Airline pushed into bankruptcy by credit-card processor's change
Saturday, April 12, 2008
NEW YORK -- Frontier Airlines, the latest airline to file for bankruptcy, was pushed over the brink by a problem that could spread to other carriers: credit-card troubles.
The carrier on Friday blamed its Chapter 11 bankruptcy protection on a cash squeeze caused by its credit-card processing company, which has decided to keep a larger chunk of the Denver airline's ticket revenue.
The move ends a policy under which the processor, First Data Corp, passed on most money from ticket sales to Frontier. The change is intended to protect First Data, which would be on the hook for ticket refunds if Frontier stops flying. Frontier plans to continue operating while in bankruptcy.
First Data's decision represents a new threat to an industry facing jet fuel prices that have soared 74 percent in one year, a new government focus on safety that has grounded thousands of flights in recent days and tight competition and falling demand that, combined, have limited carriers' ability to raise prices.
"It's just a god-awful time for this industry," said Bob Mann, an independent airline consultant based in Port Washington, N.Y. "This illustrates the uncertainty of capital markets to a T."
ATA Airlines, Skybus Airlines and Aloha Airlines all have filed for bankruptcy in recent weeks. Champion Air plans to shut down and MAXjet Airways went bankrupt in December. All cited some combination of high fuel prices and falling demand, among other factors.
While it's not uncommon that banks processing airline credit-card transactions hold a certain amount of a carrier's proceeds in their own accounts until a passenger completes his or her travel, it is unusual for a processor to suddenly change its cash withholding policy, analysts say.
In the case of Frontier, the new requirement -- known in industry speak as a holdback -- was the proverbial straw that broke the camel's back.
"We believe that we currently have adequate cash on hand to meet our operating needs," Frontier chief executive Sean Menke said in a statement. "Unfortunately, our principal credit-card processor very recently and unexpectedly informed us that, beginning on April 11, it intended to start withholding significant proceeds received from the sale of Frontier tickets."
Such a "change in established practices" would throw a serious wrench into Frontier's cash forecasts and business plan, Menke said. The bankruptcy filing prevents First Data from imposing the new cash withholding requirement, he said. The airline also threatened to sue First Data.
"The terms of our agreement with Frontier Airlines are not unique; they are considered standard industry practice and terms originally agreed upon by Frontier," First Data, of Greenwood Village, Colo., said in a statement.
"They do this because ... they're concerned that a carrier will use the proceeds in advance of travel occurring and then not have the funds to actually perform the travel," Mann said.
Companies such as First Data usually base cash withholding decisions on their own analysis of an airline's finances -- most airlines are contractually required to provide their processors with monthly cash flow reports and forecasts.
"They're doing the same thing that I'm doing," said Ray Neidl, an analyst at Calyon Securities who late last month expressed concern about Frontier's projected cash position. Earlier this week, the carrier said it had no concerns about bankruptcy. Credit-card processors constantly review the credit profiles of the companies they serve, Neidl said.
But negative news reports and analyst research notes can also undermine a credit-card company's confidence in an airline by contributing to fears that an airline's failure is imminent, said Mike Boyd, president of the Boyd Group consultancy in Evergreen, Colo.
"It could happen to any airline," Boyd said.
Shares of another discount carrier, AirTran Holdings Inc., tumbled more than 30 percent Friday as nervous investors wondered whether it too could face trouble.
After the market closed, AirTran issued a statement saying it is "in full compliance" with the terms of its credit card agreements, and has no holdbacks with any of its major credit card processors. The Orlando, Fla.-based company said its balance of cash and investments has grown to $358 million through the end of March, from $326 million at the end of last year.
President and chief executive Bob Fornaro called his company "one of the strongest low-cost carriers operating today" and said it has "ample balance sheet strength to support our operation."
Meanwhile, Neidl raised his rating on AirTran to "Add" from "Neutral" and said he does not believe the company is in any immediate danger of defaulting.
"We would use this opportunity to buy the stock since we believe AirTran has sufficient liquidity to survive through next year under the most likely scenario," Neidl wrote in a note to clients issued late Friday. The carrier's shares jumped 15 percent in after-hours trading.
Frontier's situation is not the first time credit card companies have imposed cash withholding requirements on airlines. Many did so in the months after the Sept. 11 terrorist attacks because of worries about the industry. Several airlines, in fact, declared bankruptcy in the years after the attacks, due to the downturn in business and by the recession earlier this decade. Strict cash withholding requirements were a factor in Delta Air Lines Inc.'s 2005 bankruptcy.
Now analysts believe most larger airlines have sufficient cash to weather the current economic downturn and spike in fuel prices. The six largest airlines -- AMR Corp.'s American Airlines, Delta, UAL Corp.'s United Airlines, Northwest Airlines Corp., US Airways Group Inc. and Continental Airlines Inc. -- have a combined $20 billion in cash on their balance sheets, Mann said. Their credit card processors won't likely change withholding requirements unless there is a significant change in operating conditions.
It's the smaller companies with less cash that are more at risk of facing new cash withholding rules, analysts say.
On Friday, Calyon's Neidl dropped coverage of Mesa Air Group Inc., citing its small capitalization. Last week, Mesa said Delta planned to end a major contract-flying agreement and Mesa sued to keep the deal intact. Mesa has declined to comment on whether it faces bankruptcy.
Larger carriers canceled thousands of flights affecting more than a quarter of a million passengers this week to check electrical wiring in MD-80 aircraft. The inspections were required to comply with Federal Aviation Administration safety regulations.
American Airlines was the hardest hit with nearly 3,100 cancellations, including almost 600 on Friday. The airline said it will cancel an undetermined number of flights on Saturday, but expected to resume normal operations by Saturday night. The cancellations will cost American tens of millions of dollars, but chief executive Gerard Arpey said the carrier can withstand the losses.