Vince Farrell of Scotsman Capital-Verbatim

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From: vince farrell
Sent: Monday, February 18, 2008 4:51 PM

I haven't owned an airline stock in years. I'm not likely to any time soon. The airlines have very high fixed costs (the planes), a crazy variable cost (the fuel), and have managed to make up for these problems by developing the worst imaginable labor relations since Rome enslaved the world. We might hear an announcement this week that Delta and Northwest are going to merge. There have also been rumors surrounding a potential combination between UAL and Continental and American and U.S.Air, or American and any number of others. What's up?

Glenn Tilton, UAL's CEO, has been a proponent of consolidation for a while. He's quoted in Saturday's WSJ saying the U.S. industry is too fragmented to compete against the powerful international rivals starting to encroach on U.S. soil. Lufthansa bought 19% of Jet Blue to gain access to valuable landing slots at N.Y's JFK airport (my interpretation.)

The arguments against consolidation have centered around fears that lack of competition would raise prices and cut service (what? service could be worse?) Politicians can be counted on to weigh in about job losses with combinations.But consider this. Recently, four out of the six major U.S. based carriers have operated in Chapter 11 bankruptcy, and as late as 2006 half the seating capacity was in Chapter 11 (Economist Magazine 2/16/08.) Since the bankruptcies wages are off -30%, the work force has been drastically reduced by -39% and there was a $20 billion default on pensions (also from The Economist.). This is not a viable business model. The low cost airlines have eaten away at the short haul traffic and now control 30% of seat capacity. The only area for profitable growth for the big guys are the lucrative overseas routes where they will go head to head with the well-off international carriers. Because of home court advantage type rules, the low cost short haul start-ups are not as prevalent overseas and have not been around to eat the crumbs off the cake of the bigger airlines. It's inevitable that for our domestic carriers survival, combinations have to occur. The bargaining power of larger firms is needed and the future of these household names depends upon developing long haul business where there is greater scope for savings and where premium traffic continues to grow.

If UAL/Continental or Delta/Northwest were to occur, only 5% of total seats would overlap which should ease fears about predatory pricing. But one never knows when government agencies are involved. The fireworks should start this week and I'll watch from the sidelines. I need to care about a company to invest in it. I need to root for success. I will never own a tobacco company. I'm not holier than thou, but I would hate it if Lola Jane smoked when she grew up. Why would I root for that? I really can't own an airline since in my 35 years in the investment business, I have flown so many miles I would be embarrassed if you found out the total. I really hate the airlines, but I think they should be allowed to merge

Have I mentioned I really hate the airlines ?

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From: vince farrell
Sent: Monday, February 18, 2008 11:54 AM

Television history was made Friday night ! Sir Larry Kudlow, Lola Jane's honorary Uncle Dougie Kass, and yours truly held forth on Larry's show about all manner of things. Witty repartee and pithy insights ruled the airwaves. We, of course, disagreed on most things. We did all come together for one moment ,however, as we somehow started to fondly remember the Moody Blues. Days of youth when we were kings flashed through our memories only to be halted when someone said if we really could remember the Moody Blues, we weren't having as much fun as we could have. Probably should have inhaled.

One substantive and important issue discussed was The Lord High Governor of New York, Eliott Spitzer, and his puzzling order that the monoline municipal bond insurance companies come up with a solution in the next 3 to 5 days or else. Or else what I don't know, but this is deeply troubling to me. We all remember Attorney General Spitzer and his assault on the deplorable research practices on Wall Street of recommending crazy internet stocks publically while trashing them privately. In my opinion, the punishment meted out was deserved. What was not deserved, in my view, was the methodology. No one ever had a day in court. Threats of indictment and sharp elbowed tactics ruled. A.G. Spitzer demanded resignations or he would issue indictments. Wall Street caved as being indicted is tantamount to closing shop. Former head of the NYSE, Richard Grasso, is not a sympathetic figure, and was assaulted for his compensation and sued, but the compensation committee was given a pass. Carl McCall, an influential former NYS Comptroller and leading Democrat, headed that committee.The Comp committee awarded the money, so where was their indictment? Read Charlie Gasparino's excellent book, "The Club" to get a good insight.

We debated why this move by the Lord High Governor (LHG.) I likened it to the Argentine Generals at the start of the Falkland Island war in 1982. Argentina's economy was crumbling under the junta's idiotic economic policies. Inflation was raging and hundreds of protestors had disappeared never to be seen again. Society was on the brink when the leadership figured a diversion to rally the country was needed. So, they occupied the Islands, and triggered a war with Great Britain, who had long claimed the Islands. The Argentine Navy was sunk and some 800 lost their lives and the junta eventually disappeared into the sands of time. Likewise, Venezuela's Chavez is bankrupting his country, oversees soaring food costs, and is facing mounting unrest. So, he is picking a fight with Exxon to rally the folks against the evil imperialists who are really to blame for the ills plaguing the country. This will not work. Such "diversionary" tactics never do. Those that ignore the lessons of history are condemned to repeat them.

What has this to do with the LHG Spitzer? He rode to the office of Governor on the strength of his populist trashing of Wall Street. Once there, he acted as though he still had the power of indictment and promised publicly to run "roughshod" (his word) over entrenched Albany interests. Didn't work. A couple of very public miscues later and the LHG's political standing has sunk and is going lower. Thus, in my opinion, the diversionary tactic of bullying the insurance companies to show the world he still has it. Does he want to resurrect his political career to be a Vice Presidential possibility ?

The issues facing the monoline insurance companies are deep and complex, but they are understandable and best left to the private sector for resolution. There will be pain, but that's the discipline the market eventually applies to those that stray beyond their core competency. To impose a 3-5 day limit is lunacy. Calm down Eliott. Those that legislate in haste, repent for a long time.