aloha airline, inc.

CASE: F-240
DATE: 4/92 (REV’D. 01/25/06)
ALOHA AIRLINE, INC.
In June, 1990, John Garibaldi, Chief Financial Officer of Aloha Airlines in Honolulu, Hawaii,
was considering how to structure the acquisition of a used Boeing Model 737-2M6C aircraft to
be added to Aloha’s existing fleet of 15 short-haul Boeing airplanes. Aloha was committed to
modernizing its fleet regularly by acquiring each new generation of Boeing 737 aircraft. For
example, Aloha’s average fleet age had been reduced from 15.2 years in 1986 to 11.1 years in
1990. Beginning in 1992, through both outright purchase and leasing, Aloha had plans to take
possession of eight new Boeing 737-400 planes, the latest generation of Boeing short haul
aircraft. The market value of all eight planes was estimated to be approximately $280 million.
The plane in question in this transaction was configured to carry 120 passengers in the interisland Hawaii market. In addition it had a feature that allowed for the quick removal of seats
every evening so it could carry freight at night when there was no passenger traffic. Each day the
737-2M6C would revert to normal passenger service.
The plane was offered for sale by Royal Brunei Airlines at a cost of $14 million including two
spare Pratt and Whitney engines. It was Garibaldi’s decision whether to recommend the purchase
of the airplane outright or to lease it from the Stellar Leasing Corporation in Chicago, Illinois.
BACKGROUND
Aloha Airlines is privately held company owned by several successful real estate developers in
Honolulu. It is the number one carrier in the inter-island, intra-state Hawaii market with a market
share of approximately 60 percent. Aloha’s business mainly consists of commercial and tourist
travel as well as some freight between the six islands of Hawaii.
Garibaldi accepted the CFO position at Aloha in 1985 after serving as a principal and member of
the airline audit team from the accounting firm of Arthur Young & Company. Although
Garibaldi felt that he understood the company quite well before joining, his years since had put
all of his financial skills to work as the company was in continuous need of massive amounts of
Professor George Parker prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective
handling of an administrative situation.
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Aloha Airline, Inc. F-240
p. 2
financing to modernize its fleet and keep pace with the rapid growth of inter-island airline
services in Hawaii.
The airline’s President and Chief Executive Officer, A. Maurice Myers, came to Aloha in 1983
after a serving for six years as Senior Director of Passenger Market Development at Continental
Airlines in Los Angeles. Myers described Aloha as “one of the most profitable niche carriers in
America. This was achieved, he felt, through close attention to revenue management, a
demonstrated commitment to cost control, and constant emphasis on increasing the productivity
of both assets and employees.
THE INDUSTRY
The airline industry is both capital-intensive and cyclical in nature, a potentially dangerous
combination. This reality was especially apparent in 1990, when, after eight years of steady
earnings growth, and contrary to many analyst predictions, the industry as a whole ceased to be
profitable. War in the Persian Gulf caused jet fuel prices to increase sharply.1 This, coupled with
a deep U.S. recession, had the effect of plunging most airlines into the red. Aloha’s profits fell
36 percent in 1990 from the previous year, despite of 22 percent revenue growth. Aloha’s
performance relative to other airlines, however, was exceptionally good given that the industry
as a whole lost money that year.
Even prior to the difficult conditions of 1990, the U. S. airline industry was a highly competitive
and harsh marketplace. Of the “mainland carriers,” Continental, Eastern, Pan Am, Midway, and
America West were all casualties to bankruptcy in 1990-91. And, in Hawaii, a new entrant,
Discovery Airlines, which started service in 1990, failed in bankruptcy in less than one year.
Though Aloha finished 1990 as one of only five U.S carriers to show any profit, its net earnings
were modest, a total of $812,000 on revenues of $207.4 million. Mr. Garibaldi was trying to
determine whether the latest 12 months were an aberration or the beginning of a cyclical
downward trend in earnings that would take several years to run its course.
To Lease or Borrow?
The choice for an airline interested in financing a new airplane was, ultimately, to lease or
purchase the aircraft. Prior to the 1980’s, most established airlines chose purchase. Indeed, in
1984, only approximately 20 percent of the world’s commercial aircraft were leased. By 1991,
however, leasing had become far more popular, accounting for nearly half of all aircraft
acquisitions.
Two reasons dominated in explaining why leasing tended to be more attractive in the late 1980’s:
2
First, the 1986 Tax Reform Act eliminated the investment tax credit associated with purchase.
1
2
Aloha’s per gallon fuel costs increased 102 percent between August and October 1990.
Under the investment tax credit legislation, tax-paying companies could deduct a fixed percentage (depending on
the type of asset) of 7 to 10 percent of the cost of the asset directly from their tax liability. Such credits constituted
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