Jeremy Warner's Outlook: Deny US airlines their Chapter 11 life support

Click to follow

US airlines never die - they just get reincarnated. America may be the land of the free - of red in tooth and claw capitalism - yet when it comes to airlines, something all sentimental and dewy eyed seems to come over even the most hard bitten of American money men. Somehow or other, American airlines always seem to rise phoenix like from the ashes of their own insolvency. There are far too many airlines in America, and at least a half of them are essentially bust, but politicians and legislators seem quite incapable of allowing the necessary cull. On Capitol hill and beyond, the airline lobby remains a remarkably powerful force.

First came the 11 September terrorist atrocities, then Sars, then the Iraq war, and now the high oil price. One alone of these crises would in any other industry have been enough to put any number of players out of business. The fact that all four in combination has failed to claim even a single liquidation is down to the billions in aid heaped by the Federal authorities on the airlines and the miracle of Chapter 11 - the US insolvency procedure that allows companies to seek temporary protection from their creditors.

Over the weekend, US Airways achieved the dubious distinction of becoming the first American company to file for Chapter 11 twice in two years. There is nothing wrong with the principle of Chapter 11, a relatively enlightened insolvency procedure that allows companies to force through painful but possibly lifesaving surgery. In theory, it prevents the total wipeout of creditors that might occur in a complete liquidation.

Yet with airlines, the effect is only to perpetuate and make worse an already unsustainable excess of capacity over demand. Freed from the need to meet interest costs and debt repayments, the airline will typically slash prices in an effort to generate extra revenues, undermining the position even of previously solvent competitors. It is no surprise that more than a third of the US airline industry is now in Chapter 11, for it gives a "beggar thy neighbour" competitive advantage to all who apply it. Presumably, one or more of the dinosaurs of the US airline industry will eventually be allowed to keel over and die. But there is still an awful lot of pork barrel politics involved in this industry, and there doesn't seem much appetite even for the one sacrificial scalp.

WPP/Grey Global

One small step for WPP, one giant leap for Sir Martin Sorrell. The acquisition of Grey Global is only the latest in a long line of takeovers for the hyper acquisitive advertising goliath, WPP, but there is a significance in this latest deal that goes beyond the fact that Grey was the last independent of any significance outside the sway of the big networks. It also makes WPP into the largest advertising group in the world by revenue.

Sir Martin doesn't like to make too much of this milestone. He's only there by a hair's breadth, and given the shifting fortunes of this industry, as likely as not his newly won lead over Omnicom of the US will be reversed shortly.

None the less, for the time being, Sir Martin sits atop his industry, with all the others, as it were, spread out beneath him. That's quite an achievement given WPP's origins as a tiny manufacturer of wire supermarket baskets. From these unlikely beginnings, it has taken Sir Martin less than 20 years to create the world's biggest marketing services group. His former bosses, the brothers Saatchi, can only look on in amazement at the raw energy and determination that has made it happen.

Along the way, there has been a string of acquisitions, one of which, Ogilvy, bought just before the recession of the early 1990s, nearly sunk both Sir Martin and his company. If you'd bought shares in WPP at the height of their glamour stock status just before the crash of 1987, you'd still be out of the money, such was the scale of the debt for equity swap Sir Martin was forced to concede to keep the company afloat. Few chief executives survive such a calamity.

Interestingly, the share price graphic today doesn't look so dissimilar to the way it did then - a bubble inspired peak followed by a steep decline, and then ... in the early 1990s the price fell off a cliff as the enormity of the company's financial difficulties became apparent. The superstitious might think history is about to repeat itself. Only this time around that seems so unlikely as to be virtually impossible. The mistake Sir Martin made with Ogilvy was to buy at the top of the market in cash, horribly overstretching himself in the process and making the enterprise highly vulnerable to any drop in the advertising market. All his deals since have involved a high degree of equity. There's to be no second, near death experience.

Sir Martin has also managed to prove the sceptics wrong in realising the dream of a global network of advertising and marketing services companies. Advertising is a people business demanding strong creative as well as business skills. In any such industry, diseconomy of scale is highly likely to outweigh any scale savings. Unlike accounting and investment banking, advertising has also traditionally found it hard to deal with conflict of interest.

I'm not quite sure how he's done it, but Sir Martin has managed to get the back office savings a global network can aspire to and keep the clients and the best of his people as well. There are few corporate rivalries as fierce as that between Procter & Gamble and Unilever. The fact that Sir Martin has secured their agreement to coexist in the same advertising network - for the time being at least - is quite something.

Drugs don't work

It should have been possible to see the US Food and Drug Administration's negative ruling on AstraZeneca's Exanta, an anti-clotting drug that was being widely billed as a potential blockbuster, coming a mile off, but no one did. Most worrying of all, that includes the company itself. This suggests a degree of naivety which raises serious questions about the rest of AstraZeneca's pipeline of new drugs. On Exanta at least, the company was far too optimistic. What does that say about other drugs under development?

The FDA panel which turned down Exanta raised a number of questions about AstraZeneca's methodology in clinical trials, including its interpretation of some of the data. The shares have therefore suffered a double punishment in the stock market - once for the pruning of earnings forecasts now that there are to be no US sales of Exanta to buoy revenues, and again to take account of the possibility that there may be a systemic problem at AstraZeneca which could lead to further disappointments.

Some big positions had been built up in AstraZeneca shares on the presumption of a positive outcome. It will take a while before the damage is repaired. On this front, much will depend on the pipeline update the company promises to give early next month. Yet however promising this looks, after Exanta there is bound to be a question mark over deliverability.

Inability to get new drugs approved at the rate they used to be is a problem not just for AstraZeneca, but for the entire industry. This is only in part because the FDA and other regulators have begun to demand higher standards of safety and efficacy. There are also fewer drugs being submitted for approval. Again, this may be down simply to the extraordinarily high costs of taking a compound to the completion of clinical trials. Companies are understandably reluctant to go the whole way if there is a significant chance of falling at the last hurdle.

Yet the bigger worry is that the science is reaching the limits of its inventiveness. The bulk of drug approvals these days are simply me-too versions of someone else's blockbuster. The number of genuinely new compounds coming though are on a falling trend. Much of the low hanging fruit of drug development has already been plucked. For the time being, the higher branches - dementias, cancers and other little understood illnesses of the mind and body - remain largely out of reach.