Pinnacle Airlines Bankruptcy: Equity Objects to the DIP

In the beginning of April, Pinnacle Airlines (PNCLQ or the Company) filed for bankruptcy protection in SDNY.  You can find the docket here: Pinnacle Airlines Bankruptcy Docket. This afternoon, Nantahala Capital and Hudson Bay Capital Management, who collectively own approximately 2.5M shares on PNCLQ, filed an objection to the Debtors' DIP motion (Docket #138).

The document is a short, but a fascinating read into this case. While I have not yet written about the case and have yet to establish a position (I cannot reasonably quantify the Delta damages unsecured claim), I have used the case as an example of misaligned management incentives.  More on this later.

The equity holders objection stems from the fact Delta being "the Debtors' most significant (and possibly only) customer, lessor of virtually all of the Debtors' assets, largest trade creditor and DIP lender..." might cause certain problems for PNCLQ and effectively give Delta every bit of negotiating power over the Company. And because Delta has all the power in the relationship, the filing goes on to point that "no other constituency has or can have any meaningful participation in these Chapter 11 Cases."  And this includes the equity holders up until this point. I have heard discussions are going among between equity holders about forming a ad hoc committee and sending their issues to the U.S. Trustee and it looks like this filing is the first action we've seen on the docket from equity.

One of the more eye-popping quotes from the docket: After discussing certain payments that Delta was to pay PNCLQ as a result of their Mesaba acquisition ($18-20M), the filing goes on to say:

"On information and belief, Delta did not pay these amounts, precipitating the Debtors' liquidity crisis; and, as part of the DIP facility, these amounts are forgiven and/or compromised."
For those that do not know what a "sub rosa" plan is, this document lays it out perfectly. A sub rosa plan can be related to a 363 sale or a DIP financing (like in this case).  It is effectively a defacto plan disguised as a financing arrangement without all the benefits of a formal bankruptcy plan (disclosure statement, ballot, other people able to participate in one way or the the other).

While I will not get into the valuation of PNCLQ, I'd like the reader to think about who, other than Delta, this plan benefits?  Does it benefit the shareholders?  The price action of the stock suggests otherwise. Let's look at the management team's holdings as of the filing date.
  • CEO: Sean Menke: 132,782 of 19,221,312 shares outstanding: 69 basis points
  • COO: John Spanjers: 13,711 shares or 7 basis points
  • General Counsel: Brian T. Hunt: 100,424 shares or 52 basis points
The CFO let in early March 2012 to go to Spirit Airlines.

On March 20th, the Company released an 8-K amending the Management Compensation Agreements with the CEO and COO (Menke and Spanjers, respectively).  The CEO's base salary was increased from $425,000 to $675,000 and the COO's base salary was increased from $275,000-$400,000.  The agreement also removed the long-term incentive (cash reward) for the CEO for 2012 which was "based on corporate performance relative to pre-established annual objectives".   I assume they weren't going to hit those objectives.  There has been a significant amount of noise in the press on this same issue.  

John Spanjers was the President of Mesaba, which was owned by Delta (previously Northwest) when Pinnacle acquired it in July 2010. The COO of PNCLQ left shortly thereafter and was replaced by Spanjer who has held the position of COO since.  For a little history lesson, Mesaba filed for bankruptcy in 2005 in Minnesota. Mesaba was the largest subsidiary of a company called MAIR Holdings (ticker: MAIR).  At that point, Northwest was Mesaba's only customer and after Northwest filed in September 2005, cash wasn't really flowing into Mesaba's pockets.  In effect, Spanjers has been to this song and dance before and has seen the playbook.

If I had to wager, Pinnacle, if left unchecked, will file a plan and disclosure statement that will give somewhere between 5-10% of the reorganized equity to management and the board as an incentive, with a huge slug of this going to the CEO and COO, assuming they stay independent. In addition, there will be hefty incentive cash payments along the way for filing a plan, hitting covenants, etc. Why would not want to dramatically increase your equity stake in a less levered, more streamlined airline, while at the same time impressing the people at Delta with your leadership skills (and saving them lots of money).  Very little downside to that trade. 

Remember - we always have to look at incentives of the actors in the play. If management and equity holders incentives do not line up, you have to watch the rug getting pulled out from underneath you.


John 4/19/2012  

This sounds like a safer way to play it is to wait for it to emerge from bankruptcy and buy stocks on the market. Then, the management's incentive will be better aligned. Am I right?

Anonymous,  4/19/2012  

Quick as usual Hunter.

Hunter 4/19/2012  

Update: Pinnacle Airlines Corp. (OTCMarkets.com: PNCLQ) today announced a leadership transition under which John Spanjers, currently chief operating officer of the company, will succeed Sean Menke as chief executive officer, effective June 1, 2012. - Spanjers moving up in the world! Wonder if he's been the hand moving the pieces in the background given his relationship with Delta/NWA (formerly worked there)

Anonymous,  4/19/2012  

The fact that Davis Polk represented Delta through its bankrupcy and now represents Pinnacle is an absolute joke...in fact, its the same lead attorney, Marshall Huebner. what incentive does the Davis Polk oppose any request by Delta to control the bankruptcy process? Once Pinnacle is swallowed back up by Delta (no doubt because its TBD unsecured claim will consume all the equity value), Davis Polk can go back to representing its larger and certainly more lucrative client (Davis Polk earned nearly $40 million in fees from Delta BK). Between this and the lack of management incentive, it doesn't appear anyone is around to champion the interests of shareholders.

Anonymous,  4/19/2012  

Davis Polk is not representing Pinnacle in it's dealings with Delta. Akin Gump is serving as conflicts counsel for the reasons mentioned above.

Anonymous,  4/19/2012  

Great so Akin can show up to not sue Delta later in the case because Davis Polk/management already negotiated away any prepetition claims against Delta as part of the DIP agreement.

Anonymous,  6/11/2012  

where is ted wechsler when you need him? The Berkshire rescap/ally call for an examiner makes an almost perfect template for Pinnacle management's giveaways to Delta.


hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.