidization (the practice of financing money-losing routes with profitable ones). Under deregulation Texas International was free to discontinue any unprofitable route it deemed necessary.
In June of the following year Lorenzo created a holding company for TXI called the Texas Air Corporation. The following September Texas Air created a new airline using excess TXI equipment. The new carrier, New York Airways, was created to lure business away from Eastern Airlines’ profitable northeastern routes. It maintained lower labor costs because its employees were non-union. Burdened with a significant debt, but also possessing a large amount of cash generated from TXI and New York Air, Lorenzo launched his bid for another troubled airline, namely, Continental.
Lorenzo has described his success at takeover attempts as including an element of good timing. The strategy is to wait until a company with sufficiently high debt is found, which makes it easy to acquire. Then take note of its labor contracts. If these are due to expire, then purchase the company and rewrite the labor agreements in order to bring costs into line. If necessary, challenge the unions and hold out until they compromise their demands. This philosophy has provided Lorenzo with a reputation as a union breaker. It has also given him a reputation for saving failing airlines and, ultimately, many thousands of jobs.
With that in mind, Texas Air increased its holdings in Continental to 48.5% in March of 1981. By September the company had a majority interest in Continental and completed the takeover the following year. Shortly afterwards, TXI was merged with Continental and ceased to exist as a separate airline.
The new Continental Airlines had serious labor problems which threatened to close the airline. On September 24 Continental filed for reorganization under Chapter 11 of the Bankruptcy Code. At the same time it imposed new work rules and wages scales, and filed suit in court to have the old contracts voided. Operations resumed on September 27 despite thousands of workers on strike. According to Lorenzo, the strikers later “returned to Continental with a changed attitude” because they realized that “what they were getting from the unions was pure gibberish.” In the end Frank Lorenzo had defeated Continental’s unions.
In 1985 Lorenzo initiated a takeover of debt-ridden TWA. He was challenged, however, by well known corporate raider Carl Icahn. In the ensuing takeover attempt both parties drove up the value of TWA’s stock. However, just when it appeared that Icahn was ready to cancel his bid and sell his TWA stock (at a large profit), he strengthened his position by enlisting the support of the airline’s unions. Instead it was Lorenzo who canceled the bid. Texas Air earned $26 million from the “raid” it never intended to make, and Icahn found himself in charge of an airline he probably didn’t intend to own.
Texas Air was at a disadvantage since it had no computerized reservation system (CRS) which travel agencies use to arrange itineraries. Continental was a member of the Neutral Industry Booking System, but that network couldn’t compete with American Airline’s Sabre (which dominates the market) or United Airline’s popular Apollo system. To some extent it was for the CRS that Frank Lorenzo attempted a takeover of TWA. TWA operated a well-established CRS called Pars. If Texas Air could acquire TWA, then it could acquire Pars. With Pars the Texas Air system would be better able to compete with American and United.
The following year Texas Air turned its attention to Eastern Airlines. Eastern was in unstable financial condition. It had become a takeover target because of its enormous debt. Eastern’s employees, who owned 25% of the company’s stock, were “shell-shocked” by successive crises at the airline. They wanted a labor settlement and were willing to compromise, but only if offered a fair deal. Eastern also had an established CRS, called System One, or “SODA.”
Texas Air’s $676 million takeover bid for Eastern was approved by the Federal Aviation Administration (FAA) in 1986, despite that agency’s protests that the new complexion of Texas Air would give it a near monopoly in certain markets. Conditional upon the FAA’s approval was Eastern’s pledge to sell a number of boarding gates in the northeast to Pan Am. With these gates Pan Am could more effectively compete with Eastern and New York Air on profitable shuttle flights between Washington, New York and Boston.
Barely a month later Donald Burr’s People Express re-entered the scene. It attempted to sell its bankrupt Frontier Airlines unit to United Airlines, but the deal was rejected by the United Airlines pilot’s union, which couldn’t agree on a formula for absorbing the pilots from Frontier. People Express then offered itself for sale, with Frontier included. It was at this time that Frank Lorenzo made his offer of $125 million for People Express and $176 million for Frontier. (Texas Air subsequently purchased the two airlines at a lower price.) The settlement was initiated in September of 1986 and was later approved by People Express stockholders and the FAA. Once again Donald Burr found himself working for Frank Lorenzo.
In January 1987 it was announced that People Express and New York Air would be absorbed by Continental Airlines. They would cease to exist as separate organizations, and their airplanes would be either repainted in the red and gold Continental pattern or sold. The consolidation left Texas Air with two separate airline companies which are roughly equal in size: Eastern Airlines which is characterized by excessive labor and operating costs (31% higher than Continental); and Continental Airlines which is characterized by low labor costs and profitability.
The new Texas Air Corporation controls over 20% of the domestic airline market. However, Lorenzo seems to have foreseen this. He told Fortune magazine that, “In the post deregulation era, first there was the new airline phase. Then came the consolidation and cost-cutting phase. Now we’re heading into the megaline phase, which will leave the U.S. with five to eight major carriers, instead of a dozen or so today.”
Becoming the largest of those “megalines” has put Texas Air $4.6 billion into debt. The ratio of debt to equity (net worth) is almost eight to one. This is not a problem for Lorenzo, who maintains that a substantial debt is “okay as long as you maintain significant liquidity and profitability.” Nevertheless, for the time being Texas Air is not likely to acquire any more airline companies. Lorenzo was quoted in The Wall Street Journal as saying, “Three years from now you’ll see the same Texas Air that you see today. Whatever growth we’re going to have from this time on, we can satisfy internally.”
CCS Automation Systems, Inc.; Continental Airlines Corp.; Eastern Airlines, Inc.
Deregulation and the New Airline Entrepreneurs by J.R. Meyer and Clinton V. Oster, Jr., with Marni Clippinger, Cambridge, MIT Press, 1984; Deregulating the Airlines by E.E. Bailey, D.R. Graham, and D.P. Kaplin, Cambridge, MIT Press, 1985.