A Daring New Flying Machine

By Stephen Koepp

Before the drama of hijacked Flight 847 began to unfold last Friday, executives of Trans World Airlines were preoccupied by an equally riveting, corporate development: the birth of a huge new airline company. TWA, which has struggled for the past month to escape Corporate Raider Carl Icahn, agreed to be acquired by Texas Air Corp., which already owns Continental and New York Air. The merger will create the second largest U.S. airline, after United.

TWA's takeover was the latest sign of the turbulence that continues to roil the airline industry. The fare wars set loose by deregulation in 1978 have created an environment in which only the fittest seem able to stay healthy. The turmoil has produced deep financial woes for some carriers and rampant confusion for travelers, who can barely keep up with changing prices and the innumerable restrictions that apply. Among the latest other developments:

-- United pilots agreed to return to work last week after a bitter month-long walkout that cut the airline's schedule to just 14% of its normal 1,550 flights a day.

-- In April the perennially struggling Pan Am, weakened by years of losses and a strike by ground employees in March, sold its Pacific routes to United for $750 million.

-- An ailing Frontier Airlines decided in May to sell 25 jets, about half its fleet, in order to raise $265 million. -- Major carriers have been forced into a war of so-called Ultimate Super Saver fares, which slash prices on some routes as much as 70%.

To win TWA (1984 sales: $3.7 billion), Houston-based Texas Air offered about $925 million for the company, which includes $23 in cash and securities for each TWA common share. The investment firm Drexel Burnham Lambert will help Texas Air raise the money by underwriting "junk bonds," a popular takeover tool. Icahn, who stands to make a profit of about $50 million when he sells his TWA shares to Texas Air, will probably go along with the deal.

The merger will end the independence of an airline that began in 1928 as a rail-and-air service whose first route was plotted by Charles Lindbergh. Owned briefly by General Motors in the 1930s, TWA fell into the hands of Howard Hughes in 1939. The eccentric tycoon initially fostered rapid growth but later nearly wrecked the company with indecisiveness. Hughes sold his stock in 1966. During the 1970s, TWA ventured heavily into the hotel and food-service business, which turned out to be far more profitable than the airline. Stockholders spun off the carrier as a separate company in February 1984.

TWA began a comeback last year, earning $29.9 million, its first profit in four years. Icahn came along with his takeover offer last month. He eventually acquired 33% of TWA's stock and was offering $18 a share for the rest. Despite Icahn's denials, TWA feared that if he won control he would dismantle the company by selling off some routes, as well as landing rights and jets.

Determined to avoid Icahn at any cost, TWA President C.E. Meyer launched an all-out defense. He solicited other bidders and caught the eye of Texas Air Chairman Frank Lorenzo. The resulting marriage between TWA and Texas Air could be a happy one. One reason: both own valuable foreign routes. Most of Continental's cross the Pacific, while TWA's map links the U.S. to Europe and the Middle East. In the beginning, at least, the union will be strictly financial: the airlines will maintain separate routes and personnel. Travelers will not see much difference.

Yet the combined company will be a powerhouse, commanding a fleet of nearly 300 jets, a payroll of 40,000 and more than $5 billion in revenues. While the merger requires the approval of federal regulators, none voiced any immediate objections on antitrust grounds.

The TWA takeover represents an audacious coup by Lorenzo, 45, who has longed to become an industry leader. After graduating from Harvard Business School, his first job was as a TWA financial analyst. With a school chum, Robert Carney, Lorenzo took over Texas International in 1972. He liked to boast that he had turned the once foundering carrier into the "smallest and meanest" airline in the world.

After staging a bitterly fought takeover of the ailing Continental in 1981, Lorenzo took that airline into bankruptcy proceedings in 1983. The move enabled him to dump Continental's costly labor contracts. He laid off Continental's entire staff of 12,000 and offered them their jobs back at half the salary. Only one-third returned. While that earned him a reputation as a union basher, Lorenzo's moves succeeded in reviving Continental. After losing $218 million in 1983, the company earned $50.3 million last year.

Lorenzo represents the hard-nosed new breed of airline manager who can flourish in the deregulated industry. He is expected to bring his philosophy to TWA, a sobering prospect for the airline's employees. Some staffers were / printing buttons last week that read, CALL BACK ICAHN, while complaining that TWA's board had betrayed the rank and file. "The board was all smiles. Of course, they should be," said one TWA insider. "What do they have to fear? It's not their backsides Lorenzo is going to kick." TWA is currently negotiating contracts with its machinists and flight attendants. The airline has been deadlocked since last month in talks with the 7,000 attendants, who have asked federal mediators to begin a 30-day countdown to a strike. The rise of tough bosses like Lorenzo has led large, established airlines to imitate their labor-busting tactics in order to compete. Lorenzo's takeover of TWA was "a living illustration of why we were forced to take a strike," John Zeeman, a United executive vice president, told the Wall Street Journal. United's pilots walked out May 17, protesting the airline's plan to lower starting wages for new pilots. Although the two sides reached an agreement on that issue within a week, they remained snarled for three more because pilots could not agree with United on back-to-work terms. While the company expects to restore full service in about two weeks, bad feelings between the pilots and United are likely to linger.

Airlines that fail to slash costs during the next several years may wind up bankrupt, as Air Florida did last year, or be forced into a merger with more aggressive partners. One of the most likely candidates for a takeover, or even demise, is Pan Am, which has lost some $770 million since 1981. Though the company bought more time for itself by selling its Pacific routes to United, it has almost nothing left to dispose of without going out of business.

The airlines remain caught in a feverish scramble to innovate that can bewilder consumers. They juggle their routes constantly, adding a city where competition is light and dropping ones where an abundance of rivals has slashed profits. While airfares remain low on popular routes, elaborate restrictions apply, including penalties for cancellation. But cost cutting has also produced benefits for consumers in the form of attractively priced fares. Eastern, for example, began earning extra income in April by carrying passengers on some of its formerly all-freight runs. Result: the Moonlight Special, a no-frills flight from coast to coast for just $98.

Industry experts see some positive signs for airlines. One is the drop in oil prices, which has cut the cost of jet fuel by 20% since 1981, to about 81 cents per gal. Another is the increased business that low fares have generated. U.S. carriers reported a healthy 15% gain in traffic during the first quarter of this year vs. the same period a year ago. Those increases have given at least a temporary respite to ailing firms. Republic, after losing $222 million between 1980 and 1983, posted a profit of $29.5 million for 1984.

While a few airlines, notably USAir, have been consistently strong, many are only beginning to recoup the vast losses they endured in the late 1970s and early 1980s. They will need several seasons of robust business to become hale and hearty fliers again.

With reporting by Raji Samghabadi/New York and Gary Taylor/Houston