Philippine Airlines, Inc. History

Address:

PAL Building 1 & 11
Legaspi Street
Legaspi Village
Makati, Metro Manila
Philippines

Telephone: (63) 02-818-0111
Fax: (63) 02-810-9214

Website: www.philippineair.com

Public Company
Incorporated: 1941
Employees: 14,000
Sales: P 31 billion (US$1.03 billion) (1996)
Stock Exchanges: Philippines
SICs: 4510 Air Transportation--Scheduled

Company History:

Philippine Airlines, Inc. (PAL) has been the dominant air carrier in the Philippines since its creation in 1941. Operating both internationally and within the 7,100 islands that make up the country, PAL has been something of a curiosity and scandal among the world's major airlines, for decades losing money while being traded among the handful of wealthy families in control of the Philippine economy. After 14 years of ownership by the government of deposed President Ferdinand E. Marcos, PAL was sold at the order of President Corazon Aquino in 1992 to a consortium of companies under the leadership of the Soriano and Cojuangco (pronounced "koe-HWAHNG-koe") families. Because Aquino's maiden name was Cojuangco, many believed this "privatization" of PAL was not likely to break the pattern of corruption and inefficiency that has marred the carrier's history since 1941. But events in the late 1990s would conspire to force significant changes in the airline.

Founding in the 1940s

The first Philippine air transport companies were created in the early 1930s, primarily as a means of travel and freight delivery between the nation's scattered islands. One of these pioneering companies was the Philippine Aerial Taxi Company (PATCO), which was granted a 25-year charter by the Philippine legislature in 1931 for both domestic and international flights. At that early date, when the country was still a possession of the United States, Pan American Airways provided most of the Philippines' international air transportation. PATCO settled for short flights among the major islands of Luzon, Cebu, Leyte, and Mindanao. On the less developed islands, PATCO also provided intra-island flights between distant towns.

The 1941 transformation of PATCO into PAL involved an international cast of characters, most notably General Douglas D. MacArthur, at that time in charge of the United States Armed Forces in the Philippines preparing for an expected Japanese invasion of the islands. General MacArthur, whose father had served as the first military governor of the Philippine Islands following the Spanish-American War of 1898, had served in the country in various capacities throughout his career, including a four-year period before World War II when he was employed by the Philippine government as its field marshal. (MacArthur was recommissioned by the U.S. Army in 1941 and oversaw the eventual loss of the Philippines to the Japanese in 1942.)

The general employed as his aide-de-camp a wealthy Spaniard named Andres Soriano, who had previously served as consul in Manila for the Spanish dictator Francisco Franco. Soriano controlled the large San Miguel Breweries along with a number of other corporations, and had powerful connections in the Philippine capital. In 1941 he put those connections to good use by teaming with the National Development Company, a government agency, in forming Philippine Airlines, Inc., which promptly absorbed PATCO, thereby becoming the nation's largest air carrier.

As the creation of General MacArthur's aide de camp, PAL stood an excellent chance of winning contracts from the United States Armed Forces for its transport needs in the coming war. Unfortunately for Andres Soriano and his fellow investors, the invasion came early and ended quickly, with the Japanese gaining control over the islands by the summer of 1942. It is not clear what became of PAL during the Japanese occupation, but on December 8, 1941, the day after the Japanese attack on Pearl Harbor, General MacArthur made Andres Soriano a colonel in the U.S. Army, and an American citizen as well. It is safe to assume that Soriano returned to Manila with MacArthur's liberating forces in 1944 and resumed control of his various business interests, including PAL.

There is considerable evidence that MacArthur helped Soriano and PAL whenever he could. In 1946, MacArthur instructed the War Department to fly 20 tons of bottle caps to Soriano's San Miguel Brewery to cover a shortage. In addition, the two men were both strongly anti-Communist, and MacArthur's own extensive business holdings in the Philippines made his relationship with Soriano more like one of business partners than military officers. Sterling Seagrave commented on the chaotic postwar scene in his book The Marcos Dynasty, "The $2 billion aid package [from the United States to the Philippines] was fought over and devoured by politicians, by rich MacArthur partisans, and by packs of bureaucrats."

Post World War II Activities

Helped by such massive infusions of American capital, the Philippine economy rebounded from its wartime privations. PAL prospered so quickly that by 1948 it had already bought out two of its largest competitors, Far Eastern Air Transport, Inc., and Commercial Air Lines, Inc. Within a few years three other competing lines also threw in the towel, and PAL stood alone as the airline of the Philippines. Its ownership was still split between the Philippine government and the Soriano interests. The Sorianos were minority shareholders, but handled the day-to-day management of the airline, which, if the later pattern of graft and kickbacks was already established in the 1950s, was the more lucrative end of the business. Philippine magnate Enrique Zobel once bluntly remarked in the media that "PAL is a milking cow," and most of the milk seems to have been generated by what Far Eastern Economic Review described delicately as the "company's operations, for instance by dictating its material requirements."

PAL's activities were described more directly in the New York Times, which quoted a 1989 World Bank study. The latter found that the airline was holding "millions of dollars of spare parts for aircraft it no longer owns and ground equipment so badly maintained that it has little value except as scrap." At one time PAL was even accused of carrying an "inexplicably large inventory of 750,000 sanitary napkins," as reported in the Far Eastern Economic Review. Clearly the finances were being toyed with to someone's advantage, which may help to explain how an airline that so often reported a loss in its annual report could remain a financial plum much sought after by Philippines business families.

Whatever the intrigue surrounding its operation, PAL expanded its route system and doubled passenger miles between 1946 and 1950. The airline was serving 36 domestic airports by 1955 and owned a fleet of 35 planes, some of them DC 3/C47s and the rest Convair 240s. PAL's primary business still lay in freight and communication services, such as the mail, since its ticket prices were far beyond the means of the average Filipino. From the international airport in Manila, PAL sent 33 flights weekly to Cebu City, the transport hub of the southern islands, and offered regular service to all sections of the widely scattered nation, even the more remote islands where passengers were few and the operation ran at a loss.

Indeed, the airline has repeatedly blamed its financial troubles on the large number of short, unprofitable flights it must offer as the nation's only airline. In this regard, it was significant that on the eve of its sale to private investors in 1991, PAL announced a dramatic cutback in the number of its shorter domestic flights, encouraging the formation of new private companies to take these on. PAL claimed in reports published as far apart as 1950 and 1989 that it enjoyed the lowest cost of operation in the industry, so it would be hard to explain its frequent losses other than by blaming the unprofitability of the line's short-haul domestic business. (Unless, as some suspect, the airline's "loose accounting methods" have been to blame.)

PAL under the Marcos Regime

The Soriano family retained control of PAL until the late 1960s, the period of Ferdinand Marcos's rise to power. Marcos was first elected president of the Philippines in 1965 and remained the country's absolute ruler until his forced exile in 1985, when it was discovered that he and his wife, Imelda, had systematically plundered their country for decades while amassing a fortune estimated to be at least $1 billion. Marcos literally had a hand in every major Philippine enterprise, including the nation's airline monopoly. As Imelda Marcos became a regular guest at parties and government capitals around the world, she accrued a debt to PAL of nearly $6 million in the mid-1970s. The airline's owner, Benny Toda, offered to cut the bill in half if the Marcoses would pay it; instead, Imelda Marcos demanded that he transfer his interests in the airline to the government--which meant, in effect, to the Marcoses themselves. Afraid to refuse, Toda settled on a price with Ferdinand Marcos and turned over his stock, for which he later said he was never paid.

PAL became one of the many baubles flaunted by Imelda Marcos, who by this time was one of the richest women in the world. The First Lady of the Philippines traveled around the world in her own PAL DC-8 jet equipped with beds, a built-in shower, and gold bathroom fixtures, sometimes also commandeering a second jet to carry her personal luggage. The airline was officially under the control of the Government Service Insurance System (GSIS), which controlled the pension funds of all government employees in the country and was one of the Philippines' largest financial institutions. GSIS was run by Roman A. Cruz, one of Imelda's favorites, and it was Cruz and his family who ran PAL from its takeover to the election of Corazon Aquino in 1986.

By that time the airline had racked up consistent losses for the better part of two decades. PAL was at least able to enjoy the benefits of Manila's new international airport, completed in 1982 to replace a network of runways dangerously in need of repair; but, in the words of the Far Eastern Economic Review, "the airline [was] hobbled by ineffective management and corruption." It was also plagued by employee defections to other airlines, which generally paid about four times as much as PAL and were not "hobbled" by corruption in such gross forms. During the 1980s more than 1,000 of PAL's licensed mechanics, its most valuable ground workers, were lured by competing airlines, "exacerbating flight reliability problems," according to the industry magazine Aviation Week & Space Technology. PAL had become something of an embarrassment to the international aviation industry.

New Leadership in the Mid-1980s

The rise of "People Power" in the mid-1980s, culminating in the election of Corazon Aquino and the escape by the Marcoses to the United States in 1986, apparently offered a chance for significant changes in the Philippine economy. Not dwelt upon in the international press, however, was Aquino's membership in the Cojuangco family, probably the wealthiest of all Philippine business clans and for many years crucial supporters of the Marcos regime. Observers point out that the election of Aquino changed less in the Philippines than her less affluent supporters had hoped, and the privatization of PAL in 1992 offered little evidence of any real diminution of the powers of the elite families.

President Aquino originally ordered the sale of PAL along with hundreds of other government-owned companies shortly after her election in 1986. Since the airline had been run at a loss for many years, Aquino first hired a Philippine businessman named Dante Santos to make PAL profitable prior to its sale. Under Santos, PAL did report two years of net income, but these were widely assumed to be the result of creative accounting methods rather than of any substantive changes in PAL's performance. Indeed, in late 1990, four years after the accession of Dante Santos as president of the airline, no fewer than 22 of PAL's top executives were charged with negligence, fraud, and/or mismanagement; ten of these officials were eventually fired, including an executive vice-president, two senior vice-presidents, and four vice-presidents. They were accused of precisely the sort of corrupt operational practices that had been a way of life at PAL for decades, including theft of parts, over-purchasing, and kickbacks from travel agents. It was hard to say, according to some critics, whether the firings were part of a genuine cleanup effort at PAL or merely a means of clearing the decks before the company's sale, after which the buyer might wish to install its own people in these lucrative positions.

The sale of PAL was carried out in a curious fashion. The government first paid approximately $350,000 to the Asian Development Bank for recommendations on how best to proceed with the privatization of the airline. The study concluded that a large infusion of foreign ownership and management would be needed to turn around the airline's performance. For reasons of its own, the government rejected this proposal and instead commissioned a second study, this one from a branch of the World Bank. The second report also recommended that about one-third of the airline be transferred to foreign hands, chiefly as a means of retiring some of PAL's $650 million in foreign debt. This plan was also largely ignored, however, and in the months immediately prior to the airline's sale, PAL officials admitted that they could not return the company to profitability and were expecting a shortfall between its sale price and the amount of its debt. The company itself valued the two-thirds of its assets up for sale at somewhere between P 6.35 billion and P 6.69 billion, while the World Bank study had pegged their worth between P 5.25 billion and P 7.51 billion. But when the written bids were opened in January 1992, two groups of Philippine companies had bid over P 9 billion, with AB Capital & Investment Corporation the winner at P 9.78 billion.

AB Capital represented a consortium of Philippine interests headed by the Soriano and Cojuangco families, who had created the airline in 1941. Contrary to the recommendations of both preliminary studies, none of the company was sold to foreign investors; instead, the remaining 33 percent was kept by the Philippine government, specifically by GSIS, through which the Marcoses had taken over PAL in 1978. In effect, PAL remained under the control of the same few Philippine families, this time without the bothersome intrusions of foreign investors, who might possibly insist on a more rigorous accounting of its daily operations.

Prospects for the 1990s and Beyond

Thus when president and COO Jose Antonio Garcia in early 1996 proclaimed that PAL would "take on the world" once it had "a clean house," to many observers this sounded like a familiar refrain built around false notes. According to Michael Mackey in Air Transport World in February 1996, the company had lost P 1.7 billion (US$61 million) in the fiscal year that ended March 31, a figure that in subsequent reports would be raised to $70 million (Asian Business, April 1996) and $93 million (Airfinance Journal, June 1996). Revenues had flattened, operating expenses had risen, losses were spreading, and debt-equity ratios were moving in the wrong direction. The causes of the airline's poor economic performance were likewise familiar. Mackey identified three key factors: problems with the country's aviation infrastructure, growing competition for the Philippine market, and "the huge, sprawling subject of PAL's relationship with the government and role in development of the economy."

Inefficiency was as rampant as ever in the fields of technology, logistics, and operations. Of the airline's 11 Boeing 747-200s, six had GE engines, and the rest Pratt & Whitney--thus creating a less efficient maintenance situation than if all used the same type of engine. Worse, its fleet was both small and old. The size meant limitations on the number of flights--just 14 a week to the U.S., compared to twice that many for its American competitors--and the age of the aircraft placed limits on nonstop distance. A trip from Manila to London was, as Mackey wrote in October 1997, "a Homeric odyssey" that required travelers to stop in Bangkok, Abu Dhabi, and Frankfurt. Not only did this create inconveniences for passengers, but PAL had to pay fees at every airport, thus cutting into its profit margins.

Its people posed as much of a liability to PAL as its machines. Abby Tan in Asian Business (April 1996) recorded the following litany of larcenous acts against the airline by its own employees: "In one recent incident, 13 employees were charged in a ticket refund scam in Iloilo City that was estimated to be costing the company US$3,000 every month. PAL also loses around US$15.2 million each year through theft of plane parts and other supplies. That figure doesn't include items stolen from provincial stations centres where the airline's catering and ground-handling facilities are located. In one case, security agents discovered a fuel line running directly off company grounds."

As for the relationship with the Philippine government, Mackey observed that it "would seem to be more in place in a soap opera than in real life." According to Garcia, PAL was "owned by two entities ... at war with each other": the Philippine government, with its one-third share, and the conglomerate PR Holdings. Even the nature of the ownership split was in dispute, since the government owned one-fifth of PR Holdings--which in the view of some officials gave it more than 51 percent ownership of PAL. To top it off, the CEO of PR Holdings' political position was made more problematic by his close association with the Marcos regime on the one hand, and his "frosty relationship" with President Fidel Ramos, Aquino's successor, on the other. "What the dispute effectively does," one unnamed insider observed, "is make the raising of capital more difficult."

In its domestic service, the company continued to be hampered by a government order forcing it to fly some commercially undesirable routes, an order to which competitors were not subject. And competition was growing, not only from international airlines but an upstart local carrier, Grand Air. Nonetheless, PAL was still managing to maintain vestiges of its control over the Philippine market, but by 1996 it was under pressure to relinquish its hold--and the pressure came not from Quezon City, but from Washington.

For years, U.S. negotiators had been trying to get PAL to comply with an "open skies agreement," signed in the early 1980s, whereby both U.S. and Philippine carriers would have unlimited access to markets in each other's territory. PAL had gotten its compliance deadline postponed four times. But by 1996 it had run out of largesse from the Philippine government, which was concerned that limitations on passenger service could lead to a loss of tourism income, a significant industry in that country. Thus it was confronted with a more or less final deadline of 2003. "This," as Abby Tan wrote in Asian Business, "gives PAL just seven years to fix a host of problems that have dulled its competitive edge and sapped its profits."

In the mid-to-late 1990s, PAL began taking positive steps toward eliminating its problems, both technical and human-related. In the technical realm, it began to update its aging fleet with an enormous order for new planes. In December 1995 it placed on order 24 Airbus A340-300s (in addition to four already on order), as well as 12 A320s and eight A330-300s. Financing of $1.1 billion worth of Airbus equipment came from a variety of Asian banks. PAL did not simply add aircraft; it was "refleeting," creating an entirely new service fleet, and Mackey in late 1997 predicted that with the delivery of several new aircraft in the following year, "PAL will have one of the most modern and youngest fleets in Asia."

PAL's operations would also be bolstered by a new computer system, including a $7 million revenue accounting system that became operational in 1997, as well as two mainframes ordered from a Danish company. Another "new" feature, one very familiar to most airlines but not PAL, would be a direct linkage between travel agents and the company's reservation system. Also in the realm of service, PAL began to explore the possibilities of the Chinese and Japanese markets. It had no service to the former, and only a limited number of flights to Tokyo in the latter case. By late 1997, it was "very close" to Shanghai service, as well as increased routes to Japan.

In a development that suggested increasing confidence within the community of airlines, it also entered into discussion with several possible strategic partners. "In the past," Garcia told Air Transport World, "it was exceedingly difficult to even get people to talk to us. But times are changing." As for its human resources, PAL slashed its roster of senior vice-presidents in half, to 15, and sought to train its 14,000 employees for greater efficiency. In line with its increased fleet size, it would be hiring 1,800 cabin crew staffers, as well as 2,000 mechanics.

Perhaps most significant was the airline's move toward privatization. Once Tan emerged as chairman of the company in March 1995, it appeared that PAL's future course was set: it might not remain a property of Tan--one critic quoted in Airfinance Journal claimed he was "trying to make the airline look decent and then sell it"--but it was not going to remain a property of Quezon City either. Thus in October 1997 Mackey, a critical observer, lauded the "end of government involvement and [indications] that business people are back in control."

For the fiscal year that ended March 31, 1997, the company showed losses of P 2.5 billion (US$83 million), and for the next fiscal year Garcia projected losses of P 2 billion (US$66 million). "And for the financial year ending March, 1999," he said, "if we do not break even, we should be very close to it." PAL was negotiating, he told Mackey, with Lufthansa for the German airline's catering services; with GE Engine Services for a maintenance deal; and with an unnamed company for a joint venture involving maintenance and engineering. Corporate Finance Vice-President Andy Hwang said, "To be Asia's best, we must align ourselves with the best." This is one of many new slogans, Mackey wrote, employed by the carrier that now described itself as "Asia's Sunniest Airline." By the late 1990s, for the first time in 50 years, such promises began to seem like more than mere words.

Philippine Airlines, Inc. History

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