Expert answer:AD666 University of Nairobi Trans World Airline Ca

  

Solved by verified expert:For a successful case write up, you will need the following:Case papers should address the key issues that pertain to the financial strategy and then make clear recommendations with as much support as possible.Papers should be no more than three double-spaced pages (not including exhibits) and include a cover page with your name, the date, the course number, and the title of the assignment (case name).Papers should be organized into specific sections. For example, Background, Key Issues, Recommendations with support. Keep the Introduction short and don’t be so quick to jump to the recommendation. If the issues are wrong, the recommendation can’t be correct.Late Papers will not be accepted.Your grade will depend on how well you identify the issues and argue your recommendation.All Footnotes and References Must use the APA Format.The answer is not on the internet. You may use the internet for additional background and information, but I don’t care what the company actually did. All that really matters is in the case.Remember that you only have three double-spaced pages for text. If you wish to use charts or financial analysis to support your recommendation, use an exhibit. Don’t waste space and put it in the text.This course is about Mergers and Acquisitions you should talk about that
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Case study
Reference no 201-037-1
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This case was written by John D Sullivan,Boston University.It is intended to be
used as the basis for class discussion rather than to illustrate either effective or
ineffective handling of a management situation.The case was compiled from
published sources and generalised experience.
© 2001,JDSullivan,Boston University.Revised 2004.
No part of this publication may be copied,stored,transmitted,reproduced
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Trans World Airlines
201-037-1
Trans World Airlines
In 1995, Trans World Airlines, buckling under the capital demands of the airline
industry and competition, had filed for Chapter 11 Bankruptcy protection. During this
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time, the company had taken significant steps to correct its financial problems and
improve its operating efficiencies with limited success. By February 2001, two groups
had announced their intention to purchase the struggling airline. The first group, under
the name Jet Acquisitions Group of Scottsdale, Arizona, comprised of airline industry
experts and investors, had offered $889 million for TWA without any further details, but
had stated that they wanted the company to remain an independent airline. The second
bidder, American Airlines, had offered $500 million in cash for substantially all of the
assets of TWA including their hub operations in St. Louis and most of the company’s
real estate leases and maintenance bases at more than 60 airports. Under this offer to the
bankruptcy court, American would further assume Trans World Airline’s liabilities
including worker’s compensation, employee post retirement benefits, most of TWA’s
aircraft leases which represented approximately $3.5 billion in commitments, and to
allow the company’s frequent flyer program to convert to American’s “AA Advantage
Copyright 2001 – John D. Sullivan
This case was written to stimulate class discussion and analysis and is not a critique of an effective or
ineffective management situation.
2
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Background
201-037-1
Program” mile for mile. Ultimately, under this scenario, either bid would need the initial
approval of the bankruptcy court Judge before moving forward for regulatory approval.
The Company
Trans World Airlines, a Delaware Corporation formed in 1978 with headquarters
Serving 23.9 million passengers in 1998, TWA is the eighth largest United States airline
and regularly flies to 93 cities throughout the US, Mexico, Europe, the Middle East,
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Canada, and the Caribbean using 185 aircraft.1
The company’s route structure is principally organized into two distinct sections:
North America and International. The North American route system flies passengers and
cargo to 36 states, Puerto Rico, Mexico, Canada, and the Caribbean. As of December
1998, the North American passenger revenue accounted for 88.5% of total revenue
compared to 85.9% during 1997.2
In North America, TWA operates a hub and spoke structure using Lambert
International Airport in St. Louis as its major domestic hub. In St. Louis, TWA held
approximately 76% market share (not including commuter flights) with 357 scheduled
daily flights serving 78 cities, with the next closest competitor holding only 13%.3
Trans World Airline’s second major hub, New York’s JFK, provides service to 27
domestic and international cities with approximately 40 daily departures. JFK is the
largest international gateway from North America. The use of both Lambert and JFK is
1
Trans World Airlines. Securities and Exchange Form 10K. 1998.
Trans World Airlines. Securities and Exchange Form 10K. 1998.
3
Trans World Airlines. Securities and Exchange Form 10K. 1998.
2
3
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in St. Louis, Missouri, was originally created in 1934 as Transcontinental & Western Air.
201-037-1
structured so the airline can easily support both its North American and International
connecting flights.
The company’s international routes provide passengers with both nonstop and
connecting flights from both New York and St. Louis with the majority of TWA’s
transatlantic flights being scheduled out of JFK. The present system is designed to feed
domestic service to international cities. As of 1998, TWA carried passengers through
flights from St. Louis were limited to London’s Gatwick Airport. In 1997, the company
dropped several international routes that financially under performed including New
York to Frankfurt, New York to Athens, Boston to Paris, and non-stop service from JFK
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to several domestic cities.
Fleet Modernization
TWA presently operates in a highly competitive and capital-intensive industry
where slight movements in passenger volume or revenue can have a significant impact on
financial results.
One problem experienced by many airlines is the operational
performance of its aircraft. As part of its ongoing corporate strategy, TWA has created a
fleet modernization plan to improve cost savings through less maintenance, aircraft
operating efficiencies, and two pilot aircraft. The plan is also designed to simplify the
company’s fleet structure in order to decrease maintenance costs and crew training.
Despite the initial capital costs of acquiring or leasing new aircraft, TWA believes the
benefit through cost savings, economies of scale, and crew training will offset the shortterm capital outlays in the long run. In addition, to comply with the Airport Noise and
Capacity act of 1990, the company will need to filter out its aircraft to comply with the
new regulations.
4
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JFK to Barcelona, Cairo, Lisbon, Madrid, Riyadh, Rome, and Tel Aviv. International
201-037-1
Since 1996, the company had achieved several goals. The first goal was to
reduce the average age of its fleet from 19.0 years at the end of 1996 to 16.2 years by the
end of 1998. During this time, the company also improved its reliability through on time
performance.4
By the end of 1996, the company had retired 14 B-747s and 11 L 1011s heavy
aircraft. Within fourteen months of this move, all the remaining B-747 and L 1011
To fill the gaps left by the retiring aircraft, the company had entered into several
contracts to purchase new aircraft. Since 1996, TWA has ordered a total of 27 B-757
aircraft and as of 1998, taken delivery of 16. The remaining B-757 aircraft are scheduled
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for delivery in 1999 and 2000. In 1998, the company also took delivery of two B-767300ER aircraft with an additional plane due in 1999.
The company has also ordered 39 new MD-83 aircraft and as of 1998, taken
delivery of 13. The remaining aircraft will be delivered in 1999.
In 1998, TWA had announced that it had planned to acquire an additional 125
new aircraft including 50 Boeing 717-200 for delivery in 2000, 50 Airbus A318 for
delivery in 2003, and 25 Airbus A320 for 2008.
By restructuring its fleet, TWA has significantly shifted the type of aircraft
operated to narrow-body aircraft from wide-body aircraft. In 1996, the ratio of narrow to
wide body was 80%/20% with an average seat per plane of 161. By 1998, the ration of
narrow to wide body was 91%/9% with an average seat per plane of 137. Given the
upcoming deliveries in 1999, the company expects the ratio to slightly shift to 92%/8%
and increase the average seat per plane to 145 and ultimately decrease the age of the fleet
to approximately 11.3 years.
4
Trans World Airlines. Securities and Exchange Form 10K. 1998.
5
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aircraft had been phased out of service.
201-037-1
Employee Base
At the end of 1998, Trans World Airlines employed 21,261 full time equivalent
employees. A large number of these employees were union belonging to either the
International Association of Machinists and Aerospace Workers (IAM), the Airline Pilots
Association (ALPA), and the Independent Federation of Flight Attendants (IFFA).
In 1994, the company renegotiated its contracts with each of the unions and
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beginning in 1995. Non-union and management had made similar concessions.
Cost Containment
In addition to the large capital costs associated with aircraft, each airline is also
subjected to the possibility of large swings in fuel prices. TWA utilizes more than 20
separate suppliers for jet fuel and has contracts with several of these suppliers. The terms
of these contracts vary depending on each supplier and generally include agreements in
price, payment terms, and quantities for a specified period of time. The
company
will
also purchase additional fuel if the price and availability are in the best interests of TWA.
From time to time, the company will also trade fuel and store jet fuel in facilities in key
locations. In 1998, the company began entering into future jet fuel price swaps for a
small percent of its 1999 projected fuel requirements.
But despite TWA’s hedging strategies and fuel storage capabilities, the cost of
fuel is still driven by crude oil prices. Production and refinement, as well as choices in
the types of fuel produced may have a significant impact on the availability of fuel for air
travel. As a result, regardless of hedging techniques, fuel costs could materially impact
6
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eliminated certain raises for 1994 and 1995 with the exception of a 1% semi-annual raise
201-037-1
the financial performance of the airline.
In 1996, aircraft fuel prices increased
significantly with only a moderate decline in 1997. While fuel costs declined again in
1998, 1999 reflected higher fuel prices and depending on the company’s fuel
consumption, may further negatively impact the financial results of the company. Fuel
Competition
When the United States federal government passed the Airline Deregulation Act
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of 1978, the airline industry instantly engaged in fierce competition. Low-cost low fare
rates were the marketing strategies of several “no frills” new airlines entering the
industry straining older mature airlines with higher operating costs.
To remain
financially competitive, several airlines merged and also formed alliances with
international carriers to increase service across the globe.
Frequent flier mileage plans, ground service, and other in-flight services emerged
to attract customers and maintain or grow market share. But despite several attempts by
airline management to increase revenues and cut operating expenses, intense price
competition had forced several airline companies into Chapter 11 bankruptcy protection
with no hope of re-emerging.
Trans World Airlines competes in both the domestic and international markets.
In the domestic United States market, entrance into the airline industry, from a regulatory
standpoint, is fairly easy and existing carriers may enter or exit a particular route without
regulatory approval. As a result, many of TWA’s routes may quickly shift from high to
low competition in a relatively short period of time and vice versa.
7
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usage and cost is summarized in Exhibit 1.
201-037-1
The level of competition in the international market generally depends on the
individual country of destination and any agreements the United States may gave with a
specific foreign government. Unlike domestic fares, international fares ultimately fall
under the Department of Trade, but most airlines do retain some discretion in
determining appropriate ticket prices.
Slot Restrictions
Airports such as JFK, LaGuardia, Chicago O’Hare, and Ronald Reagan
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Washington, have been deemed as high traffic and as a result, have limited slots available
for takeoff and landing during peek hours.
Noise Abatements
The Noise Act required airlines to reduce noise levels in commercial aircraft with
specific compliance deadlines. Companies such as TWA had two basic options under
this Act. The first was to retrofit older aircraft, categorized as Stage 2 aircraft, with new
quieter equipment. The second option would be to replace older Stage 2 aircraft with
modern Stage 3 aircraft. By 1994, each airline was to phase out or retrofit 25% of their
Stage 2 aircraft and by 1996, 50% of their Stage 2 aircraft. By 1999, 100% of the fleet
must meet Stage 3 requirements. To comply with the 1996 requirement, TWA retrofitted
DC-9 aircraft with engine hushkits at a cost of approximately $55.5 million.
Labor
Under the Railway Labor Act, the right of airline employees was established to
organize and bargain collectively. The Railway Labor Act provides detailed procedures
8
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Regulatory Issues
201-037-1
to be followed before a lawful work stoppage can occur. TWA has collective bargaining
agreements with four domestic unions that represent 85% of the company’s workforce.
Aging Aircraft
In 1990, the FAA initiated several directives mandating changes to maintenance
programs for older aircraft. Each plane must undergo extensive structural modifications
currently falls under these directives.
Safety
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All airlines fall under the safety regulations set forth by the Federal Aviation
Administration.
The FAA monitors aircraft maintenance and operations including
equipment, training, communications, and anything else the FAA deems a safety issue.
For the administration to ensure the company’s compliance with safety regulations, TWA
is required to obtain operating, airworthiness and other certificates before operations can
begin.
In addition, the company must comply with safety regulations in the
transportation of cargo and any public health policies initiated at both the federal and
state levels.
Foreign Ownership of Shares
Under the Federal Aviation Act of 1958, non-U.S. citizens may not own more
than a 25% voting stake in a United States airline.
9
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before a designated number of flights or deadlines set in 1994. Most of TWA’s fleet
201-037-1
Environmental
Each airline operating in the United States must comply with several
environmental regulations including The Clean Air Act, the Clean Water Act, the
Comprehensive Environmental Response Compensation and Liability Act of 1980 and
the Resource Conservation Recovery Act.
At the state level, other environmental
regulations, depending on the state and location in the state, may also include other
are currently operating in compliance with all environmental regulations.
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Legal Proceedings
On July 17, 1996, TWA Flight 800 crashed shortly after takeoff from New York
in route to Paris, France. Of the 230 passengers and flight crew, there were no survivors
aboard the Boeing 747 aircraft. Currently, the airline is a defendant in several lawsuits
relating to the crash. The company believes its current insurance coverage is sufficient to
cover the liability from the suits. However, it is difficult to ascertain the damage the
crash has caused in so far as a decrease in revenues caused by public perception of the
incident.
Conclusion
Under TWA’s present operating structure, it seemed like a difficult task for the
airline to re-emerge from bankruptcy protection with a healthy financial condition. The
options, given the required enormous future capital investment, were fairly limited.
Either TWA could find a suitor acceptable to the Bankruptcy Court or face the growing
possibility of a complete liquidation.
10
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agencies such as sewer disposal that would regulate TWA. The company believes they
1998
Gallons Consumed (in millions)
11
Year End
1997
675.8
730.3
838.9
Total Cost (in millions)
$344.6
$480.9
$585.2
Average Cost per Gallon
Percent of Operating Expenses
$0.51
10.4%
$0.66
14.3%
$0.70
15.6%
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201-037-1
Exhibit 1
Trans World Airlines
Fuel Consumption and Cost
1996
201-037-1
Exhibit 2
2000
1999
Operating Revenue
Passenger
Freight and mail
All other
$881,918
$24,399
$66,386
792,166
$23 …
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