Why Airlines Are Flying High

This piece was originally published in the Wall Street Journal on February 4, 2015.

By Rick Schifter

Over the past two weeks, one U.S. airline after another has reported record earnings for 2014. This was the fifth consecutive year of industry profitability, during which time aggregate net income exceeded $30 billion. That’s not bad for an industry that lost $29 billion from 1990 through 2009—and whose performance once inspired Warren Buffett to suggest that investors would have been better off had a capitalist shot down Orville Wright at Kitty Hawk.

Many factors have contributed to the industry’s change in fortune including restructurings through bankruptcies that led to significant cost reductions; new revenue streams such as luggage fees; the consolidation or liquidation of some airlines; an improving domestic economy; and, most recently, a decline in oil prices.

But one significant contributor hasn’t gotten the attention it deserves: private equity. These firms have driven fundamental change for decades throughout the airline industry—and much of that change resulted from three specific investments.

Private equity’s first meaningful airline foray was the leveraged buyout of Northwest Airlines in 1989 by Wings Holdings, an investment group organized by Al Checchi and Gary Wilson. Northwest Airlines thereafter focused on controlling costs and improving customer service—steps which led to record profits in the late 1990s. Still, 9/11 had a devastating impact on the industry. The terrorist attacks, and the subsequent growth of low-cost carriers, forced Northwest into Chapter 11 in 2005. It emerged as an independent company and subsequently merged with Delta in 2008. The CEO of Delta at the time was Richard Anderson —a former CEO of Northwest in the Wings Holdings years.

The second major private-equity investment in the airline industry was by Air Partners. This group, formed by David Bonderman, Jim Coulter and Bill Price, took a controlling stake in Continental Airlines in April 1993. Eighteen months after that transaction closed, the airline was teetering on the edge of a third Chapter 11 filing.

This compelled private-equity-backed Continental to make dramatic changes, including shrinking the size of its fleet by 20% and putting in Gordon Bethune as CEO and Greg Brenneman as COO. The turnaround in the next five years vastly improved employee morale—starting in 1999, Continental appeared on Fortune’s “Best Companies to Work For” list for six consecutive years—while maintaining control over costs.

Continental merged with United Airlines in 2010 and, although Continental was the smaller company, its CEO, Jeff Smisek , headed the merged company. Mr. Smisek had been recruited to Continental—and the airline industry—by Air Partners.

Messrs. Bonderman, Coulter and Price went on to establish the private-equity firm Texas Pacific Group, now TPG (where I was a partner and which I now advise). TPG acquired a controlling stake in America West Airlines in 1994. One year later America West’s Bill Franke, then CEO and the subsequent founder of the private-equity firm Indigo Partners, hired Doug Parker as CFO and ultimately chose him as his successor CEO.

Mr. Parker went on to become the industry’s consolidation champion, leading the merger of America West into US Airways, and more recently, the merger of US Airways into American Airlines . Six of the nine most senior executives currently running American, the world’s largest airline, were recruited to America West when TPG controlled it.

It is no coincidence that the CEOs of the three largest airlines today rose to prominence while their companies were controlled by private-equity firms. Following airline deregulation in 1978, many airline executives were motivated by growth over profits—and were reluctant to shed the inefficiencies which were vestiges of a regulated industry. Only after this mind-set changed, when success was measured by net income and not the number of planes, did the industry bring supply into balance with demand.

Private equity is often accused of being reckless with leverage. Yet the only full-service legacy carriers that did not file under Chapter 11 after 9/11 were Continental, America West, both controlled by private equity, and Alaska Airlines.

Moreover, private equity has provided capital to the industry when the public markets were not prepared to do so, whether to help carriers emerge from Chapter 11 (Continental and America West), to start up a new business ( JetBlue in 1999), to strengthen the regional jet model (Republic Airways in 1998), or to transform a business model ( Spirit Airlines in 2006).

The airline industry has high fixed costs, jet fuel prices subject to wide swings, and outside shocks including terrorism and volcanoes. Earnings will be highly volatile, but managements’ focus on profitability, not growth for the sake of growth, has enhanced the industry’s ability to manage through the inevitable downturns.

Over the past three years, the top 10 stock-price performers among the Fortune 500 have included American, Delta and Southwest. The market cap for the airline industry today is $140 billion, up from $35 billion at the end of 2012. Employment is up 30,000 in the past five years. The airline industry’s newfound success has many fathers—and one of them is private equity.

Mr. Schifter is a senior adviser to TPG and serves on the board of directors of American Airlines Group Inc.