Strategy

Can Air Canada be saved?

Air Canada is in such bad shape, it may be heading for bankruptcy. The solution? A whole different kind of airline.

(Photo: Christinne Muschi/Reuters)

In November 2010, the president and CEO of Air Canada mounted the stage at the Canadian Club of Toronto and boasted his company was thriving once again. Calin Rovinescu told the business crowd the company had more passengers, more revenue and a rapidly rising stock price, all signs it had successfully weathered the financial crisis of the previous year. He was careful to acknowledge “the strong leadership and responsibility” shown by Air Canada’s five unions, a nod to pension concessions made in 2009 to bolster the airline’s financial stability. “These achievements did not just happen by chance,” he said of the improving results. “They are the direct result of the very hard work of 26,000 people of whom I am very proud.”

Rovinescu was similarly magnanimous about the company’s employee relations in a newspaper interview around the same time. On the cusp of a new round of contract talks, he said his employees needed to be “empowered” and “motivated.” Sixteen months later, however, Air Canada employees seem motivated only to strike. Last June, sales and service agents staged a three-day walkout, signing a deal only under threat of back-to-work legislation. As the airline negotiated with its other unions, government intervention has become commonplace. On three other occasions, federal Labour Minister Lisa Raitt has blocked strikes through either back-to-work legislation or a referral to the Canadian Industrial Review Board. Frustration over political meddling and anger at being asked to make further concessions prompted a wildcat strike by ground workers and an alleged “sick in” by pilots, further battering the Air Canada brand and damaging its credibility with customers. “That adversarial, hostile relationship is very deep-seated, so it’s not easy to address,” says Joseph D’Cruz, a professor at the Rotman School of Management. “It’s not clear whether they can achieve a good-quality relationship.”

As labour relations have turned venomous, the airline’s balance sheet looks increasingly toxic as well. Its costs are rising, with fuel charges increasing by 27% in 2011 alone. The pension concessions made by workers that Rovinescu trumpeted in 2010 will expire next year, and the airline now faces a $4-billion pension shortfall. All told, Air Canada lost $249 million last year, compared with $24 million in 2010. This financial picture, combined with the labour strife, has forced its share price below 90¢, down from $1.10 in January and a tiny fraction of its value five years ago, when it traded at close to $20. “Once a company becomes a penny stock, it’s pretty clear investors consider it a dead company,” says Fred Lazar, an economics professor at York University’s Schulich School of Business.

The possibility of another Air Canada bankruptcy, nine years after the last one, is now widely discussed on Bay Street. Concerned about the long-term implications of the labour disputes, Standard & Poor’s warned the airline faced a downgrade on its credit rating on March 24; two weeks later, Moody’s actually dropped Air Canada from B3 (“a high credit risk”) to Caa1 (“a very high credit risk”). In addition, Air Canada has an Altman Z-Score, a common measure of a company’s financial health, that assess variables like working capital, sales and earnings as a proportion of total assets, of 0.62, which suggests the possibility of bankruptcy. (The lower the number, the higher the likelihood; in comparison, WestJet has an Z-Score of 2.09 while JetBlue sits at 1.05). “It would not take much of a shock to push Air Canada in the wrong direction,” says Lazar. “Oil prices, economic conditions in Europe or China, further labour disruptions, a new pandemic—there are any number of possibilities.”

While observers may disagree as to whether Air Canada’s sad condition is terminal or just chronic, on one point there is unanimity: the airline needs to undergo a substantial transformation of its business model to return to full health. Two changes in particular are desperately required: the launch of a low-cost carrier that can compete with upstarts like Air Transat and Sunwing, and relief for the pension woes. The company’s horrible labour relations stand in the way of both goals. That situation has to change if management and workers ever want to land safely.

In these days of wildcat strikes and back-to-work legislation, it is difficult to remember an era when Air Canada’s management and its unions didn’t seem eager to stab each other’s eyes out with forks. But it existed; it wasn’t even that long ago. When the former Crown corporation privatized in 1988, employees were given the first chance to buy into the company. Close to 40% became shareholders, a development that seemed to inspire workers to look beyond their own wages and working conditions and consider the health of the company as a whole. George Smith, who served as Air Canada’s director of employee relations during the period, recalls landing at London’s Heathrow airport and watching the pilots and flight attendants grab used copies of The Globe and Mail to check Air Canada’s stock price. “I had this little moment where I thought, ‘We have a chance here,’” recalls Smith, now a fellow at the Queen’s University School of Public Policy. “They started to understand the business complexities.”

If this sense of common purpose endured, the carrier might now resemble WestJet or Southwest, a nimble airline built on impeccable employee relations. Instead, the relationship between employees and employer cracked under the financial pressure of the past decade. True, Air Canada suffered labour disruptions in the past, including a two-week strike by ground workers in 1978 and a walkout in 1987. But it was the airline’s first bankruptcy in 2003 that turned the usual cut and-thrust of labour relations into a blood feud. The airlines’ unions agreed to combined cuts to compensation totalling close to $1.1 billion, or roughly 37% of Air Canada’s total labour costs. Pilots accepted pay cuts between 15% and 30% while flight attendants saw their wages drop by 10%. More concessions came in 2009, with an agreement for a 21-month moratorium on past service contributions, the payments used to overcome solvency deficits. Over the same period, unionists felt Air Canada executives failed to make similar sacrifices. Rovinescu reportedly saw his wages increase to $4.6 million last year from $2.6 million in 2009, while also collecting a one-time retention payment of $5 million in 2012. Chuck Atkinson, president of transportation District 140 of the International Association of Machinists and Aerospace Workers, the company’s largest union, described Rovinescu’s pay in a letter to the president as “a personal insult and a slap in the face to all our members.” (Neither Rovinescu nor any other Air Canada executives were available to comment for this article, according to a spokesman.)

Close to nine years of concessions and frustration seemingly exploded into a series of very public tantrums by union members this March. Faced with a potential strike by the airline’s machinists union and a lockout of its pilots, federal Labour Minister Lisa Raitt referred both disputes to the CIRB on March 8, then introduced back-to-work legislation four days later. The minister’s actions were meant to ensure smooth travel as schools across the country closed for spring break. That didn’t happen. As soon as she intervened, Air Canada alleges its pilots began calling in sick in protest, forcing the cancellation of 23 flights on March 17 alone.

Then, on March 21, three employees heckled and taunted Raitt with sarcastic, showy slow-clapping as she passed through Toronto’s Pearson airport. The airline suspended the offending employees, in turn prompting a half-day wildcat strike that forced the cancellation of 84 more flights. In the midst of this unrest, Aveos, Air Canada’s primary maintenance contractor, declared bankruptcy, laying off more than 2,000 employees. A former subsidiary, the repair firm was sold to private investors in 2007 as Air Canada tried to reduce its debt. Despite now being a separate company, Aveos’ closure presents its own challenges. Standard & Poor’s cited the possibility that Air Canada may be called upon to pay severance for Aveos workers. There is also a suggestion that the airline is now in violation of a legislative requirement dating back to its privatization that it keep its maintenance operations in Winnipeg, Montreal and Mississauga. Enforcing such rules might just create further business challenges for Air Canada, says David Tyerman, managing director, transportation and industrial products with Cannacord Genuity. “If Air Canada doesn’t have competitive costs on its maintenance because we want to protect jobs in Canada, there won’t be an Air Canada,” he says.

The federal government’s persistent interventions in the bargaining process also could hurt. Not only does the process tend to punt difficult decisions to future contracts, but arbitrators often prove sympathetic to union positions, as recently happened when Air Canada flight attendants won a pension that blends elements of the defined benefits and defined contributions models. “Arbitration is as bad for the company, or worse, as it is for the union, because you’re not going to get the kind of change you need,” says Smith. “As smart as arbitrators are, they aren’t business people. They don’t run airlines. So people who know a lot about airlines, from the business side and the union side, should be able to get into a back room and sort this stuff out.” The arbitrator in the flight attendants’ case wrote that “absent of compelling evidence,” he was “loath to award breakthrough items.” But compromises that permit fundamental changes are exactly what’s currently required. “From a business perspective, Air Canada needs some breakthrough items,” says Smith.

The list of once great airlines forced into a bankruptcy or merger, or out of business is lengthy, from Sabena in Belgium to Swiss Air to American Airlines and United. So-called legacy carriers struggle to compete in a world filled with low-cost upstarts like Southwest and JetBlue, along with new international carriers like Emirates Airlines, which enjoy far lower labour costs than their North American rivals. A few airlines have adapted and thrived, however. Qantas launched Jetstar, its own low-cost airline, which quickly grew to be one of the largest carriers in Asia.

And so, despite the gloomy predictions about its future, it is reasonable to think Air Canada can still reinvent itself. A strategy to attract travellers from secondary markets in the United States on their way to Europe or Asia has seen some success, selling flyers on a viable way to bypass New York’s nightmarish airports by travelling through Toronto instead. Further, Air Canada remains relatively liquid, with $2 billion in cash, along with $9 billion in total assets, according to Tyerman. “It should be able to generate significant earnings from $9 billion in assets,” he says. “There is the potential there.”

One potential source of new revenue lies in following Qantas’s example. While Air Canada has dabbled in the low-cost market in the past, with brands like Zip and Tango, those were strictly domestic airlines designed to fight back against WestJet’s growing popularity. It appears the airline is now preparing something far more substantial, with nearly 60 employees, plus consultants, working on the plan, which may launch with the minority support of a foreign airline. And while Rovinescu has publicly said he wouldn’t want to proceed with the plan without the support of Air Canada pilots, there are whispers he might.

On the second substantial issue facing the airline, the pension shortfall, Air Canada almost certainly needs to broker a compromise, likely involving contributions from both sides, and perhaps the federal government, to cover the gap. Making that kind of deal, however, will require goodwill on all sides. Finding common ground may require substantial leadership change within both Air Canada’s management and its unions. There are already signs of dissatisfaction among unionists with their current leaders. Flight attendants twice rejected tentative deals that their union bosses endorsed. More recently, 27 former executives of Air Canada Pilots Association issued a letter calling on their colleagues to embrace “new ideas,” implying support for a discount airline. The letter warns, “Nobody likes change, but change is coming.” The current executive, in a letter of its own, call on their former leaders to “rejoin the fold.”

Some question whether the marriage between Air Canada and its workers can be saved at all. “It may be that what is necessary is completely replace the management, dismantle the current airline and form new entities under new management,” says D’Cruz. Others, however, think common sense will ultimately prevail. “As quickly as possible, rational people on both sides of the table need to get together, recognize they had a huge customer-service issue and publicly declare peace,” says Smith. “And tell the customers that the customers are more important than their petty differences.”