Airline Deals Land In Bankruptcy Court

In barely more than a month, three LBO firms watched their airline investments go down in flames. ATA Holdings, Aloha Airlines and Eos Airlines Inc. each shuttered its passenger operations, and they’re unlikely to emerge from Chapter 11 as going concerns (see chart).

The failures highlight the potential pitfalls of investing in a competitive, fixed-cost, low-margin industry, sources told Buyouts. Highly leveraged companies typically have little financial flexibility, and the limited ability to maneuver becomes even more crucial when the cost of doing business increases dramatically or a company loses an important contract. Both played big roles in these companies’ demises.

The bruised LBO shops behind the wave of bankruptcies are MatlinPatterson Global Advisers LLC, backer of ATA Holdings, Yucaipa Cos., backer of Aloha Airlines, and Golden Gate Capital, the firm behind Eos Airline Inc. Although it’s true that the acquisitions of ATA Holdings and Aloha Airlines were both rescue deals, and therefore inexpensive, the buyouts shops behind all three companies can bid their equity investments farewell.

To be sure, the entire airline industry has entered turbulent skies. The buyout-backed bankruptcies represent only half of the industry’s recent stumbles; Frontier Airlines Holdings, Skybus Airlines Inc., and MAXjet Airways also filed for Chapter 11 in the past six months. And airline bankruptcies aren’t uncommon, regardless of a company’s size and relative market strength. Even major carriers like Northwest Airlines, Delta Air Lines, United Airlines, American Airlines and US Airways emerged from bankruptcy in the past five years, the latter with the help of TPG. That firm scored one of its earliest successes by overseeing the turnaround of Continental Airlines, and last year TPG Capital delisted regional carrier Midwest Airlines.

These airlines were buffeted by quickly escalating and long-lasting hikes in fuel prices, coupled with increased maintenance inspections leading to costly repairs, said Stefano Aversa, co-president of AlixPartners, a New York-based restructuring consultant. In the United States, ticket prices are too low to absorb recent cost increases, and until prices go up, “the industry will keep killing itself,” Aversa said. Ticket prices need to increase by around 60 percent to keep U.S. airline businesses solvent, an industry source told Buyouts.

With around 10 major passenger airlines in business, there’s no room for small airlines offering a nonspecialized service, Aversa said. A more rational market would see three or four major operators with the smaller players serving market niches, and he predicted three more weak links would be weeded out or sold to competitors.

In the cases of ATA Holdings and Aloha Airlines, bankruptcy court is all too familiar. The companies were each purchased in 363 sales within the past three years, and both struggled to achieve profitability after emerging from Chapter 11. “There wasn’t much [the firms] could do to cut costs,” an analyst following the businesses said.

MatlinPatterson, the New York-based turnaround firm, bought Indiana-based ATA Holdings out of bankruptcy in 2006 for $52 million. The firm shrunk the business significantly, aiming to carve out a niche in vacation-oriented routes to Mexico, Hawaii and the Caribbean. MatlinPatterson also bolted on World Air Holdings, a charter and cargo carrier, in 2007 for $315 million. ATA Holdings ultimately collapsed when its lifeline, a military transport business secured through a sub-contract with FedEx Corp., was abruptly cut off. On April 3, ATA Holdings filed for Chapter 11 in the U.S. Bankruptcy Court in Indianapolis.

Despite the failure, the firm won’t shy away from doing more airline deals, a source close to the firm told Buyouts. The investment in ATA Holdings came from MatlinPatterson’s second, $1.67 billion fund, closed in 2006. The firm is investing from its $5 billion third fund, closed in 2007. MatlinPatterson declined to comment.

Aloha Airlines is another so-called Chapter 22 case; it earlier emerged from bankruptcy protection in 2006. Yucaipa Cos., led by Ron Burkle, bought the business in a fire sale in 2006 for $43 million, with the firm investing an additional $106 million in the airline’s secured debt. The company blamed its demise on alleged unfair business practices by its competitor, claiming that Mesa Air Group Inc. used information illegally obtained in Aloha Airlines’s first bankruptcy to compete aggressively on pricing. Aloha Airlines is pursuing litigation against Mesa Air Group, set to be heard in the fall. Mesa Air has denied the allegations.

After sitting on the block for a year, Aloha Airlines filed for Chapter 11 on March 20 in the U.S. Bankruptcy Court for the district of Honolulu in Hawaii. A round of inadequate bids for its air cargo unit led Aloha Airlines’s debtor-in-possession financier, GMAC Commercial Finance, to cut off the company’s access to cash. That fatal blow forced Aloha Airlines to covert its filing into a Chapter 7 liquidation.

The Aloha Airlines purchase came from Yucaipa Cos.’s $572 million Yucaipa American Alliance Fund I, closed in 2005. That fund had earned a 48.7 percent gross IRR as of mid-year 2007, according to an industry report. The California-based firm is about halfway through fundraising for its second, $2 billion fund, the report stated. The firm did not return calls for the story.

The most recent LBO-backed airline bankruptcy is a first-time filer that’s unlikely to get a second chance. Eos Airlines, a New York-based luxury carrier, sold a 47 percent stake to California-based LBO shop Golden Gate Capital in 2005. The firm invested alongside venture capital firms Sutter Hill Ventures and Maveron LLC for a total infusion of $87 million. But Eos Airlines’s model—focused on small and intercontinental flights—made it difficult to absorb increases in fuel prices, an industry source said. Likewise, fewer passengers on its spacious luxury flights kept the company from passing on steep price hikes to its tiny pool of customers. Eos Airlines filed for Chapter 11 protection with the U.S. Bankruptcy Court for the Southern District of New York on April 26.

Eos Airlines is Golden Gate Capital’s second portfolio company to enter bankruptcy in two months; in March the firm lost its $132.5 million investment in vitamin and supplement maker Leiner Health Products. Golden Gate declined to comment.—E.G.