Bankruptcy for Japan Airlines; hope at last Jan/Feb 2010

The long–awaited radical restructuring of Japan Airlines finally got under way on January 19th, when JAL and two core units filed for bankruptcy protection under the Japanese Corporate Reconstruction Act. The chances are that the restructuring will be a success, enabling JAL to re–emerge as a lean and strong competitor with a healthy balance sheet.

It looks similar to a pre–packaged airline Chapter 11 case in the US, except for the government involvement. JAL’s reorganisation is overseen by the state–backed ETIC (Enterprise Turnaround Initiative Corporation of Japan) in co–operation with the state–owned Development Bank of Japan (DBJ) and other major creditor banks. The court named ETIC as the trustee, in full control of the JAL companies during the reorganisation.

The funding plan had been worked out in the weeks leading up to the bankruptcy filing. JAL immediately received ¥300bn ($3.3bn) from ETIC and a ¥160bn loan from the DBJ. DIP financing is through a ¥600bn ($6.6bn) line of credit provided by ETIC and the banks.

ETIC and the government are determined to avoid any loss of confidence among JAL’s passengers or suppliers. It is business as usual, with the airline continuing to meet all its day–to–day obligations, including lease payments.

ETIC indicated that the JAL companies could expect to see ¥730bn of their total ¥1,158bn debt forgiven, of which the banks’ share was about ¥350bn. This is substantial, raising hopes that JAL could end up with a pretty decent balance sheet.

JAL’s total liabilities were estimated at ¥2,300bn, making it one of Japan’s largest–ever bankruptcies. ETIC indicated that there would be additional refinancings, the proceeds of which would help meet the benefit claims.

Of course, as is typical in bankruptcies, all of JAL’s shares will be cancelled. However, ETIC said that shareholder treatment would be addressed as the case proceeds, raising modest hope that there could be something for shareholders. The Tokyo Stock Exchange will de–list JAL’s shares on February 20th.

Some experts have predicted a lengthy bankruptcy of at least three years, in part because the rehabilitation process in Japan tends to be much slower than Chapter 11 in the US. However, a swift restructuring was on the government’s wish list, and ETIC said that its aim is to achieve a “quick and fundamental reform of the JAL companies in a short period of time”.

A “maverick” CEO?

Furthermore, the initial timetable seems quite promising. All claims are to be filed by March 19th, the court will investigate them by May 24th and the trustees are due to submit their reorganisation plan by June 30th (other parties can submit reorganisation plans through May 31st). One of the most intriguing developments is the choice of Kazuo Inamori as JAL’s new CEO, to replace Haruka Nishimatsu who resigned on January 19th. The Wall Street Journal described the 78–year old honorary chairman of electronics maker Kyocera as “one of the country’s most revered entrepreneurs and management gurus”. He has turnaround experience and a reportedly “maverick style”. Inamori is a complete outsider, with no ties to JAL and no aviation experience, making him potentially perfect for the job. In late January ETIC named veteran JAL executive Masaru Onishi the new president/COO.

JAL ended up in dire financial straits due to a host of factors. The basic problems included high labour costs, a bureaucratic corporate structure, militant unions and poor morale, as well as an obligation to operate many unprofitable domestic routes. A series of restructuring efforts never really went far enough. The government stepped in to help several times, but the aid provided was modest and gave only short–term relief.

In 2007/08 JAL staged a promising recovery, but that was short–lived because of the fuel price hike, economic downturn and the H1N1 scares. JAL has been devastated by the global recession because of its heavy exposure to international routes and business traffic. In last year’s June quarter, it had a negative 26% operating margin and posted its largest–ever quarterly net loss, ¥99bn ($1.1bn).

But, importantly, before the global recession (which brought even the world’s most successful airlines like BA to their knees) JAL’s underlying performance was never that bad by global airline standards. Even with its unfavourable legacy cost structure, its losses were never that deep and its operating results were positive in many years.

So JAL is potentially a viable business. With problems such as a horrendous level of debt, expensive pension plans, high labour costs and eight militant in–house unions, the airline may be the perfect candidate for a bankruptcy restructuring.

When explaining its decision to support JAL, ETIC noted that the JAL companies were carrying “an excessive amount of debt relative to their earnings capacity”. ETIC also noted that JAL had made considerable efforts to break away from its high cost structure, had thoroughly restructured international and domestic operations to improve profitability and had downsized and updated its fleet – and was then devastated by the external economic developments. But ETIC criticised JAL for not taking sufficient action in the current crisis.

So ETIC felt that the debt elimination and reduction moves will “fundamentally improve JAL’s financial position” and that the measures proposed in the preliminary revitalisation plan will lead to a “considerable increase in profitability”.

The preliminary revitalisation plan (which may well be revised in the course of the reorganisation) aims to resolve fully the problems of “excess aircraft and routes compared to demand” and JAL not acting decisively.

The plan calls for JAL to use smaller aircraft to improve efficiency; specifically, it would retire its 37 747–400s and 16 MD–90s and bring in 33 smaller jets and 17 RJs. JAL would axe unprofitable routes (14 international and 17 domestic by March 2012) and maintain network coverage through alliances. The cost cuts include eliminating 15,700 jobs or 30% of the workforce over three years and “fundamentally revising” flight crew pay, benefits and work rules.

2013 target

ETIC had some harsh words about JAL’s rigid organisational structure, delays in decision- making and outdated IT systems. Among other things, it wants to establish an organisational structure that facilitates “swift on–site decision–making”. If these measures are implemented, the plan projects that in the FY ending March 2013 JAL could earn a ¥115.7bn ($1.3bn) operating profit on revenues of ¥1,359bn – a respectable 8.5% operating margin.

Efforts are also under way to revise JAL’s pension obligations. The company is believed to have persuaded the necessary two–thirds of its retirees to accept a 30% reduction in benefits, but government approvals are still needed.

It may be possible to raise funds through asset sales. JAL still has a staggering 203 subsidiaries and 83 affiliates. Some press reports have suggested that ETIC may be looking to shed a quarter of JAL’s subsidiaries.

One important decision that ETIC and the courts will leave to JAL’s new management is the choice of the US airline partner and hence the global alliance. The decision is likely to be excruciatingly difficult. Should JAL avoid a messy divorce and stay with oneworld and American, its original oneworld sponsor and trusted partner which is now promising it exclusivity as its sole partner in northeast Asia? Or should JAL defect to SkyTeam and Delta, which is offering it more in potential financial benefits and a ready–made network of Asian partners?

No–one can answer that except JAL. But thankfully JAL and its minders have put a stop to the bidding frenzy. Both Delta and American indicated in their recent earnings calls that they had been informed that an up–front financial investment in JAL was no longer desired.