Takeover at Continental Airlines

Frank Lorenzo next set his sights on Continental Airlines, which had a proud history going back to 1934 as Varney Speed Lines. The airline was renamed Continental Air Lines in 1937, even before the passage of the Civil Aeronautics Act, and before Frank Lorenzo was born. Lorenzo had earlier attempted to interest Robert Six, founder and chief executive of Continental, in a merger with Texas International, to no avail. Six was among the group of original oil-stained visionar­ies who had started it all in the airline business, along with Jack Frye, Eddie Rickenbacker, and Juan Trippe, and he wanted nothing to do with the financial whiz-kid from New York. By 1980, Continental’s all-jet fleet flew routes coast to coast and over the Pacific to the Far East and Australia. But by 1980, the effects of deregula­tion and a long strike by flight attendants had produced a loss of $27 million for the year. An attempted merger with Western Airlines did not succeed, and Continental was at risk.

By 1981, A1 Feldman had replaced Robert Six as CEO. Feldman was also of the old school and was no more interested in hooking up with Lorenzo than Six had been. Before joining Con­tinental, Feldman had successfully turned around Frontier Airlines using traditional business meth­ods. Unable to secure a voluntary merger agree­ment with Feldman, Lorenzo, using the assets of Texas Air, began buying Continental stock in another hostile takeover bid.

Feldman fought the takeover energetically, combining with Continental’s labor forces to present a united front in opposition. Attempts were even made to get financing that would allow the employees to buy into the company through an employee stock ownership plan (ESOP). In spite of these frantic efforts, which included the employees giving up $180 million in projected pay raises, the ESOP failed. Lorenzo ultimately acquired enough company stock through the open market to get voting control. A1 Feldman committed suicide in his office on August 9, 1981.

When Lorenzo took over, a new board of directors was selected, which included Alfred Kahn and John Robson, both former chairmen of the CAB. Because of their roles in bringing about economic deregulation, it could be said that they were both indirectly responsible for the emergence of the voracious Frank Lorenzo as a force in the airline industry. Lorenzo brought in Stephen Wolf from Pan Am as president of Continental. Lorenzo decided to merge Texas International operations and assets with those of Continental, to jettison the Texas Interna­tional name for good, and to move forward as Continental.

As the consolidation proceeded and Loren­zo’s accounting team probed deeper into Con­tinental’s finances, it soon became clear that the company was in much worse shape than Lorenzo had been led to believe. It began to look like Lorenzo might have finally made a fatal miscalculation. If Lorenzo’s investment was to be salvaged, drastic measures were going to be called for.

Phil Bakes, still Lorenzo’s right-hand man, determined that the airline’s main expense challenge was the cost of labor. Pilots aver­aged around $90,000 per year, but flew only about a third of the month. Flight attendants drew $37,500 annually. Mechanics’ wages were $40,000 a year. If Continental was going to survive, labor would have to yield to the com­petitive market consequences of deregulation. Attempts at conciliation between the two sides proved fruitless. The machinists’ union, Inter­national Association of Machinists (IAM), went on strike at Continental in August 1983. On Sep­tember 24, 1983, Continental became the second major airline to file for Chapter 11 protection under the Bankruptcy Act.

Lorenzo turned over operation of the air­line in Chapter 11 to Phil Bakes. A recent deci­sion of the U. S. Supreme Court, National Labor Relations Board v. Bildisco,1 established that labor contracts, to the extent that their provi­sions impaired the claims of other creditors, were not enforceable against the debtor corporation (the airline). This decision opened the way for

Continental to unilaterally abrogate all wage scales and work rules, which it did immediately. In effect, Lorenzo was able to legally cancel all labor contracts that were in force at Continen­tal. He then invited back its employees to work longer hours at half the rate of pay. Those who did not agree were simply out of a job. New hires were made in all areas of the company and, despite the fact that the company was in bank­ruptcy, the pilots’ union called a strike. Through the efforts of Phil Bakes, schedules were largely maintained, additional pilots were brought into the company, fares were lowered to attract more passengers, and gradually the company took on a semblance of normalcy. Two years after Conti­nental entered Chapter 11, it became the first air­line to successfully emerge from bankruptcy and to pay its creditors close to 100 cents on the dol­lar. The restructured and reconfigured airline was now ready to cope with the deregulated world.