Southern Air files for Chapter 11 protection

US-based all-cargo ACMI and charter operator Southern Air Holdings filed a petition for Chapter 11 protection while it restructures its debt obligations. The very short version of the story, in Southern’s words, is that “Currently, the Debtors do not have sufficient funds with which to operate their businesses on a going forward basis.” The full story, of course, is somewhat longer than that…

Southern Air Holdings traces its lineage back some seventy years to 1947, when an airline called Southern Air Transport (SAT) was formed. SAT had its ups and downs, and eventually restructured as Southern Air in 1999. More recently, a small Seattle-based carrier called Cargo 360 was formed, struggled, and was eventually acquired by private equity firm Oak Hill Capital Partners. Then, in 2007, Oak Hill also acquired Southern Air, and effectively merged it with the Cargo 360 operations under the newly-created umbrella of Southern Air Holdings. Both Southern Air and Cargo 360 continue to exist as legal entities, but operationally they are effectively one carrier, known as Southern Air.

Southern Air currently operates four 777Fs, four 747-400BDSFs, and three 747-200Fs in two main business activities:in two main business activities:

• Charter flying in support of US military activities generates 43.5% of Southern’s revenue. Southern is part of the Patriot Team (along with ABX Air, Omni Air International, and Sky Lease)

• Commercial air cargo transportation generates the other 56.5% of Southern’s revenue: This involves primarily ACMI leasing, but also some CMI flying (in which another carrier provides the aircraft, while southern provides crew, maintenance and insurance). DHL is now Southern’s primary ACMI customer leasing four 777Fs. Southern has ACMI-leased 747-200Fs to other carriers in the past, but those contracts have either ended or are about to end. It also currently operates at least one 777F for TNT, but this also is drawing to a close.

Both of these business activities face serious challenges. In its petition for Chapter 11 protection, Southern said the recent wind-down of US military activities plus upcoming Congressional sequestration, led to “an unexpected and significant reduction in DOD spending on air cargo transportation services in the last two financial quarters. As a result of the sharp decline in government demand, revenues generated by the Debtors’ governmental air cargo business have declined precipitously in the second and third financial quarters of 2012. The Debtors’ revenue from governmental business in the second financial quarter of 2012 was $44.9 million, approximately 34% less than anticipated for this period under the Debtors’ 2012 budget. In addition, the Debtors’ current forecast for all revenues from government business in 2012 is only $156 million, approximately 37.2% less than anticipated for this line of business under the Debtors’ 2012 budget.”

It also pointed to a “stagnant international freight market, which is a direct result of the worst global economy in decades and a generally negative economic outlook. Indeed, 2012 is expected to be the fifth consecutive year in which there is no net growth in demand for air cargo services. At the same time, excess air cargo capacity in the market for ACMI services (the “ACMI Market”) has negatively affected demand, exerting downward pressure on rates and guaranteed block hours under ACMI Contracts.

And finally, Southern said that current market conditions have “reduced the rates lessors can charge under aircraft operating leases” while at the same time the rates it pays on its four 747-400BDSFs are “at above market rates.”

Bottom line? Expenses are rising faster than revenue, and Southern’s net loss for the twelve months ended July 31, 2012 was approximately $159.8 million, an increase from a net loss of approximately $53.5 million in the twelve months ended July 31, 2011.

In its filing, Southern said it had approached “four top-tier lenders who have historically been active in the debtor in possession financing market as well as two strategic sources of investment,” but had been turned down each time, and therefore saw a voluntary restructuring under Chapter 11 protection as the only viable way forward.

After discussions with its major creditors and parent Oak Hill Capital Partners, Southern has secured an agreement that will “significantly reduce by more than two-thirds its approximately $285 million of legacy debt,” and will provide for $25 million in debtor-in-possession financing.

As is usual in these cases, Southern said “With a stronger capital structure and more competitive and streamlined business model, we will have the capability to invest in and grow Southern Air for the future. We fully expect to continue normal business operations, fulfilling all customer requirements as scheduled and providing uninterrupted high quality air cargo services during our restructuring process.”

However, as is also usual in these cases, there are a variety of hurdles to be cleared before that glowing future arrives.

• The military flying that has been a big part of Southern’s business may well continue to shrink. Having a lower cost base, or reduced debt load, will not bring in business that simply does not exist.

• Competition for ACMI business is only going to get tougher. In this case, a lower cost base will help, but again, with demand for air freight stagnant, and more and more capacity flooding into the market, this is going to be an uphill battle. Southern sees the ACMI agreement with DHL for four 777Fs as the “cornerstone” of its future business, but being dependent on a single major customer is always risky.

We will continue to update this story as we learn more. In the meantime, we wish Southern and its management and employees success in their attempt to rebuild.