Perhaps hotels & theaters enjoy a bit more protection than airlines because they are geographically fixed to a market that seeks locational convenience.
The airlines went through this same cycle in the '70s, also brought on by high fuel prices during the energy crisis. Then, it was airlines with high debt/equity ratios like Eastern that struggled and others, like Delta (ironically), with low ratios that had little problems. By referring to the debt/equity ratio I do not mean just that narrow concept. A broader measure such as fixed cost coverage is more meaningful because it incoporates not just interest payments but lease obligations, labor contracts, leases on airport gates, etc. Same today. It is correct as others have pointed out that capital intensive industries like hotels and airlines are vulnerable to adverse changes in their earnings that lead to bankruptcy. While that may be necessary to explain bankruptcy, it is not sufficient because bankruptcy can be avoided. For example, suppose that Delta was capitalized with only equity? The problem, it seems, is that a capital structure is arrived at during favorable conditions such as the late '90s (prosperity, lots of travel, stable, low fuel prices)that may have been optimal for conditions then, but it lacks flexibility to adapt to adverse conditions when operating earnings decline. Stated another way, capital structure determines insolvency risk and Delta took on too much risk -- and then aggravated the problem by selling off the futures contracts that they held that would have protected them from fuel price increases. It was a desparate gamble apparently by a management grasping at straws hoping to survive. Their capital structure is not now optimal as management and shareholders are painfully experiencing. So, I think the real question is why the market mis-priced Delta's debt relative to equity (encouraging them to borrow in one form or another rather than sell stock)and why Delta itself chose to undertake the increased risk in their capital structure. Part of the answer may be behavioral with markets not having a long-term memory, management and shareholders wanting to grow their company beyond the size that their equity can support and being reluctant to dilute their ownership by selling stock. Peter Hollings -----Original Message----- From: PEN-L list [mailto:[EMAIL PROTECTED] On Behalf Of Jim Devine Sent: Thursday, September 22, 2005 12:14 PM To: [email protected] Subject: Re: [PEN-L] bankruptcy questions > Michael Perelman writes: > >> The basic flaw is that the cost of flying one more passenger is minimal. According > >> to basic economic theory, competition drives prices down to that level, which cannot > >> support the fixed costs. On 9/22/05, David B. Shemano <[EMAIL PROTECTED]> wrote: > I suppose the same problem theoretically exists for hotels, theaters, cruise ships. Again, I don't see any evidence that entrepeneurs, investors, lenders, etc. agree with that it is impossible to make money in these industries.< it depends on the competitive environment. The average company can't "make money" (receive even a "normal" profit) in this kind of industry if there are many competitors. On the other hand, it can make a profit if competition is restricted either by the government or by private initiative. -- Jim Devine "Segui il tuo corso, e lascia dir le genti." (Go your own way and let people talk.) -- Karl, paraphrasing Dante.
