Viewing cable 03MONTREAL553, Air Canada Bankruptcy and Restructuring

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UNCLAS SECTION 01 OF 03 MONTREAL 000553 
 
SIPDIS 
 
STATE FOR WHA/CAN - PATRICIA NORMAN, EB/TRA - SUSAN PARSON 
 
STATE PASS USTR FOR SAGE CHANDLER 
 
USDOT FOR JEFF SHANE AND SUSAN MCDERMOTT 
 
FAA FOR KRISTA BEREQUIST 
 
TSA FOR SUSAN WILLIAMS 
 
SIPDIS 
 
USDOC FOR 6310/ITA/TD/TM/OFFICE OF AEROSPACE/TLARGAY 
 
E.O. 12958: N/A 
TAGS: EAIR ETRD EFIN ECON CA
SUBJECT: Air Canada Bankruptcy and Restructuring 
 
Ref: (A) Ottawa 00385 (Air Canada financial woes) 
 
 (B) Ottawa 00612 (Transportation Strategy Aviation) 
 (C) 2002 Ottawa 2824 (Report suggests liberalization) 
 (D) 2002 Montreal 1248 (Air Canada going Discount) 
 
¶1. SUMMARY: Air Canada's recent filing for bankruptcy 
protection follows efforts over the past several months to 
restructure its operations and lower its costs in order to 
remain competitive during a difficult time in the airline 
industry. However, a combination of its own business 
decisions, the rise of low-cost competitors, and several 
devastating events beyond its control helped bring the 
airline to this point. The bankruptcy protection will 
provide the airline time to develop a long-term strategy 
that might allow it to compete in a changed market. The 
Canadian government has indicated a willingness to provide 
loan guarantees to Air Canada, but there are currently no 
plans for a cash bailout. END SUMMARY 
 
¶2. On April 1, 2003 Air Canada sought protection under the 
Companies' Creditors Arrangement Act (CCAA), Canada's 
equivalent to Chapter 11. Even before the bankruptcy 
filing, Air Canada had declared a Force Majeur, citing the 
war in Iraq, in order to find relief from some contractual 
obligations and to justify the impending layoffs of 3,600 
workers, about 10 percent of its total workforce. The Force 
Majeur declaration prompted a swift negative reaction from 
many of the airline's unions, which had already agreed to 
work with the company to save C$650 million annually in 
labor costs. 
 
¶3. During 2002 Air Canada lost C$428 million, most of that 
amount in the final quarter. Since 1999, Air Canada has 
lost C$1.7 billion and is currently losing about C$3 million 
per day. It has over C$13 billion of accumulated debt, 
approximately C$8 billion of which resulted from the 1999 
acquisition of Canadian Airlines (then its main rival), 
which was purchased primarily for its profitable Asian 
routes. Air Canada's pension liability is also C$1.3 
billion. It is the third major North American airline to 
seek protection from its creditors in the past 18 months, 
after United Airlines and USAIR. 
 
¶4. As recently as 2000, Air Canada carried about 80 percent 
of Canada's domestic passenger traffic. The company's 
overwhelmingly dominant market share has led rivals to 
accuse it of predatory pricing. Predatory or not, the 
airline's strategies have evidently not been successful: in 
the last 12 months, Air Canada has lost 12 percent of its 
domestic market share to its low-cost competitors, 
principally Calgary-based WestJet. Cameron Doerksen, 
aerospace analyst for Dlouhy Merchant Group, a Montreal- 
based investment bank, told post "they [Air Canada] simply 
cannot compete in the low-cost carrier market with a big 
airline budget," a view echoed by Michel LeBlanc, CEO of 
Montreal-based low-cost carrier Jetsgo. 
 
¶5. Over the past two years, Air Canada has tried to compete 
with its low-cost rivals by dividing its business into the 
main Air Canada brand and four new subsidiaries and brand 
names: Zip, Tango, Jazz and Jetz (REFTEL D). Most operate 
on a lower wage/cost structure, but growth potential is 
limited by union contracts to a relatively small scale of 
operation, lest they cannibalize the main Air Canada 
operations and their higher-wage jobs. Doerksen asserts 
that despite these efforts to compete in the low-cost 
market, where it might be difficult for a traditionally high- 
cost carrier ever to compete effectively, Air Canada will 
need to focus on its primary strength: long-haul 
international business travel. 
 
¶6. While Air Canada prepares a restructuring plan, expected 
in the middle of May, financial services company GE Capital 
has extended a C$1 billion line of credit to the airline. 
Air Canada CEO Robert Milton has also called on the Canadian 
government to provide loan guarantees during the 
restructuring, claiming it is impossible for Air Canada to 
compete with U.S.-based carriers that received a large 
financial package from the U.S. government following the 
terrorist attacks of September 11, 2001. Transport Minister 
David Collenette has previously indicated a willingness to 
consider loan guarantees, but no grants. Meanwhile, the 
Parliamentary Committee on Airlines recently called for the 
federal government to assist all Canadian airlines by 
suspending airport rents and security fee collections for 
two years. Both LeBlanc of Jetsgo and Clive Bedoe, CEO of 
WestJet, agree that all domestic airlines are vulnerable to 
current market conditions and believe that a national 
bailout should apply to all airlines, not just Air Canada. 
 
¶7. Air Canada returned to Ontario Superior court on April 
¶22. In a hearing attended by attorneys from its labor 
unions and over 100 creditors seeking payment, Air Canada 
requested an extension of its restructuring window to June 
30, permission to delay its annual meeting until a 
restructuring plan is complete, and approval to renegotiate 
some of its labor agreements. Air Canada had tentatively 
been permitted to suspend some of its contractual 
obligations when it made its CCAA filing on April 1. Unlike 
U.S. Chapter 11, the CCAA has not historically permitted 
companies to void collective bargaining agreements. On 
April 22, Ontario Justice James Farley rescinded some of the 
protections given Air Canada on April 1, but encouraged the 
airline and its unions to continue negotiations that would 
allow Air Canada to produce a viable restructuring plan. 
Both sides tried to interpret this outcome as a victory; the 
unions because Justice Farley denied Air Canada's request to 
bypass its agreements, and Air Canada because it may have 
obtained more flexibility in dealing with its unions than 
many companies have in the past. Air Canada's decision to 
make its CCAA filing in Ontario is believed by some analysts 
to have been influenced by a recent Quebec court ruling in 
the case of Quebec mining company Jeffrey Mine, Inc., that 
collective agreements are protected during a restructuring 
period. 
 
¶8. In order to raise cash, Air Canada has in recent months 
attempted to sell some of its key holdings. In February 
2003, it sold a 35 percent stake in Aeroplan, the airline's 
frequent flyer program, for C$245 million, and recently 
renegotiated an agreement with the Canadian International 
Bank of Commerce (CIBC) that will allow it to generate cash 
by selling frequent-flyer miles to retailers and insurance 
companies. The Jazz subsidiary, a pan-Canadian domestic 
carrier, has been put up for sale, as has Air Canada 
Technical Services (ACTS). ACTS may have a potential buyer 
in La Federation des travailleurs du Quebec (FTQ), which has 
2,500 members working at ACTS in Quebec. Andre Viau, 
portfolio manager for aerospace with the FTQ pension fund 
management group, told post "the deal is not yet clear. 
While we have a double interest in saving jobs and making 
some money, we might be looking to take on a small stake." 
Selling Jazz may prove more difficult; unlike some of the 
new subsidiaries, Jazz is burdened with older equipment and 
high labor costs, making it a relatively unattractive 
property in a slow airline market. In addition, federal law 
restricting foreign ownership of Canadian airlines to 25 
percent limits the pool of potential buyers. CEO Milton and 
other industry insiders have called on Transport Minister 
Collenette to amend this law, but he has stated that it 
would remain in place until the U.S. makes the same change. 
 
¶9. Air Canada's bankruptcy filing has caused short-term 
problems for others in the Canadian aviation system. 
NavCanada, the Crown Corporation that operates the country's 
air-traffic control system, is in financial jeopardy because 
Air Canada - its best customer - has failed to make its C$4 
million weekly payment since the CCAA filing. Air Canada 
owes Aroports de Montreal C$11.5 million for unpaid rents 
and services rendered, and the Greater Toronto Airport 
Authority has seen its bond ratings lowered by Standard and 
Poor's in the wake of the Air Canada bankruptcy filing. 
Justice Farley has denied creditors' statutory right to 
seize Air Canada's assets until after a restructuring plan 
is submitted. 
 
¶10. Air Canada is continuing regular operations during its 
restructuring, and the impact on travelers should be 
minimal. However, in addition to lingering effects of the 
September 11 attacks and the war in Iraq, the recent 
outbreak of SARS is affecting Air Canada especially hard; 
their most profitable international routes are to Asia, 
while Toronto serves as its primary Canadian hub. Even 
before the CDC and the World Health Organization issued 
travel advisories for Toronto, many people had been avoiding 
Toronto's Pearson Airport. Taken together, Air Canada is 
experiencing a drop in passenger traffic at a time it can 
little afford it. Air Canada several days ago mentioned 
that it might look to route some of its international 
flights to other airports - in particular Halifax and 
Montreal - but no such plan is yet in place. 
 
¶11. In the longer run, prospects may be more encouraging for 
both Air Canada and others. Typically, an airline of Air 
Canada's size will emerge from bankruptcy protection between 
20-30 percent smaller, according to Doerkson. Viau believes 
the new Air Canada will be smaller but stronger. "With a 
smaller airline, they [Air Canada] will probably look to 
increase their outsourcing contracts, which will be good for 
the aerospace sector in Montreal," he told post. Milton 
recently announced that a restructured Air Canada will have 
to shape itself along the lines of the new North American 
airline business model, with smaller planes and lower 
operating costs. Air Canada has recently joined a 
consortium to purchase regional jets from Bombardier; Air 
Canada would initially acquire 25 of these jets to serve 
short-haul, moneymaking routes. Air Canada recently named 
former Bombardier CEO Robert Brown to its board, which 
suggests that Bombardier is likely to remain Air Canada's 
principal aircraft supplier in this market, as opposed to 
its primary competitor, Brazil's Embraer. 
 
¶12. Comment: Air Canada's current predicament appears to be 
the result of both its own decisions in recent years and a 
number of unfortunate circumstances beyond the company's 
control. Like many airlines, Air Canada has sought to lower 
its costs, either through changing union contracts or 
establishing new business models. These measures have and 
will likely continue to generate resistance but are probably 
essential to Air Canada's long-term viability. End Comment. 
KANTER