Prof. Ribstein today gave me a good example to use when discussing why LBO firms aren't able to compete in down markets: airlines and hedging. When I teach about leveraged buyouts, we talk about the pros and cons of the resulting, highly leveraged firm. Some argue that these firms create shareholder value because all of their excess cash is accounted for in debt service. Managers cannot waste. If managers want to engage in a costly activity like capital expenditures, they either have to get a waiver from creditors, who may or may not think the expenditure is a great idea, or they may simple have to forego the activity. The flip side of course is that a highly leveraged firm does not have the cash to invest in necessary capex, such as technology expenditures or expansion, and cannot compete on price with competitors with cash reserves.
As Larry points out, in the airline industry, the airlines in bankruptcy or on the brink of bankruptcy are not hedging, but the profitable Southwest Airlines (my "hometown airline") is profitable, and so is able to hedge. Because it is able to hedge, it becomes even more profitable. The airlines who cannot afford hedging programs incur more losses.
Sort of like monopoly when your little sister/brother is busy buying houses and hotels, but you're just trying to get around the board without dying. When you land on Boardwalk, you don't have the cash to buy it. Bitter irony, that Monopoly game.
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