The failure of TWA: Setting the record straight

Nowadays, I go on to these pages where former TWA colleagues meet and chat, and usually, if you scroll down the page for a few seconds, you'll invariably come to an article written about activist investor/corporate raider, and, one time owner of TWA, Carl Icahn.  A handful of the folks who comment afterwards may have clicked and read the article, but, as more comments emerge, most have not.  Just the mention of Icahn's name sends many of the old timers into such a rage there's no reasoning with cold, clear logic or facts, no matter who wrote it.  It gets old.

It's time to set the record straight once and for all about TWA and it's demise.

TWA's corporate history began on July 16, 1930, with the merger of Transcontinental Air Transport (TAT) and Western Air Express, forced by the Postmaster general, Walter Folger Brown, who was looking to consolidate the air mail system into his vision of efficiency and speed.  There were three major transcontinental routes, the north route from New York to Los Angeles via Cleveland, Chicago, Denver, and other major cities, went to United.  The Southern route, through Dallas and other southern cities, went to American.  The central route, which only had Phoenix, Albuquerque, Kansas City and St. Louis as the major cities, with a LOT of small cities in between, went to TWA.

TWA has also had the knack of being the target of takeovers from the most extreme of investors.  From John D. Hertz, to Hollywood heavyweight Howard Hughes, to Activist Investor/Corporate Raider Carl Icahn.  They all had different reasons for their purchases, too.  Hertz was one of the initial investors in TAT and the Pennsylvania Aviation Industries Corporation, which merged to form Transcontinental & Western Air after the merger, run by Jack Frye.

From the very beginning, T&WA showed poor financial performance, losing almost $200,000 a month between 1930 and 1932.  Capital was pouring in from the creditors on record, and enough financing happened for TWA to phone the Douglas Aircraft Co. for a replacement for their aging and obsolete wooden airplanes.  The result was the DC-1, forerunner to the iconic DC-3.  TWA was run on a shoestring until 1939, when Howard Hughes bought a controlling interest, buying out Hertz and several other Board members and shareholders.  As time went on, he would come to own 78% of the total shares of the airline, and his stamp was on just about everything, Speaking of everything the airline had, every asset down to pencils and sharpeners were mortgaged to keep some part of the airline viable and flying.

During Howard Hughes reign, nothing was in the airline's name, except the employees.  The airline did not have one single solitary asset in its control.  Every last airplane, airport property, ticket office, desk was the property of Hughes Toolco.  Hughes was known for delaying flights because of a late running Hollywood starlet, or "borrowing" one of the airline's Constellations and flying it around for weeks at a time, when it was badly needed on the competitive transcontinental routes against American and United, or Trans-Atlantic against the god-awful Pan Am and foreign airlines.  A lot of TWA'ers look at the Hughes time with fondness and remembrance and nostalgia.  I do and don't for a variety of reasons.

Because of the immense amount of Hughes' holdings and iron fist control he had over the airline and every aspect of its operations, banks refused to lend TWA money for various reasons, whether to finance new airplanes, meet payroll, etc.  During the dawn of the Jet Age though, with the new jets being far more expensive than the piston liners they are replacing, the banks forced Hughes to put his shares up in a trust or sell his ownership of TWA, as they were not willing to play ball with him, or Toolco anymore.  In 1966, he was ordered to sell his control of TWA by the US Federal Court since he also owned Hughes Aircraft, and it was seen as a conflict of interest.  The sale emptied $547 million from TWA's coffers and put the airline back on the ropes, with new jet planes though, and a LOAD of bad debt.

Once Hughes' control was relinquished, then Chairman Charles C. Tillinghast, Jr. formed the Trans World Corporation, in order to diversify the airline into other businesses and bring in revenue during all four quarters of the year.  Alongside TWA, and using TWA's income for these purchases, came along companies such as Hilton Hotels International (the non-domestic hotels of Hilton), Canteen Foods, Century 21 Real Estate, among others.


My opinion on Holding Companies for airlines is mixed.  Mega Carriers like United and American are ok with them and work well in those tight confines.  Other airlines, like both iterations of Frontier Airlines, actually failed because of being set up in Holding Company formats, and management lost sight and control of what was going on.  The first Frontier Airlines filed bankruptcy and shut down, while the second Frontier filed bankruptcy and was absorbed by Republic Airways, Inc. and summarily spun off shortly afterwards.  Smaller companies don't need these structures.  TWA, at its size, sure as hell didn't need it either, as hindsight is always 20/20, TWA's revenues and income were what was funding the purchases of all these other companies, instead of running the damn airline.

Onwards.  The 1970's was a relatively quiet time for the airline, aside from massive overcapacity on its domestic 747 and L1011 flights, about the only thing the airline managed to do was change the flight attendant uniforms in rapid fire fashion.  No one at the airline gave the upcoming deregulation buzzing in Washington a second thought, in fact, most of the senior executives laughed it off or said TWA was too strong to be weakened by airlines such as Southwest or Midway, to whom it even sold its DC-9's off to.

TWA's route structure at the dawn of deregulation was anything but ready for the oncoming slaughter.  International flights were all routed through the already too-small Terminal 5 at New York's JFK International Airport, and the domestic system was routed through cities such as St. Louis, Chicago, Pittsburgh, and so on.  About the only thing TWA did during this time was begin building up a hub at St. Louis, and take delivery of MD-80's and 767's, while retiring the venerable Boeing 707's.  It managed to eke out small profits, and the parent company as a whole was profitable.

So profitable was Trans World Corp that it started spinning off the least profitable chunks.  TWA was the first one off the block in late 1984 and very quickly became caught in the cross hairs of Texas Air boss Frank Lorenzo.  TWA's unions and employees were so against Lorenzo owning TWA (he had deunionized Continental in 1983 using the US Bankruptcy System) they were looking for ANYONE else to outbid Lorenzo.  Waiting in the wings, was activist shareholder Carl Icahn, who had quickly grabbed a good 20% chunk of the outstanding stock.


Icahn immediately saw problems with TWA's management, and he publicly chastised upper management and began eliminating those who did not fit with making TWA a better performer for the shareholders.  That's right, companies are also responsible to their shareholders, hell, IT IS THEIR MONEY that keeps a company going.  Employees at the airline at this time couldn't fathom why Icahn was demanding cuts in labor.  In simple economics even a unionized worker bee can understand, there are people out there who will gladly work for less than one quarter of what your tenured paycheck is worth.  Simple economics, you will be paid what the market bears, not what some union shop thug says you need to get so he can hold a job while doing the least amount of work possible.

The spinoff from TW Corp and subsequent buyout with junk bonds couldn't have come at a worse time.  The airline, for the little long range planning that went on, was deep in the middle of converting its operations to a disjointed hub and spoke system with domestic operations centered in and around St. Louis, while the International system stayed at the iconic Terminal 5 (and Terminal 6 for a long while) at New York's JFK Airport.  In hindsight, this was a good and bad idea all rolled into one.  It makes no sense to fly someone to St. Louis, just to connect to a JFK-bound flight and then onwards across the Atlantic.  Lots of potential revenue was lost with this scheme.  Icahn's management knew this, and in the very early 1990's quite a few spokes were added to JFK to various cities, and a mini-hub was created in Atlanta after perennial loser Eastern Air Lines shut down.

A crippling 10-week flight attendant strike, constant hijackings and terrorist involvement, the purchase and merger of Ozark Air Lines and their aging fleet of DC-9's, plus the move to Icahn's private office complex at Mt. Kisco, NY all hampered TWA's success.  The intra-European services were dropped when the 727-100's were supposed to be replaced by DC-9's, but that fell through as the leasing contracts for the DC-9's specified they could not be flown outside the US while Icahn controlled TWA.  Around the time the DC-9 plan fell through, Icahn continued his purchase of TWA stock, both outstanding and privately held, in what amounted to an $1.2 Billion purchase deal, placing each share at roughly $20 each.  TWA went private on August 6, 1987; with the approval of the Board of Directors, all the union heads, and Icahn's private equity fund, as well as the Securities and Exchange Commission (SEC).

Let me interject here, about the pros and cons of taking (or keeping) a company private.  First, you are responsible to no one but your own creditors who helped you purchase the company.  For Icahn that would be almost a third of the Wall Street power banks, plus then king of the junk bond hill, Michael Milken and his brokerage house Drexel Burnham Lambert, who also helped Alfred Checchi buyout Northwest Airlines and Frank Lorenzo build up his Texas Air Empire.  Second, not a single soul on  Earth can tell you how to run your own company, and labor turns into a much larger liability.  There is no Board of Directors oversight, no shareholder revolt, and if the employees whine and go one strike, if you're unlucky enough to be unionized, you can simply shut the company down with zero responsibility.  Also, you and you alone can build the company up to any size you want, and if its good enough, will be profitable.  If not, you'll be another TWA or god forsaken Westinghouse.

On the other hand, seeing as to how highly capital intensive airline operations are, taking an airline private would be disastrous for anyone short of a Bill Gates, or Howard Hughes.  The massive amounts of capital needed to be freely open and accessible are far too much for a private owner for anything larger than a small outfit running 8 seat Cessnas.  Airlines simply cannot be run privately.

To keep a private TWA running, and to pay off creditors, Icahn did what the outgoing TWA Board signed off to.  If the airline does not perform to expected standards, Icahn has the authority and the right to sell off assets to satisfy creditors.  Once TWA went private, he set about doing so.  First went the outstanding orders for Boeing 767's McDonnell Douglas MD-80's, and Airbus A330's to replace the well past their prime Boeing 747's and Lockheed L-1011's.  TWA, from 1987 to 1993, when Icahn was ousted, took delivery of a grand total of 13 airplanes.  Several notes from his earlier purchase of TWA stock had become due, so Icahn had to find the capital somehow, so he emptied out and sold the pension funds, which as a private company, he was allowed to do .  Then notes from Drexel Burnham came due, to the tune of $445 Million.  Icahn sold 6 routes from the United States to London/Heathrow, then publicly stating he was going to use the funds to purchase the then on its deathbed Pan American World Airways.  Nothing doing, he was paying Drexel back.

In 1990 the first Gulf War hit, and the public almost stopped flying across the Atlantic, where TWA had previously been making money.  After the loss of the Heathrow routes, TWA could not make money Internationally if it tried.  So Icahn, trying to cut costs further, made TWA file for Chapter 11 Bankruptcy on February 1, 1992, being the 5th airline in 12 months to file for either Chapter 11 or Chapter 7.  Icahn went public and said "This was not one of my most stellar investments." citing he had also pumped in roughly $200 million of his own funds to keep the airline afloat during the Mideast hostilities.  Bondholders within Icahn Enterprises were asking for blood, the employees were also out for vengeance, and Icahn lost his total control of the airline once the Chapter 11 filing went through.

Under the proposed reorganization, bondholders agreed to $1 Billion in debt for 88% of Icahn's 90% control.  Supposedly that would have left TWA with $700 to $800 million in debt, at far lower interest rates than what the bonds called for.  It would have saved TWA almost $150 million a year in interest payment alone.  Until Icahn reneged and added a further caveat.of an additional $200 million, plus interest just to get him to leave.  The business plan going forward was to have revenues floating around $5.7 million, a virtual impossibility with one real domestic hub and a rapidly aging fleet.  Even Robin Wilson, who was an architect in Western Air Lines' massively successful turnaround in 1983 couldn't fix TWA.  So, on June 29, 1995, TWA filed for its 2nd bankruptcy, had $500 million in debt forgiven, and was saddled with the now famous Karabu Ticket Agreement from Carl Icahn.

What is the Karabu deal, you ask?  Let me tell you.  It actually began in TWA's first bankruptcy, as a way for Icahn's other travel related companies to bilk off TWA tickets at a lower fare for any flight not originating or terminating in St. Louis.  This eroded TWA's ability to control its yield per passenger.  This was one of the agreed upon deals made by then Pilots union rep. William F. Compton.  It made the $5.7 Million annual revenue goal further impossible to reach.  As a caveat to the 2nd bankruptcy, Icahn, by agreement dated August 15, 1995, lowestfare.com LLC, another Icahn subsidiary, was joined as a party to the Karabu deal.  Pursuant to the new deal, Karabu and lowestfare.com could purchase an unlimited number of system tickets.  System tickets are tickets for all applicable classes of service which were purchased by Karabu from TWA at a 45 percent discount from published fares.  In addition to system tickets, lowestfare.com was allowed to purchase bucket domestic consolidator tickets, which are tickets purchased at bulk fare rates, for specific origin/destinations.  These were capped at $70 million per year based on the full retail price of the tickets.  Pricing power evaporated from TWA and it was basically competing with itself.

In July 1996, TWA Flight 800 to Paris exploded on climbout from New York's JFK Airport.  The resultant investigation and cause led management to throw out then CEO Jeffrey Erickson, who had previously started up Reno Air, and replace him with William F. Compton, former pilots union boss.  First thing management did was order 125 new planes it couldn't afford.  Boeing 717's, more MD-80's, 757's and 767-300ER's were ordered, as well as 100 Airbus A320 family aircraft, in order to utilize non refundable deposit cash paid for the earlier A330 order from 1989.  The Europe routes were dismantled, save for London and Paris out of St. Louis, and the Middle East flights from JFK.  St. Louis operations were beefed up, focus cities opened up in San Juan, Puerto Rico; Washington/National, D.C.; and Los Angeles, California.  A massive code share with America West Airlines was initiated.  TWA began winning awards left and right for various reasons, including 3 JD Powers Awards.

As much as the turnaround was positive, there were negatives as well.  A single hub in St. Louis did not make sense for a primarily domestic carrier.  TWA had incredibly bad credit terms on the leases for their new planes and could barely afford to pay for them.  On top of all of it sat the Karabu noose.  When the Internet exploded in the late 90's and people began booking travel online, TWA was one of the last to jump aboard the bandwagon, meanwhile lowestfare.com was filling TWA's planes...and their own bank accounts.  It became clear that by the end of 2000,  not only was the Karabu sucking TWA dry to the bone, but it had sucked out the marrow as well.  The airline, with barely a  few million in cash on hand, and not enough to meet the next month's expenses, went looking for a partner.


In December 2000, it became evident to the Board of Directors that Bill Compton, while he did some good for the airline in the last few years, was not the person to lead the airline into this new century.  They quietly set about looking for a new management team that could garner support, find new financial backing, and instill a VIABLE operating strategy for the carrier as the countdown to 2003 (when the Karabu contract would expire) wound down.

Bill Compton, without the BOD's approval or knowledge, contacted Don Carty of American Airlines.  He brought a deal to the Board that protected not only their investments, but gave himself an equitable golden parachute, while letting American cherry pick which assets it wanted.

On January 9, 2001, the board of Directors at TWA met to agree on a structured purchase plan of certain TWA assets by AMR, Corp. Parent Company of American Airlines, and placed into a shell company named TWA, LLC, as long as TWA first filed for Chapter 11 protection.  Along with the bankruptcy protection was $300 million in cash, and another $200 million DIP (debtor-in-possession) financing from American to keep TWA flying through the bankruptcy proceedings.  When the court approved the sale, American had all of the operating assets of TWA, a vast majority of the remaining employees, and even agreed to partially fund their pensions.  More than $600 million in debt remained after the sale, but, that's a far better cry that $1.2 Billion.  The Karabu contract was invalidated, as were quite a few other bad deals TWA had made in its history.  The last TWA flight was December 1, 2001.  Some employees went to American, some did not, but that's a story for another time.


From what can be foretold here, TWA didn't fail because of one man, rather, it was doomed to fail from the very beginning.  Lack of cohesive management save for two people, Jack Frye, and later on, Ralph Damon.  That lack of  management through almost eight decades of flying are what killed our TWA.