Why The Proposed Airline Industry Bailout Is Problematic

Airlines spent 96% of their available cash flow on stock buybacks over the last decade. They shouldn’t get any money without conditions.

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Socialism is always un-American until corporations need a lifeline. Just before Thanksgiving in 2017, The Wall Street Journal held its CEO Council conference, which included the country’s chief executive officers. It featured Gary Cohn, then the chief economic advisor for the Trump administration.

At the time, Cohn was the White House’s lead cheerleader for a proposed tax cut that we now know cost over $2 trillion. He made the same trickle-down promises we’ve heard for years — “The tax plan will pay for itself!” “CEOs will use the tax will to boost salaries for their employees!”

At one point during the gathering, the WSJ’s John Bussey asked the CEOs if they planned to use the proposed tax cut to increase investment in their companies.

The result? Crickets.

To be clear, a group of CEOs told Gary Cohn to his face they had no intention of actually doing the thing that was the central argument for doing the tax cut in the first place.

The CEO’s reaction was no surprise to anyone watching the markets. At the time, corporations were already sitting on a motherlode of cash. Even before the proposed tax cut, the level of stock held globally by nonfinancial US companies rose to a record of $2.3 trillion.

The rest is history. Republicans passed their tax cut, showering already flush US corporations with tons more cash. And the CEOs did what they said they would with the windfall.

Now, as companies teeter on the edge of bankruptcy from the fallout of the global pandemic, these same titans of capitalism race to embrace socialism as they look to the government (read: taxpayers) to save their companies.

Last week, an industry advocacy group requested a bailout to the tune of $50 billion of the proposed stimulus for airline-related companies like American, Delta, United, and Southwest. One might ask, how can these massive corporations be out of cash so quickly? What happened to their mountain of money?

Here’s where it gets crazy.

After the 2008 financial crisis, airlines went on a spending spree, but not on increased capital expenses or giving their employees better wages. Instead of doing any of those things or saving for the future, airlines spent close to $50 billion—buying back their shares.

Source: Bloomberg

Airlines are notoriously risky businesses. Think about it — they were disrupted by 9/11, then by the Icelandic volcano eruption, and the Great Financial Crisis, all in the last decade.

After going through all that, you’d think they would save for a rainy day.

But they didn’t. Over the last decade, the most prominent players in the airline industry decided to use every spare penny they had to buy back their stock.

Collectively, airlines spent 96% of their available cash, also known as free cash flow, on stock buybacks. American Airlines takes the cake; the company bought $12 billion in shares of its stock, even though it had negative cash flow.

Source: Marketwatch, Factset

Don’t get me wrong. Corporate buybacks can be a legitimate strategy. Full disclosure — I’ve managed buyback programs for some of the largest companies in the S&P 500.

So here’s a pro tip: when you hear that buybacks are a way of ‘returning money to shareholders,’ understand that CEOs are shareholders, and a large part of their compensation is in company shares. And buybacks can help CEOs engage in a ton of legal self-dealing.

Here’s how it works. Between 2014 and 2019, CEOs of Delta, American, United, and Southwest received $430 million in stock-based compensation, in addition to salary and other benefits.

From 2015 to 2016, as American Airlines bought around $12 billion of its shares, the company’s CEO, Doug Parker, sold between $4 million and $11 million shares a month. In total, he’s reaped over $150 million through his sale of American Airlines stock.

Source: Ben Hunt — Epsilon Theory

I’m not against companies or their management making money. But thanks to Wall Street, the airline industry is as financialized as the housing market. The result is a perverse incentive for CEO behavior that isn’t always in a company’s best interest.

I can’t help but recall all the times I’ve heard politicians, especially so-called conservative Republicans, preach ad nauseam about the importance of making responsible choices.

I remember the times they’ve criticized the poorest Americans, telling them to stop buying new iPhones so they can afford better healthcare. For months, they’ve warned us that proposals like Medicare for All and The Green New Deal are the slippery slope to socialism.

But with the coronavirus pandemic and the threat of global economic collapse, all is forgotten. And now instead of Wall Street, it’s the airlines that want Americans to open their collective wallets to save capitalism with socialism.

But if we as a country decide Southwest or Delta is too big to fail, do we also want to bail out Warren Buffet, who owns about 25% of the big four airlines? The good news is that, since the financial crisis, we’re all a lot wiser.

We saw how last time almost no one in corporate America paid for their bad decisions. Now, in a weird alignment of the left and right, even President Trump believes anyone receiving government money should be put on a tight leash.

Perhaps instead of throwing a life raft to corporations in the hopes that they do the right thing, this time, we need to drive a hard bargain, just like Warren Buffet would.

Unlike the last government bailout, we need mandatory compensation caps on senior management—no massive layoffs on the back end.

And as long as the airlines owe America money, no more stock buybacks.