In the late winter and early spring of 2020, the COVID-19 pandemic brought a dramatic reversal of fortune for one of the worlds largest and most profitable airlines, Delt

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Senior Lecturer Ted Berk and Ryan Flamerich (MBA 2021) prepared this case. This case was developed from published sources. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2021 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

T E D B E R K

R Y A N F L A M E R I C H

Delta Air Lines: Navigating the COVID-19 Storm

In the late winter and early spring of 2020, the COVID-19 pandemic brought a dramatic reversal of fortune for one of the world’s largest and most profitable airlines, Delta Air Lines, Inc. As the novel coronavirus spread globally, the airline industry faced a massive and sudden drop in activity. Governments around the world began restricting travel and ordering national lockdowns to stem the spread of the disease; the United States federal government barred travelers from the European Union and other countries, with increasing numbers of U.S. states requiring quarantines for inter-state travel.

Just a few months earlier, Delta had been celebrating record financial and operational performance, benefitting from a transformation plan executed over the previous decade that included investments in its fleet, customer service, and international joint ventures. For 2019, Delta had reported $6.2 billion of pre-tax income, $8.4 billion of cash flow from operations, $3 billion of cash returned to shareholders, and $1.6 billion in employee profit sharing. In addition, the company set new records for reliability and customer satisfaction.1

In 2020, however, Delta revealed a $7 billion pre-tax loss for the second quarter alone. As demand for its services plummeted in the face of the pandemic, Delta’s chief executive Edward Bastian, chief financial officer Paul Jacobson and other company leaders announced a series of initial financial and operational actions in response. By summer, even amidst the second wave of coronavirus infections in the United States, these measures had reduced the company’s cash “burn” from $100 million per day at the start of the pandemic to approximately $27 million per day.2 (See Exhibit 1 for Delta’s cash burn calculation.) Now, Bastian and Jacobson would have to determine if Delta was sufficiently well- positioned to survive and eventually compete in the post-COVID recovery … or if they needed to take further action to prepare for a prolonged crisis.

Delta Air Lines Delta Air Lines traces its roots back to the 1925 founding of Huff Daland Dusters, established in

Macon, Georgia as one of the first companies to spread fertilizers and pesticides using aircraft. The company was renamed Delta Air Service to reflect the Mississippi River Delta region it served, and it expanded rapidly (especially after World War II) to provide mail and passenger services from a new base in Atlanta, Georgia.3 Protected throughout its early decades by Depression-era regulations that

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prevented large-scale competition on its routes in the eastern United Statesa, Delta invested in innovations such as jet engine-powered aircraft, electronic booking systems and a hub-and-spoke network.

Industry deregulation in 1978 created an opportunity for Delta to expand geographically. With over 30 airline bankruptcies between 1979 and 19854, many of the aircraft and flight routes left vacant by defunct airlines were gobbled up by larger players, including Delta. Delta’s revenue more than doubled during the initial deregulation period, from $2.2 billion in 1978 to $4.6 billion just six years later.5,6

Delta’s operations continued to grow until the terrorist attacks of September 11, 2001b. Bastian described the impact the attacks had on the airline: “In Atlanta, it was eerie. Our offices are right across from the airfield, and there was just the sound of silence for several days. It was like a pall that sat over the airport, the office, everything. We saw international business drop to almost nothing overnight. We had to let 15,000 people go in two weeks because we didn’t have any cash coming in. It took us 10 years as a company to recover from that.”7

Faced with reduced passenger demand, rising fuel costs, and increased competition, Delta would ultimately lose more than $10 billion before following its competitors Northwest Airlines, United Airlines, and US Airways into bankruptcy, four years after the attacks.8

Delta’s most recent decade

Delta emerged from bankruptcy in 2007 and merged with Northwest in 2008 to form, at the time, the world’s largest airline. Rapid consolidation among major airlines became a hallmark of the following decade. By 2016, four major airlines carried over 70% of passengers in the United States: Delta Air Lines (merged with Northwest Airlines), United Airlines (merged with Continental Airlines), Southwest Airlines (merged with AirTran), and American Airlines (merged with U.S. Airways and America West Airlines). (See Exhibit 2 for U.S. carrier market-share trends.) These mergers were seen by many analysts as successfully right-sizing the industry, resulting in the longest period of industry profitability since deregulation.9

As the first of the major carriers to merge, Delta was well-positioned to enhance operational effectiveness and on-board product earlier than competitors. By the end of the 2010s, Delta led U.S. airlines in rates of on-time arrivals and enjoyed the lowest number of canceled flights and misplaced bags. The company’s gains in service were rewarded by customers: Delta’s planes were fuller than peers, and Delta achieved the highest average effective prices of any legacy carrierc in 2019.10 At the same time, Delta’s operating costs were similar to or lower than its competitors, allowing the company to attain the highest profitability among legacy carriers. (Delta’s recent annual and quarterly financial information can be found in Exhibits 3, 4 and 5. Summary financial information for key Delta competitors is in Exhibit 6.)

a The Civil Aeronautics Act of 1938 established the Civil Aeronautics Board (CAB) to regulate flight routes and pricing, industry entrants, and fares. Interstate air travel was deemed a public utility, and the CAB was granted broad authority over fares and routes. The Airline Deregulation Act in 1978 created an aviation free market and transferred the CAB’s regulatory powers to the newly created Federal Aviation Administration (FAA).

b On September 11, 2001, terrorists hijacked four airplanes departing from New York and Boston, crashing them into the World Trade Center in New York, the Pentagon in Virginia, and in rural Pennsylvania. At least 2,977 people were killed in the attacks, and air space over the United States was closed for two days.

c Legacy carriers refer to those carriers existing prior to deregulation: American Airlines, Delta Airlines, and United Airlines as of 2019.

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Delta achieved these results alongside a relatively conservative approach to fleet modernization; with an average age of 15.8 years in 2019, Delta’s aircraft were the oldest of major U.S. and many leading foreign airlines.11 Similarly, rather than invest in a large international fleet, Delta took significant equity stakes in joint venture partners to carry Delta’s passengers beyond major global hubs and gain access to key congested markets such as London, Paris, and Shanghai.

Managing an Airline It’s true that the airlines had a bad 20th century. They’re like the Chicago Cubs. And they got that bad century

out of the way, I hope.

— Warren Buffet12

For much of the post-deregulation period, the U.S. airline industry had struggled to establish consistent profitability. Through the 1990s and 2000s, the rise of online travel agencies such as Expedia and Priceline created fare transparency; in addition, recent entrants such as JetBlue and Spirit offered newer, more fuel-efficient aircraft with reduced amenities, enabling these airlines to compete largely on price.13 As a result, average inflation-adjusted ticket prices fell from $604 in 1993 to $514 in 2000 to $355 by 2019.14 Indeed, Bastian led a company that was not only in a highly competitive industry but also was characterized by revenues strongly linked to the macroeconomic environment, significant fixed costs, large capital requirements, and meaningful operational complexity.

Airline Revenue

In light of the relatively fixed costs of each flight, airlines had innovated premium services, loyalty programs and sophisticated pricing algorithms to attract customers to, and maximize revenue from, every available seat and physical space on each aircraft.15 Passenger services in the main and premium cabins of an aircraft accounted for approximately 90% of revenue for the legacy carriers; this increasingly included ancillary revenue streams related to a customer’s journey, such as fees for baggage and Wi-Fi services.

Cargo services, mostly sold by weight, enabled business customers to ship goods quickly or with specific requirements. In addition, non-flight revenue sources could be significant and highly profitable for airlines, including profit-sharing agreements with co-branded credit cards and passenger lounge memberships. (See Exhibit 7 for a description of Delta’s SkyMiles loyalty program and partnership with American Express.)

Operating Costs

To deliver these services, airlines’ largest operating costs were typically payroll and fuel; combined, these categories comprised nearly 49% of Delta’s operating costs in 2019.16 Most employees – including pilots, mechanics, and flight attendants – were members of independent unions. Indeed, the airline industry was among the most heavily unionized in the United States.17 Since deregulation, U.S. airlines had experienced 16 strikes; in addition, unions could take non-strike actions such as work slowdowns to pressure airline management and operational performance especially during contract negotiations.18 While unions represented over 80% of employees at Southwest, United, and American Airlines,19 only 19% of Delta’s employees were represented by a union in 2019.20 Profit-sharing arrangements between the airline and staff had contributed to limiting flight-attendant unionization attempts at Delta, for example.21

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Fuel typically remained the second largest operating cost of an airline, even though jet engines had become far more efficient since their introduction. (See Exhibit 8 for historical jet fuel prices.) Some airlines chose to hedge this cost in some periods, while Delta took the unique approach of purchasing an oil refinery in 2012 to help control its supply of jet fuel. That facility experienced mixed results as oil prices had continued to fall from 2012 levels.22

See Exhibit 9 for a comparison of key operational metrics for the legacy carriers. 23,24,25

Capital investment & funding

Airlines typically required very significant and ongoing capital investments to acquire and maintain a fleet of passenger planes, landing rights, and airport real estate. Bastian described Delta’s 2019 capital expenditures in the following way: “We’ll invest almost $5 billion in capital, which is fundamentally our R&D. Our technologies run multiple years. They’ll run up to 20 to 30 years as we roll out new fleets. Airplanes, airports, we got new airports going up in LA and Seattle, Salt Lake, New York, rebuilding LaGuardia.”26

In addition to the capital investment, ongoing maintenance costs on aircraft were also significant; Delta’s 2019 fleet maintenance expense was $1.75 billion.27

In light of these revenue, cost and investment dynamics, Delta had established a debt to EBITDARd ratio target of 1.5 to 2.5x to guide its funding decisions. According to Jacobson in January 2020, “Delta’s investment-grade balance sheet remains an important competitive advantage.”28 Indeed, Delta was the first legacy airline to regain an investment-grade rating after the bankruptcies that had followed the September 11 attacks, resulting in lower financing costs than peers.

COVID-19 and Delta’s Initial Response On January 5, 2020, the World Health Organization (WHO) released its first risk assessment and

advice on the status of pneumonia cases in China’s Wuhan province. By January 13th, the illness was determined to be the result of a novel coronavirus, technically designated “severe acute respiratory syndrome coronavirus 2” (SARS-CoV-2); cases of the disease now called COVID-19 were being identified throughout Asia. With high fatality rates from COVID-19 particularly among older individuals and those with underlying health conditions, as well as accelerating global spread, WHO formally declared a global pandemic in progress on March 11, 2020.29 Governments around the world, including the United States, began closing borders and restricting air travel to contain the spread of the virus. (See Exhibit 10 for U.S. infection data and Exhibit 11 for historical passenger enplanements.)

The immediate drop in passenger volume left Delta losing $100 million per day.30 Bastian summarized management’s initial approach to the situation as follows: “Our response has been focused on three priorities. First, protecting the health and the safety of our employees and our customers. Second, preserving our financial liquidity to work through this crisis. And third, ensuring we’re well-positioned to recover once the virus is contained and building a plan to accelerate our progress through this period of recovery.”31

d Earnings before interest, taxes, depreciation, amortization and rental costs. This metric is commonly used to measure operational performance in businesses with significant rental expenses, effectively excluding the financial impact of the firm’s decision to lease or own certain assets required in the business.

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Delta dramatically reduced operations to reflect falling passenger levels. This step involved parking more than 600 aircraft in short-term and long-term storage facilities, over half of Delta’s fleet.32 At the same time, Delta accelerated its plan to permanently retire older, less efficient jets to further reduce flight and maintenance costs. For the June 2020 quarter, these actions had reduced Delta’s available capacity by 85% versus the same period in the prior year.

Fewer flights allowed for operations to be consolidated at airports, reducing facility maintenance and rent charges. Payroll costs would be reduced by voluntary departures and early retirements of 17,000 employees; in addition, 37,000 of Delta’s 90,000 employees took unpaid leaves of absence during the summer of 2020.33 Further, Delta delayed aircraft modifications and future aircraft deliveries from equipment manufacturers as part of a $3.5 billion reduction in planned capital expenditure.

At the same time, Delta sought to maintain its customer service as best as possible. For example, in light of the pandemic conditions, Delta committed to limit passengers on its aircraft to 60% of capacity and to block middle seats until at least the end of September 2020; competitor Southwest had made a similar statement, while American and United removed their seating caps earlier in the pandemic.34

With these actions, Delta had reduced its cash burn rate to $27 million per day in June, while American’s and United’s daily burn rates stood at $55 million and $40 million, respectively.35,36 Delta leadership had set a goal of achieving cash-flow break-even by the end of the calendar year, but some analysts expressed skepticism, pointing out that this was highly dependent on the pace and timing of any recovery in demand.37

Beyond operational changes, Delta executed a number of significant balance-sheet actions intended to protect the business in the crisis and strengthen its position for the eventual recovery. It had amassed $15.7 billion in available liquidity by June 2020, a significantly larger amount than American ($10.2 billion) or United ($9.5 billion).38,39,40 Major sources of Delta’s liquidity included:

• $4.9 billion in payroll support from the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, the United States government’s financial relief program for individuals and businesses impacted by the pandemic, of which $1.4 billion was in the form of an unsecured loan and the remainder in a grant;e

• $3.5 billion in new senior secured notes due 2025, plus a new $1.5 billion term loan due in 2023, both of which were collateralized by landing rights, airport gate rights, and flying rights between certain destinations;

• $3.0 billion drawn from previously undrawn credit facilities, including extending the maturity of $1.3 billion of these facilities from April 2021 to April 2022;

• $3.0 billion raised from a new 364-day term loan facility, secured by certain aircraft, plus $2.8 billion raised from sale-leaseback transactionsf involving 85 aircraft, and $1.4 billion in other financings secured by aircraft;

• $1.3 billion in new unsecured notes due 2026.

e The payments under the CARES Act required Delta to agree not to conduct involuntary employee layoffs or furloughs through September 30, 2020. In addition, the program included restrictions on executive compensation, prohibited stock repurchases and dividends through September 30, 2021, and required Delta to maintain so-called essential air service as directed by the federal government. Further, the U.S. Treasury received warrants to acquire over 6.5 million Delta shares at an exercise price of $24.39.

f In a sale-leaseback transaction, an airline sells aircraft to a leasing company in return for cash; at the same time, the airline enters into a lease under which it operates the plane(s) and pays ongoing rent to the leasing company for the aircraft.

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In addition, Delta negotiated with its lenders to amend certain terms of its credit facilities. Previously, Delta had agreed to maintain a level of operational profits (specifically EBITDAR) that would more than cover its obligations to pay interest and aircraft rent with a 25% cushion (a so-called fixed charge coverage ratio covenant).41 Going forward, Delta agreed instead to maintain at least $2 billion of liquidity. (See Exhibit 12 for further detail on Delta’s financing and liquidity.)

These changes, along with the uncertain industry conditions, had led rating agencies S&P and Fitch to downgrade Delta’s credit rating to “junk” status: BB and BB+, respectively.42

Preparing Delta’s Balance Sheet for the Future As the summer of 2020 unfolded, the outlook for the airline industry – and for the pandemic –

remained uncertain. Travel bookings were increasing from their spring lows. The United States government had approved Operation Warp Speed, seeking to develop a COVID-19 vaccine in record time; preliminary expectations were that a vaccine could be available in late 2020 or early 2021. However, Dr. Robert Redfield, the head of the U.S. Centers for Disease Control, predicted: “I do think the fall and the winter of 2020 and 2021 are going to be probably one of the most difficult times we’ve experienced in American public health because of … the co-occurrence of COVID and influenza.”43

Looking ahead to the holiday season, rising infection counts could see a return to the shutdowns experienced in the spring and would likely further reduce passenger demand during what was usually the busiest travel period of the year.

In this context, Bastian and Jacobsen would need to determine how best to manage Delta’s capital structure going forward. If the company decided to take further action, a range of options might be considered, including one or more of the following:

• Borrow against aircraft. Although Delta had completed a sale-leaseback transaction earlier in the summer, the company still had approximately $6 to $7 billion worth of aircraft that were available as potential collateral for new borrowing.44 This could be structured in a number of ways, including a further sale-leaseback or a secured loan.

• Borrow against SkyMiles program. Delta’s competitor United had successfully raised a $6.8 billion financing earlier in the summer using its MileagePlus loyalty program as collateral. (See Exhibit 13 for a summary of United’s loyalty financing.) Delta’s SkyMiles program was approximately 25% larger than MileagePlus, potentially allowing Delta to raise even more capital than United in this manner.45 As Jacobson told analysts when asked about the MileagePlus borrowing, “We’re an infinitely competitive business, but hats off to United for that execution. I thought they did a very good job with that. And it’s one that I think is available to a multitude of carriers.”46

• Borrow from the U.S. Treasury. On top of the initial relief funding agreed in April 2020, the federal government had offered to make available a further $4.6 billion in loans to Delta. The company had until September to decide whether to accept and draw the loans. The loan was expected to have a term of 4-5 years, an interest rate of LIBORg plus 3-4%, and to be secured on

g The London Interbank Offered Rate (“LIBOR”) is the interest rate at which major global banks lend to each other on a short- term basis. It is commonly used as a benchmark interest rate for lending. LIBOR will be phased out starting at the end of 2021 and gradually replaced with alternative benchmarks depending on the currency, such as the secured overnight financing rate (“SOFR”) for US-dollar-denominated borrowing.

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various company assets such as aircraft or possibly the frequent flier program. Under the legislation that authorized the government loan program, the loans would include covenants that set restrictions on employee compensation, stock repurchases and dividends, and employment reductions. Additional compensation to the government would come in the form of warrants issued to the Treasury to purchase common stock.47

• Raise common equity in the public market. Delta’s common stock had traded between $25 and $35 per share during the summer, far from its pre-crisis range of $55-60 per share. (Delta’s historical stock price can be found in Exhibit 14.) Common equity would not include any ongoing requirement to pay dividends; although Delta had paid quarterly dividends to its shareholders since 2013, the terms of its relief funding from the Treasury would preclude it from choosing to pay dividends in the near term.48,49 So far, American and United had each raised approximately $1.1 billion in equity to strengthen their financial positions during the pandemic, while Southwest had raised $2.2 billion.50,51,52

• Sell non-core assets. In connection with Delta’s global partnership strategy, the company held investments in international carriers such as Air France-KLM and China Eastern; Delta also held a stake in private-jet operator WheelsUp. Even after writing down its investments in LATAM, Grupo Aeromexico and Virgin Atlantic to zero in the most recent quarter, Delta valued its various strategic investments at approximately $1.4 billion in the aggregate.53 In addition, Delta continued to own an oil refinery purchased in 2012 for $150 million, although the pandemic downturn had negatively affected the facility’s performance.54

The first months of the pandemic had brought massive operational and financial change at Delta. Now, Bastian would have to decide whether to take further action or pause to see how the pandemic would unfold. Should Delta raise additional funding, and if so, for what purpose and in what form? How would customers, employees, suppliers, shareholders, lenders, and rating agencies react to the various alternatives under consideration? The decision could determine whether the airline survived the pandemic and maintained its competitive edge afterwards.

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Exhibit 1 Delta Air Lines Daily Cash Burn ($ millions)

Source: Delta Air Lines Q2 2020 Earnings Announcement

Month ended June 30, 2020

Net cash (used in) / provided by operating activities 75 Net cash used in investing activities (754) Adjustments:

Net purchases of short-term investments 1,091 Net cash flows related to certain airport construction projects and other (30)

Total 382

Proceeds from financing arrangements reported with investing activities (422) CARES Act grant proceeds (761) Adjusted total (801) Days in period 30 Average daily cash burn (27)

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Exhibit 2 Major United States Airlines, Share of Enplanements (Domestic and International)

Source: Created by casewriters using data from Bureau of Transportation Statistics, “Air Carriers: T-100 International Segment

(US Carriers Only)”, from agency website, https://www.transtats.bts.gov/Fields.asp, accessed October 2020.

Note: Enplanements from subsidiaries are included with parent company where applicable.

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Exhibit 3 Delta Air Lines Historical Profit & Loss Summary (December 31; $ millions)

Source: Compiled by casewriters from S&P Capital IQ; Delta Air Lines 2019 Form 10-K, pp. 27-28.

Note: Other revenue includes loyalty program, refinery, and ancillary businesses.

2017 2018 2019

Passenger & cargo revenue 37,691 40,620 43,030 Other revenue 3,447 3,818 3,977

Total revenue 41,138 44,438 47,007

Operating expense (34,963) (38,979) (40,357) Operating income 6,175 5,459 6,650

Interest expense (396) (311) (301) Other non-operating expense (20) (1

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