By 1995, Continental Airlines had been down so many times, it was considered the palooka of the airline industry. Facing its third bankruptcy at that time, the battered airline was all but ignored by the financial community. In stepped 39-year-old Larry Kellner, who was charged with rebuilding the airline’s bloodied reputation. He gave Continental not just a fighting chance, but a stab at victory.
Kellner’s chief challenge was to rebuild Continental’s relationships with investors, analysts, banks, creditors, and rating agencies–no easy task. “Larry had to take a company that had lost all external credibility and re-tore the confidence of Wall Street and the investment community,” says Gordon Bethune, Continental’s chairman and CEO, adding, “The challenge was to raise billions of dollars in financing. And Larry did that in the most cost-effective manner, raising money within 85 basis points over Treasuries.”
Kellner’s formula for success is a mix of street smarts, solid financial acumen, a willingness to try new approaches, and an ability to persuade others to believe in the mission–akin to asking the financial community to throw good money after bad. “I arrived in an environment in which we had more than $500 million in debt and a billion dollars of aircraft operating leases in default,” recalls Kellner, the former CFO of American Savings Bank of Irvine, California. “We had basically run out of cash. Things were so bad for so long that Gordon needed to ask Boeing to return the predelivery deposits on aircraft due us. Boeing agreed to give half back–about $30 million–which they said they’d mail to us. Gordon said thanks, but could you wire it instead, we need to make payroll in two days. That’s what life was like back in early ’95.”
Nothing but Sky
To reroute the airline financially would require convincing Continental’s external stakeholders that the skies were clearing. This objective was so critical, Bethune tagged it as one of the major components of his widely acclaimed “Go Forward” plan. And Kellner achieved the near-impossible–with financial savvy and frank confessions.
“Larry had a huge task ahead of him,” says Don Shokrian, vice president of Chase Securities Inc., the New Yorkbased investment bank. “We’re talking several billion dollars in refinancing. He deserves credit for taking a partnership stance with the banking community and investors. The information flowed readily, and he opened the doors to Continental’s management.”
After signing on as CFO in June 1995, Kellner’s first task was to fix several pieces of debt that were in default. “We went to work with our largest creditor, General Electric, to restructure roughly $600 million in outstanding debt, which was expensive and not viable for us long-term,” he says. “We also were stuck taking over planes from Boeing that they had already built for us and were financing to the tune of 12 percent. Well, it’s impossible to make money when you’re taking planes with that kind of debt.”
Continental also had equity holders that were concerned about share dilution. In addition, Air Canada, which had invested $55 million to help bring Continental out of its second bankruptcy in 1993, wanted its investment back. “They had been in about a year and a half and had seen the equity not do that well,” Kellner says. “They were scared to death.”
Air Canada had warrants to buy an additional 12 million shares of equity in Continental. But Kellner decided to buy the warrants back. “It gave us the equity to solve all the other problems without diluting everybody’s share count,” he says. Meanwhile, thanks in large part to Bethune’s and Brenneman’s fine- tuning of Continental’s on-time performance and other customer-related criteria, its stock price surged. “It was at about $8 a share when I got here; two and a half months later, it was at $15,” Kellner says.
After purchasing back the Air Canada warrants, Kellner cut a deal with Boeing to finance it out of the picture. “I told them, ‘Hey, you’re a lender, and you’ve taken a big risk by lending to a lousy creditor,'” he says. “‘If we can get you totally out, will you give us all the benefits?’ They said yes.”
Breaching the Boeing impasse led to other refinancings. Says Chase Securities’s Shokrian, “It helped Larry get back into the flow of information with the syndicated- loan market, which gave us the leverage to refinance the GE debt. Continental now had its first working-capital facility in 10 years.”
“I told GE I’d work with them to take them out of the $600 million, but I needed them to buy lease equity on the planes,” Kellner says. “They came in and bought the airplane lease equity and then went into the open market using enhanced equipment trust certificates to refinance the 12 percent debt on our existing aircraft. Our savings were about $20 million a year just on those planes.”
More deals followed, earning accolades for Bethune’s “Go Forward” team. Even more important, the airline achieved substantial credit-rating upgrades. Numbers tell the tale: Continental’s annual net interest expense fell from $204 million in 1994 to $75 million at the end of 1997; net debt to equity dropped from 37.3 on March 31, 1995, to 4.4 on December 31, 1997; and more than $6 billion in financings ultimately were completed between November 1995 and April of this year. Continental’s unrestricted cash skyrocketed to over $1 billion, giving the firm the cash necessary to run a $7 billion operation and provide for the next economic downturn.
Kellner’s candid ways with external stakeholders removed a shroud of uncertainty. “I believe in underpromising and overdelivering,” Kellner says. “My approach is to be blunt, direct, honest, and to make sense. You go to stakeholders with what you want to do–not some crazy idea– tell them why, listen, compromise, and move on.”
It was a winning approach. “Pre- Larry Kellner, Continental was not forthcoming about their situation and didn’t have a good idea about where they were and where they were going,” says Tom Schreier, director of equity research covering the airline industry for Credit Suisse First Boston in New York. “As analysts, we are forced to translate Continental’s strategy into detailed performance criteria, and Larry knows that. He’s a master of details, which isn’t a universal skill among CFOs.”
Of the 11 equity analysts that follow Continental, 7 have “accumulate” or “buy” ratings. Large investors are heeding the advice. There are now more than 130 institutional investors in Continental, representing in excess of 80 percent of its outstanding shares, compared with 30 institutional holders representing 45 percent of its shares in early 1995. “We chose them three years ago, and now have roughly 8 million shares,” says Robert Gendelman, a principal at New Yorkbased investment firm Neuberger & Berman LLC. “Larry was a big part of our decision. He truly understands the underlying business and how to create an appropriate capital structure for that business.”