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Cablegate: Air Canada Bankruptcy and Restructuring

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 MONTREAL 000553

SIPDIS

STATE FOR WHA/CAN - PATRICIA NORMAN, EB/TRA - SUSAN PARSON

STATE PASS USTR FOR SAGE CHANDLER

USDOT FOR JEFF SHANE AND SUSAN MCDERMOTT

FAA FOR KRISTA BEREQUIST

TSA FOR SUSAN WILLIAMS

SIPDIS

USDOC FOR 6310/ITA/TD/TM/OFFICE OF AEROSPACE/TLARGAY

E.O. 12958: N/A
TAGS: EAIR ETRD EFIN ECON CA
SUBJECT: Air Canada Bankruptcy and Restructuring

Ref: (A) Ottawa 00385 (Air Canada financial woes)

(B) Ottawa 00612 (Transportation Strategy Aviation)
(C) 2002 Ottawa 2824 (Report suggests liberalization)
(D) 2002 Montreal 1248 (Air Canada going Discount)

1. SUMMARY: Air Canada's recent filing for bankruptcy
protection follows efforts over the past several months to
restructure its operations and lower its costs in order to
remain competitive during a difficult time in the airline
industry. However, a combination of its own business
decisions, the rise of low-cost competitors, and several
devastating events beyond its control helped bring the
airline to this point. The bankruptcy protection will
provide the airline time to develop a long-term strategy
that might allow it to compete in a changed market. The
Canadian government has indicated a willingness to provide
loan guarantees to Air Canada, but there are currently no
plans for a cash bailout. END SUMMARY

2. On April 1, 2003 Air Canada sought protection under the
Companies' Creditors Arrangement Act (CCAA), Canada's
equivalent to Chapter 11. Even before the bankruptcy
filing, Air Canada had declared a Force Majeur, citing the
war in Iraq, in order to find relief from some contractual
obligations and to justify the impending layoffs of 3,600
workers, about 10 percent of its total workforce. The Force
Majeur declaration prompted a swift negative reaction from
many of the airline's unions, which had already agreed to
work with the company to save C$650 million annually in
labor costs.

3. During 2002 Air Canada lost C$428 million, most of that
amount in the final quarter. Since 1999, Air Canada has
lost C$1.7 billion and is currently losing about C$3 million
per day. It has over C$13 billion of accumulated debt,
approximately C$8 billion of which resulted from the 1999
acquisition of Canadian Airlines (then its main rival),
which was purchased primarily for its profitable Asian
routes. Air Canada's pension liability is also C$1.3
billion. It is the third major North American airline to
seek protection from its creditors in the past 18 months,
after United Airlines and USAIR.

4. As recently as 2000, Air Canada carried about 80 percent
of Canada's domestic passenger traffic. The company's
overwhelmingly dominant market share has led rivals to
accuse it of predatory pricing. Predatory or not, the
airline's strategies have evidently not been successful: in
the last 12 months, Air Canada has lost 12 percent of its
domestic market share to its low-cost competitors,
principally Calgary-based WestJet. Cameron Doerksen,
aerospace analyst for Dlouhy Merchant Group, a Montreal-
based investment bank, told post "they [Air Canada] simply
cannot compete in the low-cost carrier market with a big
airline budget," a view echoed by Michel LeBlanc, CEO of
Montreal-based low-cost carrier Jetsgo.

5. Over the past two years, Air Canada has tried to compete
with its low-cost rivals by dividing its business into the
main Air Canada brand and four new subsidiaries and brand
names: Zip, Tango, Jazz and Jetz (REFTEL D). Most operate
on a lower wage/cost structure, but growth potential is
limited by union contracts to a relatively small scale of
operation, lest they cannibalize the main Air Canada
operations and their higher-wage jobs. Doerksen asserts
that despite these efforts to compete in the low-cost
market, where it might be difficult for a traditionally high-
cost carrier ever to compete effectively, Air Canada will
need to focus on its primary strength: long-haul
international business travel.

6. While Air Canada prepares a restructuring plan, expected
in the middle of May, financial services company GE Capital
has extended a C$1 billion line of credit to the airline.
Air Canada CEO Robert Milton has also called on the Canadian
government to provide loan guarantees during the
restructuring, claiming it is impossible for Air Canada to
compete with U.S.-based carriers that received a large
financial package from the U.S. government following the
terrorist attacks of September 11, 2001. Transport Minister
David Collenette has previously indicated a willingness to
consider loan guarantees, but no grants. Meanwhile, the
Parliamentary Committee on Airlines recently called for the
federal government to assist all Canadian airlines by
suspending airport rents and security fee collections for
two years. Both LeBlanc of Jetsgo and Clive Bedoe, CEO of
WestJet, agree that all domestic airlines are vulnerable to
current market conditions and believe that a national
bailout should apply to all airlines, not just Air Canada.

7. Air Canada returned to Ontario Superior court on April
22. In a hearing attended by attorneys from its labor
unions and over 100 creditors seeking payment, Air Canada
requested an extension of its restructuring window to June
30, permission to delay its annual meeting until a
restructuring plan is complete, and approval to renegotiate
some of its labor agreements. Air Canada had tentatively
been permitted to suspend some of its contractual
obligations when it made its CCAA filing on April 1. Unlike
U.S. Chapter 11, the CCAA has not historically permitted
companies to void collective bargaining agreements. On
April 22, Ontario Justice James Farley rescinded some of the
protections given Air Canada on April 1, but encouraged the
airline and its unions to continue negotiations that would
allow Air Canada to produce a viable restructuring plan.
Both sides tried to interpret this outcome as a victory; the
unions because Justice Farley denied Air Canada's request to
bypass its agreements, and Air Canada because it may have
obtained more flexibility in dealing with its unions than
many companies have in the past. Air Canada's decision to
make its CCAA filing in Ontario is believed by some analysts
to have been influenced by a recent Quebec court ruling in
the case of Quebec mining company Jeffrey Mine, Inc., that
collective agreements are protected during a restructuring
period.

8. In order to raise cash, Air Canada has in recent months
attempted to sell some of its key holdings. In February
2003, it sold a 35 percent stake in Aeroplan, the airline's
frequent flyer program, for C$245 million, and recently
renegotiated an agreement with the Canadian International
Bank of Commerce (CIBC) that will allow it to generate cash
by selling frequent-flyer miles to retailers and insurance
companies. The Jazz subsidiary, a pan-Canadian domestic
carrier, has been put up for sale, as has Air Canada
Technical Services (ACTS). ACTS may have a potential buyer
in La Federation des travailleurs du Quebec (FTQ), which has
2,500 members working at ACTS in Quebec. Andre Viau,
portfolio manager for aerospace with the FTQ pension fund
management group, told post "the deal is not yet clear.
While we have a double interest in saving jobs and making
some money, we might be looking to take on a small stake."
Selling Jazz may prove more difficult; unlike some of the
new subsidiaries, Jazz is burdened with older equipment and
high labor costs, making it a relatively unattractive
property in a slow airline market. In addition, federal law
restricting foreign ownership of Canadian airlines to 25
percent limits the pool of potential buyers. CEO Milton and
other industry insiders have called on Transport Minister
Collenette to amend this law, but he has stated that it
would remain in place until the U.S. makes the same change.

9. Air Canada's bankruptcy filing has caused short-term
problems for others in the Canadian aviation system.
NavCanada, the Crown Corporation that operates the country's
air-traffic control system, is in financial jeopardy because
Air Canada - its best customer - has failed to make its C$4
million weekly payment since the CCAA filing. Air Canada
owes Aroports de Montreal C$11.5 million for unpaid rents
and services rendered, and the Greater Toronto Airport
Authority has seen its bond ratings lowered by Standard and
Poor's in the wake of the Air Canada bankruptcy filing.
Justice Farley has denied creditors' statutory right to
seize Air Canada's assets until after a restructuring plan
is submitted.

10. Air Canada is continuing regular operations during its
restructuring, and the impact on travelers should be
minimal. However, in addition to lingering effects of the
September 11 attacks and the war in Iraq, the recent
outbreak of SARS is affecting Air Canada especially hard;
their most profitable international routes are to Asia,
while Toronto serves as its primary Canadian hub. Even
before the CDC and the World Health Organization issued
travel advisories for Toronto, many people had been avoiding
Toronto's Pearson Airport. Taken together, Air Canada is
experiencing a drop in passenger traffic at a time it can
little afford it. Air Canada several days ago mentioned
that it might look to route some of its international
flights to other airports - in particular Halifax and
Montreal - but no such plan is yet in place.

11. In the longer run, prospects may be more encouraging for
both Air Canada and others. Typically, an airline of Air
Canada's size will emerge from bankruptcy protection between
20-30 percent smaller, according to Doerkson. Viau believes
the new Air Canada will be smaller but stronger. "With a
smaller airline, they [Air Canada] will probably look to
increase their outsourcing contracts, which will be good for
the aerospace sector in Montreal," he told post. Milton
recently announced that a restructured Air Canada will have
to shape itself along the lines of the new North American
airline business model, with smaller planes and lower
operating costs. Air Canada has recently joined a
consortium to purchase regional jets from Bombardier; Air
Canada would initially acquire 25 of these jets to serve
short-haul, moneymaking routes. Air Canada recently named
former Bombardier CEO Robert Brown to its board, which
suggests that Bombardier is likely to remain Air Canada's
principal aircraft supplier in this market, as opposed to
its primary competitor, Brazil's Embraer.

12. Comment: Air Canada's current predicament appears to be
the result of both its own decisions in recent years and a
number of unfortunate circumstances beyond the company's
control. Like many airlines, Air Canada has sought to lower
its costs, either through changing union contracts or
establishing new business models. These measures have and
will likely continue to generate resistance but are probably
essential to Air Canada's long-term viability. End Comment.
KANTER

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