Gremlin on the Wing

Why TWA keeps losing money and how Carl Icahn keeps cashing in at the airline's expense

In the 1980s, TWA was one big flying complaint. The planes were dirty, aging and rarely punctual, and the airline was showered with complaints from angry passengers. In 1985, TWA became embroiled in a hostile takeover battle with Frank Lorenzo, then CEO of Texas Air Corp. Lorenzo was reviled by airline unions because of his anti-union proclivities, and Icahn rode in like a knight in shining armor. Supported by employees, he began buying TWA shares and took control of the airline in 1986.

In September 1988, Icahn used $1.1 billion in borrowed money to complete a buyout he had begun three years earlier. Not long thereafter, Icahn took the company private. The move took $610 million out of TWA, of which about $469 million went to Icahn, and added nearly $540 million to TWA's debt. What Icahn and others couldn't foresee were the difficulties that lay ahead for the passenger-airline industry.

With Iraq's invasion of Kuwait, oil prices spiked and a recession took hold in the U.S. in 1991. Six major airlines, including the heavily indebted TWA, were forced to seek bankruptcy protection. Three of them -- Pan Am, Midway and Eastern -- didn't survive. TWA did, but Icahn took a beating and was forced out. "I've lost on TWA," Icahn said at a New York press conference in 1992. "They were the worst investment I made in the last decade."

In June 1995, TWA signed an eight-year deal that allowed Carl Icahn's Karabu Corp. to buy airline tickets at a steep discount. Karabu is steadily taking a bigger share of TWA sales as a result of the deal and putting pressure on the airline's bottom line.
 Dollar amounts reflect the full published fare. Karabu actually pays TWA about 55 percent.
Source: Trans World Airlines Inc., 10-K filing, U.S. Securities and Exchange Commission
In June 1995, TWA signed an eight-year deal that allowed Carl Icahn's Karabu Corp. to buy airline tickets at a steep discount. Karabu is steadily taking a bigger share of TWA sales as a result of the deal and putting pressure on the airline's bottom line.
Dollar amounts reflect the full published fare. Karabu actually pays TWA about 55 percent.
Source: Trans World Airlines Inc., 10-K filing, U.S. Securities and Exchange Commission

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The airline emerged from the first of two bankruptcies in January 1993, leaving it in the hands of creditors and angry employees. Icahn was out as chairman but still on the hook for the airline's pension obligations. He agreed to lend TWA $190 million for working capital to keep the airline flying. Two years later, TWA had to go back to bankruptcy court for protection against creditors. And when the Icahn loan came due in 1995, TWA didn't have the cash. So TWA agreed to give Karabu Corp., an Icahn company, the right to buy (and resell) tickets over a 99-month period.

Under the terms of the "Karabu Ticket Program Agreement," dated June 14, 1995, Icahn could purchase a limited number of "domestic consolidator tickets" -- up to $610 million in total retail value at a 40 percent discount. The number of consolidator tickets Karabu could buy was staggered -- no more than $120 million worth during the first 15 months; then no more than $70 million worth in each year of the contract. Karabu was also allowed to buy an unlimited number of "system tickets" at 55 percent of full retail price throughout the life of the agreement.

In an effort to safeguard its interests, TWA restricted how Karabu could market the discount tickets. According to the agreement, Karabu had to sell the tickets "without any public advertisement or public promotion referring directly or indirectly to TWA in any way." That restriction, TWA figured, would blunt the competitive advantage for Icahn. They figured wrong.

To sell the tickets, Icahn in August 1995 launched Global Discount Travel, which initially sold the TWA discount tickets by way of a toll-free telephone number and through its affiliations with other travel agencies. But the growth of the Internet offered a promising alternative. In October 1996, Global started a Web site, www.Lowestfare. com, as a way to book tickets on TWA. Within two years, the company was putting much of its effort into developing the Web business, and in August 1998, Lowestfare. com Inc. was incorporated with Carl Icahn as chairman and principal shareholder. Global would become a subsidiary of the new privately held "dot.com" company.

At first, TWA likely didn't foresee the long-term consequences of the Karabu deal. The agreement restricted how Icahn could sell its tickets, and in 1995, few businesses had gauged the possibilities of e-commerce. But the numbers, according to the airline's filing last month with the SEC, tell the story. Karabu bought TWA tickets with a retail price of $16 million in 1995, $139.7 million in 1996, $236.1 million in 1997, $247.4 million in 1998 and $286 million in 1999. In all, the report shows that since the agreement, Karabu has paid $514 million to buy TWA tickets with a retail price of $925 million.

Although Karabu passes along much of the savings to Lowestfare.com customers, it's still a profitable undertaking. According to its SEC filing in March 1999, Lowestfare.com generated 98 percent of its revenues from the sale of TWA tickets. And it made gross profits of $141.5 million -- roughly 25 percent of revenues -- from 1996-98.

TWA has tried to put a stop to the hemorrhaging, without success. Less than a year after the agreement was signed, the airline filed a suit in St. Louis County Circuit Court alleging that Icahn violated conditions of the deal by selling tickets directly to the general public and through travel agents. But in May 1998, a judge found in Icahn's favor, saying that TWA's legal arguments just didn't add up. TWA, Judge Kenneth M. Romines ruled, failed "to acknowledge that monies generated by Global (now Lowestfare.com) sales have paid down TWA promissory notes.... In sum, TWA has not proved a breach of the "Ticket Agreement.'" The airline is appealing the decision and has warned investors in its SEC filings that the ruling, unless overturned, could have a significant "adverse effect on revenue."

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