JOHN DVORAK'S SECOND OPINION
Carl Icahn will destroy Yahoo
Commentary: Investor's all-stars will first try to deal with Microsoft
By John C. Dvorak
Last update: 6:35 p.m. EDT May 16, 2008

BERKELEY, Calif. (MarketWatch) -- Shareholders of Yahoo Inc. are now being confronted by Carl Icahn and the slate of directors he has to replace the current board. The thinking is that the company's directors screwed up an opportunity to sell to Microsoft Corp.

I've looked over the current directors of Yahoo and Icahn's proposed replacements. Here's what I think of them, keeping in mind that to be on this board it might be useful if you knew something (anything) about computers and the Internet. In some cases, I seriously doubt that the person named even knows how to turn on a computer.

Let's look at them:
Jerry Yang, founder. He should not be the chief executive but should be the chairman of the board. Why isn't he?

Roy Bostock, chairman of the board here and at Northwest Airlines. He's also a director at Morgan Stanley. Sounds like a professional board guy. What's this have to do with the Internet?

Ron Burkle, finance guy and Bill Clinton pal. Burkle's an expert in supermarkets and other things, as well as board member of Occidental Petroleum Corp. What does he bring to the party, knowledge about coal reserves? I doubt he can even use email.

Eric Hippeau. The second of the board members besides Yang who actually knows the business. Negative: He's been on the board the longest and signed off on too many dumb deals.
Vyomesh Joshi, a VP at Hewlett-Packard Co. Are you kidding me? He's from the printing division. What's Yahoo got to do with that?

Arthur Kern. Known as a nice guy. He's been on the board forever and is the new-media guy. Also must have signed off on a lot of dumb deals.

Robert Kotick, chairman and chief executive of Activision Inc. OK, he's in the business. Finally!

Ed Kozel. I could be wrong, but Kozel seems like the real sleeper on the board, with a background in technology as well as finance. He's probably underappreciated.

Maggie Wilderotter. Seems like another lightweight to me; apparently her connection to Microsoft as a former VP is her real allure. She's another professional director who's on various other big-name boards. Must be good at networking.

Gary Wilson, another board member from Northwest Airlines. Yeah, that makes sense. I smell a drinking club!

So this board stinks overall.

That said, at least this group is familiar with the company. Icahn wants to drag in a bunch of out-and-out finance/law guys, along with Dallas Mavericks owner Mark Cuban.

Cuban made his fortune by selling Broadcast.com to Yahoo back in the late 1990s for more than $5 billion. After that it disappeared from view. Another $5 billion down the drain.

Let's look this new group over:
Lucian Bebchuk. Famous corporate lawyer who's an expert in corporate governance. Will serve as the procedural bully on the board.

Frank Biondi Jr. The former Viacom Inc. executive sits on a lot of boards, including Seagate Technology's. He might have a clue but that won't be his job. His job will be to say "yes" to Icahn.

John Chapple. Too many accomplishments to be a real person. Another impressive seat-filler with little or no hook into Yahoo's sort of business.

Mark Cuban. My guess is he's being brought in to be the next chief executive after basketball season is over. Projected tenure? Six months.

Adam Dell. Another VC and finance guy with a law degree.

Keith Meister. He's Icahn's personal economic hit man.

Edward Meyer. Might be OK; at least he knows advertising.

Brian Posner. Another guy with too many items on the "what I did over the weekend" list (see Chapple, above). Do these guys actually sleep, ever, or is this a giant bragfest?

Robert Shaye. Another lawyer-MBA type who also is a Hollywood mogul. Cripes.

Of course, there's Icahn himself as coach/chairman of this all-star team.

Here's the deal: If these guys get on the board, they will first try to package a deal for Microsoft and walk away with more money. If they cannot do that, they will be unable to manage Yahoo since they are all professional place-sitters on everything but Internet companies.

So they will immediately parcel out and sell off the company piece by piece until Yahoo is dead. Looking at the bios of these guys tells you this is something they can do.

And they'll do it fast.
You really don't understand capitalism. Looking objectively, Icahn hopes to turn around UNDER-functioning companies and make better use of their capital (including people). In the end, the intention is that the capital will be used more efficiently?

Lack of foresight and oil prices going through the ceiling cause layoffs at AA !

Lack of planning for the future by buying fuel efficient aircraft to replace gas guzzling Super-80's and management a bonus program for rewarding this behavior have caused AA to slash thousands of jobs across many job classifications.

Will flight attendant leaves absorb the layoffs?
Will higher prices promote a profit for the airlines?
How about a new business plan with fares reflecting the actual cost of flying a person or freight from point A to point B?

How about some foresight and planning to run an airline with efficiency? How about it?

With two oilmen in the White House...did we NOT expect this?

Editorial Comment:
May 20, 2008
Senator Ted Kennedy diagnosed with a glioblastoma

Our hearts go out to the Senator and his family during this grim news about the glioblastoma found in the Senators brain. Always fatal, this is the worst diagnosis and at the very least, an uncomfortable and very sad end a storied career in the United States Senate.

A friend of labor, the airlines and the middle class, Senator Kennedy has always fought for working families, as an advocate for doing the right thing at the right time.

Senator Kennedy rose above the Kennedy dynasty and became a very strong voice for the people, in nearly 40 years in the Senate. Intense personal pressure to succeed from his famous father and a legacy unheard of in common times, gives Senator Kennedy his own place in history equal to his famous brothers, as he stood firmly for what he always believed was good for the average person...a fighting chance to achieve the American Dream.

Dear Delta Flight Attendants,
(from a concerned group of former Ozark, TWA, and current AA flight attendants)

As former members of the Association of Flight Attendants, we strongly encourage you to vote and elect AFA as your collective bargaining agent. The Association of Flight Attendants can and has consistently provided protections that other other unions or non-union groups cannot.

Many years ago, AFA represented the interests of our colleagues at Ozark Airlines. At that time, we were caught up in a merger with TWA led by notorious corporate raider Carl Icahn. We knew the expected challenges we would be facing and we knew the challenges our union brothers and sisters at TWA were facing as they were out on strike and continued to walk the picket line as the purchase agreement was being consummated.

AFA’s representation was absolutely crucial to our welfare during the TWA/Ozark merger process. The Ozark flight attendants virtually walked away from that merger unscathed with seniority intact and date of hire received.

However, it is a far different story for our TWA family.

When American Airlines purchased TWA in 2001, every single one of our colleagues (Ozark & TWA) was stripped of seniority and stapled to the bottom of the seniority list, our domiciles and satellites closed and the entire TWA Flight Attendant workforce was corralled behind a fence in STL. After 9/11, every single TWA attendant (some with as many as 40 years) was furloughed, many without furlough/severance pay for nearly five years. Others were not as fortunate; they were terminated as their five year recall rights expired.

As time went on, the writing was on the wall for those awaiting recall. Now finding ourselves at the forefront of battle and a grassroots campaign to extend the recall rights of our colleagues, we knew what had to be done. Ultimately, we landed on the door steps of many politicians, media venues and labor organizations, including that of AFA for support and for that we are ever so grateful.

Many of these middle-aged flight attendants lost a lifetime of building their career, seniority, pay and benefits; a travesty that could have been averted with AFA’s representation.

AFA was not our collective bargaining agent during the AA/TWA merger, as they were during the “fair and equitable” TWA/OZARK merger. AFA was the first of many labor organizations that gave us support and encouragement when we so desperately needed to extend our recall rights to preserve our careers. AFA exemplifies the spirit of “true unionism”.

Today, thanks to the assistance of many Senators, several labor unions and AFA, our ex-TWA colleagues now have a two year extension and some have even been recalled.

Just as in those days, airline consolidation is again on the horizon. Don’t allow yourselves to be sitting ducks for corporate America, OPEC, or terrorism. The ability to preserve and protect our career, seniority and benefits is with a strong, solid and experienced union with a winning track record. AFA continues to prove its strength and integrity when it counts most. Take it from an ex-TWA Flight Attendant, we know, we have been on the losing end.

Steenland: Fuel costs may shrink merged Delta/Northwest
Memphis Business Journal

Northwest Airlines Corp. will keep a "vibrant" hub and a substantial number of jobs in Minneapolis-St. Paul after the airline's merger with Delta, Northwest CEO Doug Steenland told business leaders Monday.

But he warned that soaring fuel costs may ultimately mean a smaller company.
BLOGGER COMMENT: (which is basically B.S., meaning)
THERE WILL BE MASSIVE LAYOFFS AND DOWNSIZING, AND THOUSANDS OF JOBS LOST, WHICH WILL BE A SMOKE AND MIRRORS GAME...A DISGUISE FOR MAKING A PROFIT BY THE LAYOFFS, NOT AN OPERATIONAL PROFIT)
Speaking at a meeting of the St. Paul Area Chamber of Commerce, Steenland said the combined carrier will keep its reservation offices, data center and flight-training facility open following the close of the deal.

Overall, he likened the deal's impact on the Twin Cities to the 1998 merger between Minneapolis-based Northwest Corp. and San Francisco-based Wells Fargo & Co. Then, Minneapolis lost Northwest's corporate headquarters but ultimately gained jobs as Wells Fargo kept a big division here.

But with the price of oil soaring, Steenland said it's hard to predict how many workers the carrier will employ in the future.

"This can only go on so long," he said of airlines absorbing high energy prices. "Fuel costs will have to be passed on to consumers. That will mean higher fares, so we'll see demand come down, and the airline will have to shrink."

Northwest (NYSE: NWA) and Delta Air Lines (NYSE: DAL) last week began crafting a plan for integrating the carriers, Steenland said. The companies expect the merger to close by the end of the year. Northwest may operate as a standalone airline for a full year after the deal wraps up, he said.

While the combined airline's headquarters will be based in Atlanta, the merged company will continue to have a big presence in the Twin Cities. "What won't be different is that Minneapolis-St. Paul will continue to be a vibrant, robust hub," Steenland said.

The airline also will continue to support Twin Cities cultural institutions and non-profits, he said.
Based in Eagan, Minn., Northwest operates one of its three U.S. hubs at Memphis International Airport.
Minneapolis / St. Paul Business Journal

Delta/Northwest deal's dangerous model
The ambitious plan to create the world's largest airline increases costs but may not improve revenues.
By Barney Gimbel

Delta CEO Richard Anderson says the merger is 'a combination about addition not subtraction.'

NEW YORK (Fortune) -- With his slicked back hair and rimless glasses, Delta CEO Richard Anderson looked like an older Clark Kent when he strode to the podium at the Barclay Hotel in New York Tuesday morning. And perhaps underneath that dark suit was, in fact, a superman costume. That's because in less than a year at the helm of Delta, he pulled off what was thought to be an impossible task - a $17.7 billion merger with Northwest to create the world's largest airline.

But can Anderson's superhuman strength wring a stronger company out of a combined Delta (DAL, Fortune 500) and Northwest (NWA, Fortune 500)? And will the copycat mergers that are expected to follow strengthen the industry? It's certainly no slam-dunk, as the new Delta will raise its costs in the near term without offering a concrete way to substantially increase revenues.

Investors panned the deal, with both Delta and Northwest stock down sharply by midday Tuesday.

Ever since the days of Juan Trippe's Pan Am, there has been a persistent fantasy among aviation CEOs that he who has the most planes (and flies the most routes) wins. In today's parlance, you might call that the Delta Model. Anderson believes that the best way to survive $110-a-barrel oil is by growing into a carrier with potential revenues of $30 billion.

But in doing so, he plans to defy the conventional wisdom of airline mergers and create what some believe would be a dangerous model for the industry's long-term sustainability. There are two strategies management traditionally deploys in airline mergers - cutting overlapping flights to slash costs or expanding globally to increase revenue. Trimming routes was the approach touted by US Airways in its unsuccessful bid for Delta last year. At the time, US Airways (LCC, Fortune 500) suggested it could save nearly $1 billion by combining the two carriers and lopping 10% off the flight schedule.

At Tuesday's press conference, Anderson made it clear he was not cutting routes or hubs. The plan rests on combining two complementary networks of routes. That makes sense in theory: Northwest has a large Asian network, and Delta has a large European and Latin American one. So why not combine the two while making better use of the company's airplanes?

Use Northwest's large Boeing 747s through high-traffic Atlanta instead of Minneapolis, for example. These proposed efficiencies will create more than $1 billion in revenue synergies, Anderson said. "It's a combination about addition not subtraction," he added at the press conference. "In a network business, scale and scope are important."

In practice, analysts say, increasing revenues through increased efficiencies will be hard to come by. One plus one rarely equals three. "The appeal of consolidation is redundancy - the network overlap - that can be eliminated," JP Morgan analyst Jamie Baker wrote in a recent report. "The value creation comes in the form of shedding duplication."

Then there are the pilots. The original plan for the merger when it was first touted earlier this year included a seniority integration agreement so the airline could instantly combine the workforce. But after Northwest and Delta pilots couldn't agree, Delta's management made a lucrative deal with its own pilots that guarantees them a 5% pay raise next year and a 4% raise for the next three years. Even better for the pilots, it guarantees them no layoffs for the first two years after the merger closes. That means Delta can't reduce the number of planes or routes it flies.

But management failed to come to any agreement with Northwest's pilots, who generally outrank Delta's pilots in seniority, and are far from happy with the deal. "One can only conclude that the Delta pilot leadership and Delta management have made an arrangement to try to disadvantage the Northwest pilots economically and with respect to our seniority," wrote Dave Stevens, the head of Northwest's pilots union, in a letter to his colleagues. "No pilot group is going to put up with this. No amount of money can sustain a carrier which creates this level of discord. This is a recipe for failure."

Until Northwest pilots are on board with the deal, Delta can't combine operations. It seems inevitable that the new Delta will eventually have to offer a similarly generous deal to Northwest pilots -- pushing labor costs even higher.

None of this bodes well for the airline industry. After a Northwest-Delta deal, expect to see the remaining large carriers - American (AMR, Fortune 500), Continental (CAL, Fortune 500), United (UAL) and US Airways - attempt similar mergers with similar terms. And then what do you have? Bigger companies flying the same routes with the same airplanes - only now with higher labor costs. For some reason, in the airline business, people always forget that bigger doesn't mean better.

Delta and Northwest: a mistake from the start.

Why Airline Mergers Don't Work
by Victor Cook

Ever wonder why over the last 30 years Southwest Airlines managers (LUV) spent only $0.03 on mergers and acquisitions for every $1.00 of shareholder value they created? By comparison, Delta management (DAL) spent $2.35 for every $1.00 of value they created. And Northwest (NWA) spent $1.61 on M&A for every value dollar they created. In Louisiana we have a name for this kind of strategy. It's called jumping over a dollar to get to a nickel.

Does Herb Kelleher, former CEO of Southwest Airlines, know something about creating shareholder value that other CEOs don’t know? Perhaps he understands that in the domestic airline market earnings don’t necessarily increase with market share. Or in economics speak, changes in earnings with respect to a changes in market share may be very inelastic. Because the demand for air travel is very price elastic.

BELIEVE IT OR NOT

Believe it or not, elasticity is one of the most powerful metrics in business. In a single number, elasticity pins to the wall the relationship between percent changes in price and quantity. In theory, if the percent change in quantity purchased by customers is greater than the percent change in price paid, demand is elastic. Alternatively, if the percent change in quantity is less than the percent change in price, demand is inelastic.

Then why does one rarely see price elasticity numbers used in industry analyses? In the real world, price and quantity data are notoriously ill behaved. That’s why your Econ 101 professor couldn’t use real numbers in his or her hand-drawn demand schedules.

It is, however, possible to get at the relationship between price and quantity in the real world if you have access to a large base of precise data, an in-depth knowledge of econometric methods and lots of time on your hands. About the only people I know with these resources are doctoral students in economics. Therefore, I was not surprised to find exactly what I was looking for in Jong-Ho Kim’s 2006 dissertation on “Price Dispersion in the Airline Industry: The Effect of Industry Elasticity on Cross-Price Elasticity.”

Dr. Kim based his research on data from the Department of Transportation’s Origin and Destination Survey from the 1st quarter 1989 through the 4th quarter 1997. This is a 10% random sample of all tickets issued in the U.S. In his dissertation Dr. Kim hypothesized that:
Southwest’s entry provides a natural setting for investigating how travelers respond to the changes in air fares.

More specifically, we can make full use of variations in relative prices among airlines and the revenue shares of airlines by focusing on Southwest entry routes. Consequently, we can focus on coach class travel in those markets where Southwest entered and has been serving since then. … [R]ival airlines adjust their average fares upon Southwest’s entry and remain relatively constant in ensuing quartersIn that study, when Southwest entered a new market (city-pair), estimated price elasticity ranged from a high of -2.6 (with only one other competitor), to -1.63 (with four other competitors), to a low of -1.1 (with 7 other competitors). All of these estimates were statistically significant.

WHAT HERB KNOWS

I think Herb Kelleher understands – as no sitting airline CEOs seems to – a fundamental principle about competition.
Given:
a capital intensive industry,
with few meaningful scale efficiencies,
delivering a highly perishable product,
within a partly regulated infrastructure,
operated by talented professionals,
in a very price sensitive market, with
free entry and court protected exit,

shareholder value can best be created organically. How? By maximizing the satisfaction of employees, passengers, suppliers, partners, and shareholders. Here is the corollary to that fundamental principle:

In airlines, building market share through mergers short circuits the creation of satisfied stakeholders.

The purpose of this article is to examine why mergers don’t work today in domestic airlines, using the DAL/NWA merger as an example.

EARNINGS ELASTICITY

Elasticity can be expressed for any pair of variables. Take earnings elasticity for example. It’s the percent change in earnings divided by the percent change in market share. Here’s what happens. Cutting price leads to an increase in market share. But it also leads to a decrease in earnings. Theoretically, in a price elastic market with few scale efficiencies and a perishable product, earnings and market share are not happy partners.

Suppose the management of a hypothetical airline with 20% of all domestic revenues decides it would be good for earnings if they increased share of revenues to 30%. The quickest way to do that is to merge with a company that has 10% of the market. In a matter of months its market share increases by 50%. Bingo!

But in a highly price sensitive market for a perishable product, earnings may increase only a little, say about 6%. The ratio of the percent change in earnings to the percent change in market share (0.06/0.50) is just 0.12. In this hypothetical case, earnings are highly inelastic with respect to market share. Is this is a bad thing? Yes. It’s a classic case of jumping over a dollar to get to a nickel.

MAXIMUM EARNINGS MARKET SHARE

To test the hypothesis that the DAL/NWA merger won’t be good for shareholders I ran a maximum earnings market share analysis on the combined companies in a strategic group with seven other domestic airlines for the calendar year 2007.

In a nutshell, maximum earnings occur when EBITDA generated by the last share point exactly equals the cost of acquiring it. I worked out the details of how to calculate maximum earnings share in my book Competing for Customers and Capital. I applied the results to eight domestic airlines in the 1st quarter of 2003 when only two of them weren’t losing money. If you want to get an overview of that analysis see my audio slide show The Rule of Maximum Earnings. It’s short and no walk in the park.

Table 1 sets the stage for this analysis with each carrier’s share of the combined $114.7 billion revenues in calendar 2007. American Airlines (AMR) captured 20.0% of total revenue. UAL Corp (UAUA) walked away with 17.6%; Delta and NWA got 16.7% and 10.9% respectively.
Continental (CAL) generated 12.4%; US Airways (LCC) had 10.2%; followed by Southwest with 8.6%; Jet Blue (JBLU) at 2.5%; and Frontier (FRNT) with 1.2% of group revenues.
Combined, DAL and NWA actually captured 27.6% of total revenues. Since both carriers were financially cleansed by bankruptcy court, what is your guess about their potential to maximize earnings?

Combining DAL & NWA revenue and costs as they appeared on their individual income statements produced an actual 2007 market share of 27.6% of group revenues. The vertical axis on this chart is the marginal cost as well as marginal earnings per share point.

Marginal costs continuously increase reflecting the underlying reality of competition. The marginal earnings schedule is constant, reflecting the assumption that there would be no major changes in the scale of combined operations. Under this assumption, maximum earnings market share is 26.7% of group revenues. If synergies were to be found after merging, the effect would be to push actual and maximum earnings market share even closer together. In either event, the combined companies come within no more than 90 basis points of realizing maximum earnings. That’s the good news.

TOTAL EARNINGS ALMOST AS FLAT

The bad news is the total earnings schedule is almost as flat at the marginal earnings schedule.

Market share appears on the horizontal axis ranging from 20% through 35% of group revenue. In this chart, total earnings appear on the vertical axis ranging from zero to $8 billion. There is just a $10 million difference between actual and maximum earnings.

A DOUBLE WHAMMY

I began this article by pointing to the painful price elasticity that exists in this capital intensive market for perishable products. For carriers competing with Southwest in the same city-pair, reported price elasticities range from -1.1 upwards to -2.6 depending on the number of competitors in the market. If you’re the only other carrier in a market with a 10% price premium in a city-pair boarding 1,000 passengers a day, 260 of them likely will switch to Southwest.

So you have to match LUV’s price. If you’re competing for 10,000 passengers a day in a market with four other carriers, including Southwest, and you don’t match LUV’s price, 1,630 of them likely will switch to Southwest. So, you’ve still got to match its price.

But, just as bad, you’re likely to be facing a highly inelastic earnings/share schedule. In the DAL/NWA example presented in this analysis, there is just a $30 million difference between total earnings at a 20% share of revenues ($3.56 billion) and a 35% share of revenues ($3.59 billion). That represents just a 0.8% increase in EBITDA across a spread from 20 to 32.5 revenue share points, a 63% increase. Without extraordinary synergies, a merged DAL/NWA might be facing an earnings/share elasticity of just a little over 0.01. Looks just like a double whammy.

What’s an airline CEO to do in this situation? Reconfigure the business model. Is there a road-map on how to do that? Yes, it’s called The Momentum Effect by Professor J.C. Larreche of INSEAD. It’s going to be published in hard copy by Wharton next month.
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