United Airlines’ $300 Million Skeleton In The Closet: Hong Kong Route Impairment
While United Airlines wants to look past its Continental Airlines merger, it appears to be dealing with an even older matter: writing down the value of the Asia-Pacific network it acquired in 1985 from Pan Am, which gave United the dominant position in the region it still enjoys today.
United has taken a $296 million impairment on its Hong Kong routes in two tranches, first a $206 million charge announced in January 2019 – before the civil disruption in Hong Kong that is seeing airlines post losses but not make write-downs. The first tranche was blamed on costs rising faster than revenue. The second tranche, of $90 million, was announced in early January 2020 and represented a full impairment of the Hong Kong route. It was blamed on decreased demand and revenue.
Hong Kong was one of thirteen Asia-Pacific destinations United bought, along with 18 widebody aircraft, from Pan Am for $750 million in 1985, equivalent today to $1.8 billion after inflation. The transaction also included parts, property and facilities. United declined to comment if it still attributes value to any of the twelve other markets it bought.
To simplify the cost by ignoring the transaction’s large aircraft expense, each destination on average was worth $58 million, or $138 million today after inflation, far below United’s $296 million impairment. Yet is unclear why United kept such high value for so long. United’s Asia-Pacific network historically generated healthy profits that should have gradually written down the transaction value. Pan Am’s Asia-Pacific network made $132 million in the two years prior to its sale.
United said the Hong Kong routes were valued as an intangible asset part of collateral for a loan. The asset classification seems questionable given the commercial and legal evolution of international aviation as it pertains to two areas, traffic rights and slots.
First, traffic rights: United bought Pan Am’s Asia-Pacific network at a time of heavy regulation when countries only allowed a specific number of airlines and flights – thus creating value to the route authority. Since then the US has championed open sky agreements, a sweeping change that permit an unlimited number of airlines from either side to offer as many flights as they wish.
The US and Hong Kong removed restrictions on passenger flights in 2002, liberalizing the market and permitting any US or Hong Kong airline to fly as much as it wants. That should have meant United’s Hong Kong assets lost all value; United no longer had any access another US airline could not gain.
Whereas United in 1985 bought further route access to Hong Kong, American Airlines last decade used free market access to launch two Hong Kong flights. United declined to comment about impairment methodology and why the valuation remained for so long. United’s first impairment said it was done as part of its annual review.
Second, slots: United has not indicated the valuation was related to Hong Kong airport slots, but either way this could not be possible. Aviation growth outpacing infrastructure expansion has made more airports slot congested. Perhaps best known is London Heathrow, where airlines can legally sell their slots to each other. The most expensive known sale was Oman Air spending $75 million for a slot pair at peak timings. Those transaction opportunities can allow airlines to value their Heathrow slot portfolio.
But slots at Hong Kong cannot be sold. Official rules only permit trading between an airline and its subsidiaries (for example, Cathay Pacific and Cathay Dragon), or between subsidiaries (Cathay Dragon and HK Express). So without being able to sell its slots at congested Hong Kong, United could not ascribe value to the slots. Other Asian airports also tend to prohibit slot sales, unlike European and American counterparts.
Besides Hong Kong, United’s Pan Am transaction included access to Auckland, Bangkok, Beijing, Manila, Melbourne, Osaka, Seoul, Shanghai, Singapore, Sydney, Thailand and Tokyo. United already served Hong Kong and Tokyo, but the Pan Am deal gave it more exposure. The markets have all since become open skies with the exception of mainland China and Tokyo Haneda.
The US assigns airlines to the limited permissions to land in mainland China and at Tokyo Haneda. Approval is given to an airline for a specific city-pair combination, and the airline needs permission if they want to later change it. Alternatively the authority can be re-allocated to another airline, as happened to a Delta Haneda slot that was re-allocated to American. Being unable to freely transfer an authority would also challenge the ability to provide a valuation on those flights.