Delta, Northwest file for Chapter 11; E*Trade prices two-part offering

By Paul Deckelman and Paul A. Harris

New York, Sept. 14 - To the surprise of exactly nobody, Delta Air Lines Inc. sought protection from its bondholders and other creditors via a Chapter 11 filing Wednesday, bringing an end, at last, to a saga that began over a year ago, when the money-losing Atlanta-based Number-Three U.S. airline carrier first began to be hit with bankruptcy rumors. The filing with the U.S. Bankruptcy Court for the Southern District of New York came despite desperate efforts by the company's management to try to cut expenses, including wringing over $1 billion of labor-cost concessions from its employees, but in the final analysis, Delta was unable to outrun its rapidly escalating fuel costs and its heavy debt and pension burden.

Minutes after Delta's filing, rival Northwest Airlines Corp. filed a similar petition at the same Manhattan courthouse, also done in by escalating fuel prices, as well as labor and pension costs. That filing also had been largely expected by the financial markets (see related stories elsewhere in this issue for details of the respective bankruptcy filings).

The two companies' bonds were holding around the same levels to which they had been whittled down, with Delta in the mid-to-upper teens, and Northwest - whose bonds plunged badly on Tuesday - around the mid 20s. Both sets of bonds were now trading flat, or without their accrued interest.

Overall sources marked high yield unchanged on the day despite the late-Wednesday news that Delta Air Lines Inc. and Northwest Airlines Corp. filed for bankruptcy.

One source remarked that, apart from the hedge funds, the bankruptcies of the two legacy air carriers are not expected to attract a lot of attention among high-yield players.

The primary market also saw some airline-related activity, as Continental Airlines Corp. priced an issue of split-rated equipment-backed pass-through certificates, just a day after the Houston-based Number-Five U.S. carrier filed a $1 billion mixed shelf registration with the Securities and Exchange Commission.

But the big news coming out of the new-deal arena was E*Trade Financial Corp.'s successful two-part offering, which included a tranche of 8% senior notes due 2011 added on to its existing issue.

Primary market players also saw price talk emerge on a number of deals, including those for Ashton Woods USA LLC, Euramax International, IKON Office Solutions, Pacific Energy Partners and Perkins Family Restaurant; the majority of those issues are expected to price as early as Thursday or Friday.

E*Trade tight to talk

New York City-based online brokerage E*Trade did the day's only deal, a $450 million two-part transaction (B1/B).

The company priced a $100 million add-on to its 8% senior notes due June 15, 2011 at 103.45, resulting in a 7 1/8% yield. The yield came on the tight end of the 7¼% area price talk.

E*Trade also priced a new $350 million issue of eight-year senior notes at par to yield 7 3/8%, tight to the 7½% area price talk.

JP Morgan and Morgan Stanley were joint bookrunners for the acquisition financing.

The deal went well according to a buy-side source who spotted the new notes at 101 bid, 102 offered when they were released for trading.

Talking the prices

With rumors, whispers and "rough guidance" having been passed around earlier in the week official talk was finally heard Wednesday on a chunk of new issue business that is expected to price by Friday's close:

* Pacific Energy Partners talked its $150 million offering of 10-year senior notes at the 6 3/8% area. Lehman Brothers and Banc of America Securities are joint bookrunners. The books close early Thursday afternoon, with pricing expected thereafter;

* Ashton Woods USA LLC/Ashton Woods Finance Co. talked its $125 million offering of 10-year senior subordinated notes at a yield in the 9¼% area. The UBS and Wachovia-led deal is set to price Thursday afternoon;

* IKON Office Solutions talked its $225 million offering of 10-year senior unsecured notes at the 7¾% area. Wachovia Securities and Lehman Brothers are joint bookrunners. Pricing is set for Friday morning;

* Perkins Family Restaurant talked its $190 million offering of eight-year senior notes (B2/B) at 9 5/8% to 9 7/8%. The Wachovia-led deal is expected to price on Friday morning;

* Euramax International talked its $315 million offering of eight-year senior subordinated notes at 9¾% to 10%. The deal, via Goldman Sachs & Co. and Credit Suisse First Boston, is expected to price on Friday; and

* Metallurg Holdings talked its $100 million offering of non-rated five-year class A secured notes at 10½% to 10¾% at a discounted dollar price of 98.00. Pricing is expected on Friday. The class A notes are part of an overall $160 million two-tranche offering. The $60 million tranche of class B notes will be sold in a true private placement. Jefferies has the books.

E*Trade up in trading

When the new E*Trade 7 3/8% notes due 2013 were freed for secondary dealings, a trader saw them firm to 101 bid, 102 offered, from their par issue price earlier in the session.

He saw the 8% add-on notes due 2011at 103.75 bid, 104.75 offered, up slightly from their 103.45 issue price.

Secondary focuses on airlines

Back among established bonds, the airlines seemed to be the main focus, and within that sector, Delta and Northwest, although there were no huge price movements, since the bankruptcy buzz had been swirling around Delta for many months, and around Northwest for a number of weeks.

A trader, noting the news of Delta's filing shortly after 4:40 p.m. ET, said that all of the company's bonds were trading at 15.5 bid, 16.5 offered, trading flat, up from 15 bid, 16 bid, earlier.

"It doesn't matter" any more about the coupon and the maturity, he said, since all bonds in a bankruptcy situation trade pari passu. At one time some weeks back, Delta's benchmark issue, the 7.70% notes scheduled to come due on Dec. 15, had traded substantially above its other bonds, such as the 7.90% notes due 2009 and the 8.30% notes due 2029, among others, which eventually compressed to trade right on top of one another - but the 7.70s began careeening downward and this week finally joined the other bonds around the mid-teens.

Another trader saw all of the bonds at 16 bid, 16.5 offered, trading flat, while a third saw them after the filing at 16 bid, 17 offered, flat, up from 15.5 bid, 16 offered earlier on.

Delta's New York Stock Exchange-traded shares, now considered a distressed penny stock, dropped seven cents (8.71%) to 71 cents per share on volume of 27.6 million shares, almost triple the usual turnover.

A trader said that before the news of Northwest's bankruptcy filing, which hit the tape shortly after 5 p.m. ET, the Eagan, Minn.-based Number-Four U.S. airline carrier's benchmark 8 7/8% notes due 2006 had risen to 30 bid, 32 offered from prior levels at 27 bid, 29 offered, its 10% notes due 2009 were a point better at 24 bid, 26 offered, while its 8.70% notes due 2007 and 7 7/8% notes due 2008 were each unchanged at 25 bid, 27 offered, and its 9 7/8% notes due 2007 were also unchanged at 26 bid, 28 offered, with all bonds trading flat following Tuesday's news that Northwest had not made some $42 million in obligated payments to regional carrier Mesaba Aviation and to holders of some of its equipment certificates.

Another trader saw the 8 7/8s at 29.5 bid, pre-filing.

After news of the filing, yet another trader said, the 8 7/8s dropped to 22 bid, 24 offered, down eight points from where they had been, while the 10s were also at that level, down two points from where they were pre-news, with all the bonds trading flat, "and that's all you need to know."

That third trader said that from where he sat, "it's certainly a possibility" that either the Delta bankruptcy or the Northwest insolvency - or maybe even both - might be a prolonged process, not unlike the marathon restructuring that UAL Corp., the corporate parent of Number-Two U.S. carrier United Airlines, has been undergoing since December 2002.

Elk Grove Village, Ill.-based UAL is now expected to emerge from bankruptcy sometime early next year, and the trader said the company "is milking it for all its worth," since as long as it is in bankruptcy, it doesn't have to service any debt, unlike its competitors, and it has managed to off-load its pension obligations onto the federal government's Pension Benefits Guaranty Corp.

He opined that both of the newly bankrupt airlines may well have decided to file now because the federal bankruptcy laws are scheduled to change on Oct. 17. Among other things, debtors filing after that deadline will have less time in which to present a reorganization plan, opening the way for creditors and other stakeholders to submit plans not necessarily to management's liking.

"In doing so [filing now], they are allowing themselves plenty of time to do what they need to do - there is no time constraint to file a reorganization plan."

Although bankruptcy has traditionally been seen as a last resort when all else has failed, the trader said that now that the other shoe - finally - has been dropped by both Northwest and Delta, "this could be good" for each company and for the industry.

"If all goes according to plan, they should come out smaller, and I think everyone is hoping for some consolidation action" that will cut down on the airline industry's overall capacity - the number of planes flying and seats available, a glut which has helped to keep ticket prices at levels too low to generate enough revenues to help the carriers cope with skyrocketing fuel prices and other expenses.

"These companies will shrink, because they will have to shrink, and in doing so, some company, or another airline can scoop them up or merge with them," the way AmericaWest Holdings Corp. is buying US Airways Group Inc. out of bankruptcy, a deal given final approval by the Arlington, Va.-based Number-Seven U.S. airline's creditors on Wednesday.

One scenario which he said is not beyond the realm of possibility is the combination of Delta and Northwest themselves, about which he said "rumblings have been heard" in the market for a while. "It's possible, you never know. If it does happen, [they're] going to do what should have happened 25 years ago - the elimination of the duplicate service the two competitors currently run to the same markets, instead letting Delta focus on its southern U.S. base while Northwest builds on its strength in the Midwest and its international routes."

However, he noted, "that's just one option. A number of different things could happen. But I hope that this industry changes for the better now - people have learned their lessons."

While it's possible that either Delta or Northwest could merge or, more likely, be acquired by another carrier not currently in bankruptcy, the way AmericaWest is buying US Air, or the way industry leader AMR Corp.'s unit, American Airlines, acquired Trans World Airlines Inc. in early 2001, such combinations are by no means a panacea for the industry.

Analyst warns of merger challenges

One airline industry analyst skeptical about consolidation scenarios is Bill Mastoris, a managing director at BNY Capital, who notes that a major obstacle in trying to make two separate organizations into one is how to handle the seniority issues that would come up in combining the workforce groups of two merging companies, each with their own seniority schedules. This is especially true since any merged entity will likely be smaller than the sum of the two pre-merger companies in terms of fewer routes flown and fewer planes in the air - meaning fewer pilot and other air crew slots and, down the line, fewer ground crew positions as well.

"The merging of the pilot group is going to be extremely difficult," he cautioned. "We've seen an indication of that with AmericaWest and US Air. It's not necessarily a smooth operation, and if you go back throughout history, it's been very, very rough, and the track record for airline mergers has been pretty miserable."

As for the possibility that Delta and Northwest might be able to merge with one another, if they can find a strong financial partner to help them out, he said that "you had a lot of analysis that's been done on United, by a lot of different groups that would [potentially] take a position, but nobody has really stepped forward in a very volatile fuel price environment, with what is still generally characterized as an uncertain fare environment" - and United's assets are probably better and more attractive to a would-be investor than a combined Delta/Northwest entity's would be.

Mastoris said "neither carrier really wanted this." He said a "confluence of factors, and the short time frame in which they had to get a lot of very difficult tasks accomplished" pushed the carriers into the courts. Seasonally speaking, he said that if each airline is "not at their peak cash levels right now, then they're awfully close" - but even so, they were still not able to overcome all of the various financial obstacles, including fuel costs, which left bankruptcy as "probably the best [alternative], although it was an unfortunate alternative."

The analyst disagreed with the proposition that the impending change in the bankruptcy laws helped to perhaps artificially speed up the decision to file for protection on the part of each company. While the Oct. 17 deadline might be a factor to be considered, "given the fact that fuel is fairly high at this point, and given that there's an uncertainty looking forward into the seasonally weak fourth quarter and [2006] first quarter when it comes to passenger traffic, and it's also a period that's characterized generally by lower fares than you have during the peak season, I'm not sure it would have made a huge difference."

That having been said, the deadline was there, he said, as "an absolute must" date by which the carriers would have had to have achieved their pension relief and have gotten their labor cost concessions, in the case of Northwest, if they were to have avoided bankruptcy.

"I know that [Delta chief executive officer] Gerry Grinstein tried to do everything he possibly could to keep Delta out of bankruptcy, which is the right thing to do - but also, by the same token, what [he] needed to get done, in terms of additional concessions, additional funding, in conjunction with fuel prices, made that Oct. 17 date seem a whole lot larger than it would have otherwise appeared several months ago." It "loomed a whole lot larger as liquidity was eroding."

Mastoris said that while Hurricane Katrina - which caused energy prices to shoot up after it disrupted Gulf of Mexico petroleum production - "certainly did not help," it would not be accurate to say that the hurricane was what pushed the two carriers over the final precipice and into bankruptcy, since "all of the same general macroeconomic trends and factors [in place before the storm] were still there, while fuel prices, after spiking upward, have since come back down to levels "not inconsistent with where they were before Katrina actually hit."

He does not believe that either company - even with the extra time granted by the current bankruptcy laws - is likely to be in Chapter 11 for anywhere nearly as long as UAL has been. "This is going to be a much more expedited bankruptcy." He said that the aircraft market "has been largely defined in terms of lease rates and value," while "the labor rates are pretty clear," including fair compensation for pilots, mechanics baggage handlers, reservation agents and the like. "I think there's not going to be a huge disagreement there."

The UAL bankruptcy process, extended as it has been, has now created "a blueprint" for dealing with the insolvencies of other large, nationwide legacy carriers such as Delta and Northwest.

The UAL reorganization has been long and contentious in part due to United's efforts to shed its heavy pension burdens, which were eventually absorbed by the PBGC , and Mastoris cautioned that "the threat will clearly be there" that either Delta or Northwest, or both, might seek a similar federal takeover, since both airlines, before their bankruptcy, had been loudly lamenting the negative impact their pension obligations had on their finances - Grinstein and his opposite number at Northwest, Douglas Steenland, even went to Washington in early June to testify before a Senate committee, seeking approval for extending the time they would have to make up their unfunded pension liabilities.

"I think it would be incumbent upon Congress to go ahead and act, certainly before year-end, and I am sure that will be communicated" by the companies, and "if you don't get it, I think you could have a dumping of those pensions."

However, he said that the Delta and Northwest employee groups - which saw how their the pensions of their counterparts at United, as well as at US Airways, were reduced when PBGC took the United plans over - "are going to work to preserve those pensions, and will be willing to sacrifice more, in terms of wages and non-pension benefits, than they have at any time in the past" in order to preserve their pensions. "What happened at United, and what happened at US Airways clearly has had an impact, no question."

Northwest's Nasdaq-traded shares - which had lost more than half of their remaining value in very heavy trading on Tuesday,- on Wednesday recovered some of their lost ground, rising 30 cents (19.11%) to $1.87. Volume was 78.5 million shares, about 11 times the norm.

Tembec plunges

Outside of the airlines, a market source saw Tembec Inc.'s bonds fall like a chopped-down pine tree after Standard & Poor's downgraded the corporate credit and senior unsecured ratings of the Canadian forest products company and that of its Tembec Industries Inc. subsidiary to CCC+ from B previously.

After that downgrade, the company's 8 5/8% notes due 2009 fell to 77.5 bid from earlier levels at 81.125. Its 7¾% notes due 2012 dipped to 72 bid from 73.75, and its 8½% notes due 2011 were two points lower at 74.5.

Tembec "is currently not generating enough funds from operations to cover its interest and maintenance capital spending obligations," warned S&P credit analyst Daniel Parker in his downgrade message. "We believe the company's cash generation will continue to be very weak because of the appreciation of the Canadian dollar to the US dollar," with the Canadian unit having risen to 84 U.S. cents, the analyst said. He also noted high energy and fiber costs.

While Tembec "has adequate liquidity to ride out multiple quarters of weak cash generation," Parker projected, its liquidity position in the long run "is not sustainable absent material asset sales, a potential refund of softwood lumber duties, or improved cash generation."

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