The carrier's Robert Milton and crew will take to the skies in a rebuilt airline after one of the most complex restructurings in Canadian corporate history, KEITH McARTHUR and BRENT JANG write
By KEITH McARTHUR, BRENT JANG
Saturday, August 28, 2004 - Page B4
Robert Milton had a tough choice to make -- maybe the toughest choice of his career. It was early April, 2004, one year after Air Canada filed for bankruptcy protection in a desperate bid for survival, and now it was all crashing down around him. Hong Kong businessman Victor Li had served notice that he was abandoning his $650-million rescue investment. Calin Rovinescu, Mr. Milton's close friend and most trusted lieutenant, had opted for the escape hatch. Now Mr. Milton, Air Canada's embattled president and chief executive officer, had to determine whether he, too, would bail.
Twelve months of constant bickering -- with creditors, labour unions, potential investors and government officials -- had taken a heavy toll on both executives. As chief restructuring officer, Mr. Rovinescu had carried the bulk of that burden. Mr. Milton knew his own strengths were in operations, not restructurings, and he wasn't sure whether he wanted to take the challenge without the support of Mr. Rovinescu.
Air Canada's advisers were nervous. Mr. Milton had never been the most popular CEO, but if he left the Montreal-based airline at that critical juncture, it would send a chilling signal to the capital markets about Air Canada's prospects. And if the airline couldn't attract a new investor to replace Mr. Li, Air Canada's restructuring might well be doomed.
"He considered it, recognized that it would have been destabilizing and chose to stay . . ." Mr. Rovinescu says. "Frankly, it was more significant for him as CEO to be the guy who takes Air Canada out [of bankruptcy protection] rather than just being the guy who does the right thing by putting it in."
The next several months will reveal whether or not Mr. Milton made the right choice. Air Canada is set to emerge from bankruptcy protection on Sept. 30 after one of the most visible, complex, and antagonistic restructurings in Canadian corporate history. It was an 18-month odyssey that repeatedly pitted unions against one another and against management, and featured fierce infighting between creditors and potential investors.
The struggle has allowed Air Canada to slash debt and operating costs, attract hundreds of millions of dollars in new equity and place a massive order for 90 new, smaller aircraft that will allow it to serve the domestic market in innovative ways and focus on international expansion.
Will it be enough to ensure survival in an industry plagued by unforeseen crises and enormous financial losses? On paper it should be. After carving billions of dollars off its debt load and slashing operating costs by hundreds of millions of dollars, Air Canada should have the tools it needs to compete against international giants and smaller low-cost domestic rivals.
While some observers are predicting clearer skies for Air Canada, there remain pessimists who predict that the airline could be back in bankruptcy protection again within the next few years. After all, there are numerous examples of airlines that have repeatedly failed at attempts to restructure their operations -- notably Canadian Airlines International Ltd., which was acquired by Air Canada in early 2000.
But most observers agree that while the restructuring was far from smooth, the 18-month time line was remarkably quick, given the complexities of the task at hand. Compare that with United Airlines parent UAL Corp., which has languished in bankruptcy protection since December, 2002, and is showing no signs of emerging any time soon.
Air Canada's was no simple restructuring. Usually, a business uses the Companies' Creditors Arrangement Act to clean up its balance sheet by settling debts at cents on the dollar. Air Canada certainly did that. The airline that entered bankruptcy protection with a staggering $13-billion in debt (including off-balance-sheet lease obligations) will emerge with a more manageable load of roughly $5-billion in total obligations. In the process, Air Canada's old investors will lose their ownership stake to all those who were owed money by Air Canada.
But Air Canada needed to do much more than wipe out debt. Mr. Milton and Mr. Rovinescu knew that for Air Canada to survive, it had to radically transform its operations from a relic of a former Crown corporation with outdated work rules into a lean, efficient airline able to compete with low-cost rivals like Calgary-based WestJet Airlines Ltd.
In early 2003, as they watched their dwindling cash reserves, the executives were fully aware that Air Canada needed to change. They also worried about losing control of the airline if they filed for bankruptcy protection. They crafted a plan to bring in new investors and slash labour costs out of court.
But on March 21, 2003, a federal agency made an out-of-court restructuring impossible. The Office of the Superintendent of Financial Institutions, which oversees pensions at federally regulated companies, ordered Air Canada to immediately pay $135-million into its underfunded pension plans. The regulator was trying to ensure that Air Canada would be able to meet its pension obligations if it went bankrupt. Instead, it had the opposite effect, forcing Air Canada to file for bankruptcy protection on April 1, 2003.
At the time, Air Canada executives and their advisers were livid at OSFI, but in retrospect, the regulator's order was fortunate. The drastic drop in revenue arising from the severe acute respiratory syndrome outbreak would have made the filing inevitable, but OSFI forced Air Canada to file before things got too bad.
"It turned out to be a blessing in disguise, because this company would only have gone in [to bankruptcy protection] in a weaker state than it did had it gone in two months later," said Sean Dunphy, the lead Stikeman Elliott LLP restructuring lawyer on the case.
For the next 12 months, Air Canada stumbled from one crisis to another. A battle over labour concessions nearly killed the airline. But Mr. Justice James Farley, the Ontario Superior Court judge overseeing the restructuring, held the parties to impossibly tight deadlines and appointed his friend and colleague Warren Winkler to mediate the talks. The folksy Mr. Winkler lightened the high-pressure atmosphere with long-winded anecdotes about his childhood in Pincher Creek, Alta., and stories of his dogs Maggie and Gretzky.
He was widely respected by both labour and management officials, who referred to him as Saint Wink. In progress reports to Judge Farley, Mr. Winkler used the code-name Jazz, and Judge Farley was known as Tango, after two of Air Canada's airline brands.
Under pressure from the two judges, Air Canada and its unions reached 11th-hour deals that allowed the airline to cut its $3-billion annual labour bill by $1.1-billion.
Then, after Air Canada chose Mr. Li's Trinity Time Investments Ltd. as the equity investor, the disgruntled runner-up, Cerberus Capital Management LP, fought to have the selection overturned, which held up the entire restructuring for several weeks.
Throughout the restructuring, Mr. Rovinescu, and to a lesser extent Mr. Milton, were criticized by creditors and labour leaders over what was seen as a tightly controlled process with little room for consultation or compromise. Some creditors grumbled that they had never seen a restructuring where the executives who presided over a company on its way down had so much control over the way back up.
Mr. Rovinescu admits that he chose to run the restructuring with an "iron fist" because he had seen so many other restructurings drag on and he didn't believe Air Canada could afford that kind of time.
"In a restructuring of this complexity, it is almost impossible to please all the stakeholders at the same time. If everybody is equally displeased, that is almost a measure of success," said Mr. Rovinescu, a former corporate lawyer from Stikeman Elliott.
Criticism peaked in November of 2003 when it emerged that Mr. Milton and Mr. Rovinescu each stood to receive at least $20-million in Air Canada stock under its deal with Mr. Li. (A recent Bay Street estimate of where Air Canada's stock will trade in 2005 suggest those stock grants would have been worth $49.5-million for each of the two executives.)
The executives knew the magnitude of the bonuses would cause a backlash among employees who had given up so much in concessions. But they also felt they deserved the reward. They sincerely believed that they had been largely underpaid for years in what they saw as two of the toughest jobs in Corporate Canada.
The stink of the bonuses hung over negotiations in the spring when Mr. Li insisted that the unions agree to further labour concessions. He wanted the risk in Air Canada's pension plans to be gradually shifted from the airline to its employees. The unions dug in their heels and refused. After all, they had agreed to $1.1-billion in concessions the previous spring under the explicit promise from Air Canada that the pensions would not be touched.
On March 24, Mr. Milton and Mr. Rovinescu flew to London, England, to update Mr. Li on the pension negotiations and on Air Canada's business plan. It was clear that Mr. Li did not like where things were headed. It wasn't just that the unions appeared inflexible; it was also that Air Canada appeared to be having trouble meeting its cost and revenue targets.
A few days later, Mr. Rovinescu told Air Canada's board of directors that he was worried Mr. Li might abandon the airline. If this happened, Mr. Rovinescu told them, he would leave his post.
On April Fools Day, 2004 -- one year to the day after Air Canada filed for bankruptcy protection -- Mr. Rovinescu got the call he was dreading. Frank Sixt, an old friend of Mr. Rovinescu's who was working for Mr. Li on the deal, called to request an urgent conference call with Mr. Milton. The Air Canada executives took the call from Mr. Li at Mr. Milton's house in the Montreal suburb of Westmount, during which the Hong Kong billionaire informed them that it was over. He blamed "union intransigence," among other factors, for his withdrawal.
Judge Farley was furious when he learned of Mr. Li's departure. After all, lawyers for Air Canada and the court-appointed monitor had repeatedly assured him that Mr. Li's bid carried little or no execution risk. The no-nonsense judge was growing tired of what he saw as an us-versus-them mentality in the restructuring and with Mr. Rovinescu's self-described iron fist. He strongly believed that Mr. Rovinescu had to yield some of his control to Murray McDonald at Ernst & Young, the monitor firm. Mr. McDonald, who was not afraid to challenge Air Canada management on controversial issues, delivered that message to Mr. Rovinescu. Some took this as a sign that Judge Farley was responsible for Mr. Rovinescu's departure, but in fact, the CRO had decided on his own that his time had come.
A group of creditors led by Deutsche Bank AG were the first to step into the void left by Mr. Li's departure, agreeing to expand a $450-million rights offering to $850-million. There were few strings attached to the Deutsche Bank deal. But Air Canada said its labour concessions weren't panning out as planned and said it needed another $200-million in cuts to reach its $1.1-billion target. Once again, Saint Wink was brought into the fray to save the day. Round 2 of the labour talks was much more difficult. The same people who were passionate, aggressive negotiators the previous spring had become exhausted and lethargic through the trials of the restructuring.
Next, Air Canada ran an auction to see whether it could raise another $250-million. Two investors put in bids. One was New York-based Oak Hill Capital Partners LP, founded by Texas billionaire Robert Bass. Behind the scenes, Mr. Rovinescu was using his knowledge of Air Canada's restructuring plan to advise Oak Hill.
The other bidder was Cerberus Capital, the New York investment fund that had lost out to Mr. Li seven months earlier. Tensions were high between Air Canada and Cerberus. The aggressive New York fund -- named after the three-headed dog that guards the gates of Hell in Greek mythology -- had made no secret of the fact that it thought the equity selection process had not been fair when it lost to Mr. Li in the first round.
Furious that Cerberus had held the restructuring hostage as it sought to overturn the results, Air Canada's spin doctors responded with suggestions that Cerberus wasn't trustworthy, and attempted to use the media to get their message out.
When the bids came in on June 18, the Cerberus offer was clearly better. The Deutsche Bank group felt strongly that Cerberus should get its chance to invest, especially after Cerberus made some minor improvements to its bid.
But there were some who suggested at the end of the auction that Air Canada didn't need an equity sponsor after all. Mr. Milton, for one, was concerned. He would ask one confidant: "With Deutsche Bank and Cerberus in here, how long do you think my lifespan is going to be?" Mr. Milton set up a private meeting with Cerberus officials who told him that while there were no long-term guarantees that he would remain CEO, there was no hidden agenda to replace him. Cerberus officials also promised that in the event that Mr. Milton left, they would abide by his contract, which guaranteed him a golden parachute of three years' salary and a bonus estimated to be worth $5-million.
Finally, Mr. Milton set aside the strained relations and recommended the board approve the Cerberus deal, which gives the New York investment fund three seats on the board, but not control of the company.
Mr. Milton turned down a request to be interviewed for this story.
Last Monday, Judge Farley gave his final blessing for Air Canada's plan of arrangement after the airline's creditors voted 99.6 per cent in support of the plan. Under the plan, Air Canada's former shareholders will be virtually wiped out, with creditors, Cerberus and management becoming the new owners of the company. Creditors will end up with an 87-per-cent stake, and Cerberus will own about 9.2 per cent of the new company. About 3 per cent of the equity will be set aside for management compensation. Because of foreign ownership rules, Canadian investors will control the company, with foreign investors, including Cerberus, receiving variable voting shares.
Among the creditors receiving stock are Air Canada's unions, which have more than $840-million in claims -- roughly 10 per cent of the accepted claims.
But the unions are in the process of selling their claims to hedge funds and don't stand to be long-term investors.
Air Canada's unions say stock ownership isn't part of their mandate. Contrast that with the non-unionized WestJet Airlines, where an overwhelming majority of employees own stock.
Indeed, Air Canada's demoralized work force will be one of the toughest challenges for the airline as it moves forward. Douglas Reid, a business professor at Queen's University, says a crucial part of the airline's strategy should be empowering employees.
"Air Canada needs to address that vital element" by giving front-line workers the flexibility to solve problems quickly and directly for passengers instead of seeking approval from layers of supervisors, Prof. Reid says. "What you want is an employee who says: 'I had a passenger who had a problem and I solved it.' "
Motivating employees is just one of the challenges facing Air Canada. Other factors, such as stubbornly high jet fuel prices, will make it difficult to execute the business strategy in a profitable fashion. Then there's the caveat that whatever the merits of the recovery plan, all bets are off should there be another SARS outbreak or terrorist attacks.
McGill University business professor Karl Moore says Air Canada is in a position to recover, but it needs to work on improving a corporate culture that has been fraught with internal battles.
Prof. Moore says the tussles include those between management and labour, management and suppliers, and lingering ill will between long-time Air Canada staff and those who joined from Canadian Airlines.
"Air Canada has got to beat off the competition rather than fight among themselves," he says. "They've got to work together as team, focusing on pleasing customers, winning customers back and keeping them."
Air Canada is planning a major public relations campaign to ensure that its employees and the travelling public know that the airline that comes out of bankruptcy protection on Sept. 30 won't be the bloated beast that went in.
The airline is banking on its international routes to fuel much of its growth, allowing it to cede some domestic market share to WestJet, Montreal-based Jetsgo Corp. and CanJet Airlines, a division of Halifax-based IMP Group International Inc.
Air Canada has found that the best profit margins are on overseas routes, so it's concentrating on preserving its dominant position on transatlantic and transpacific markets from Canada. Although there's some indirect competition from U.S. carriers, which operate from American hubs, Air Canada has no peers within Canada when it comes to scheduled service to Asia, Europe and Latin America.
The trick will be for Air Canada to give up some domestic passengers to its rivals, but not let too many seats slip away. Even though the Canadian market has become a battleground for consumers seeking low fares, Air Canada still needs to maintain a strong presence domestically because a dozen or so Canadian cities are considered vital as feeder centres for international business and tourist travellers.
In short, the mantra at Air Canada won't be market share, but profitability. That means devoting less energy to the dogfight within Canada while expanding service abroad. Service began last month to Colombia and Venezuela, and flights to Peru are slated to start in November.
"Air Canada's future profitability lies in its international route network, its international reputation," says Rick Erickson, managing director of Calgary-based RP Erickson & Associates, an independent aviation consulting firm.
Mr. Erickson believes that Air Canada's restructuring plan appears to be viable, considering that billions of dollars in debt have been erased.
Still, he cautions that the company's mainline and its regional subsidiary Jazz Air Inc. will continue to have a rough time against WestJet, Jetsgo and CanJet.
Air Canada estimates that it held 51 per cent of the domestic capacity in May, down from 56 per cent in May, 2003. Mr. Erickson reckons that Air Canada's domestic share could slip to 45 per cent over the next year or so.
Assuming Air Canada's comeback strategy does work, it could pay off in relatively short order. Nick Morton, an analyst with RBC Dominion Securities Inc., said in a research report this week that while the airline appears headed for a $742-million loss this year, it could post a profit of $290-million next year and $474-million in 2006.
That would be an impressive turnaround for a company that lost $4-billion between 2000 and 2003 -- or $3.6-million a day. But the restructuring has taken a serious toll on the airline's creditors, suppliers and -- above all -- its employees.
"People have given up a lot," said Kent Wilson, president of the Air Canada Pilots Association. "The restructuring has been painful and it hurts, and a lot of people are marginalized and diminished by it, but in the end, you've got to roll with it and then get on with life."
As always, Mr. Milton is undeniably bullish about Air Canada's future. But this is a CEO who has watched crisis after crisis all but destroy his airline in the five years since he was appointed to the job. Some of those threats have been internal, but many have been beyond his control. And while Air Canada is ahead of revenue targets, the rise in fuel prices is making it difficult to meet cost reduction plans.
In a telephone message to employees this week, Mr. Milton cited the spike in fuel prices as a reminder that the airline's emergence from CCAA does not guarantee clearer skies.
"Like the impact of Sept. 11 and the SARS virus that we faced in the past three years, we have recently been reminded just how much external factors can have a serious impact on our business," he said.
After the clouds clear
Since filing for bankruptcy protection on April 1, 2003, Air Canada has slashed its debt and operating costs in order to better compete with its low-cost rivals. After placing an order last year for 90 jets with less than 100 seats, Air Canada will emerge from bankruptcy protection with a smaller fleet
so it can reduce domestic capacity while maintaining frequency. A snapshot of the company before filing and after emerging from bankruptcy protection at the end of September:
DEBT (INCLUDING OFF-BALANCE SHEET LEASE OBLIGATIONS)
NUMBER OF FULL-TIME EQUIVALENT EMPLOYEES
NUMBER OF PLANES IN OPERATION (EXCLUDING JAZZ)
DOMESTIC MARKET SHARE**
ANNUAL LABOUR BILL
**Market share, first quarter 2000 vs. 2004, based on numbers from WestJet, Jetsgo and Air Canada (excluding Jazz)
SOURCE: AIR CANADA AND OTHER COMPANY DOCUMENTS
Robert Milton, Air Canada's president and chief executive officer, seriously considered leaving the airline in early April, but decided to stay to see the restructuring through. He is optimistic about Air Canada's future prospects.
Hong Kong businessman Victor Li was initially seen as a solid investor who posed little or no closing risk. But Mr. Li threw Air Canada's restructuring into turmoil in April when he announced that he would not proceed with his investment.
CAW boss Buzz Hargrove and other labour leaders dug in their heals when Mr. Li insisted that pension risk be gradually shifted from Air Canada to its employees. Mr. Li blamed "union intelligence" for his departure.
Mr. Justice James Farley of the Ontario Superior Court grew tired of what he saw as an us-versus-them mentality in Air Canada's restructuring and wanted the chief restructuring officer to yield some control over the process to the court-appointed monitor.
Calin Rovinescu says he ran the restructuring with an iron fist so the proceedings didn't get bogged down in delays. He left his post as chief restructuring officer in April after Victor Li walked away from his proposed investment.
Murrary McDonald of Ernst & Young, the court appointed monitor, is credited with helping to keep the restructuring on track. He wasn't afraid to challenge Air Canada management on controversial issues.