City Insider - FT journalist David Stevenson on the travel industry

Bright rays of hope haven’t been much in abundance in the travel industry as of late, especially for Thomas Cook.

The sorry state that the industry’s number two now finds itself is almost entirely self inflicted and  doesn’t really warrant much repeating in this column – like many companies it’s learnt the bitter lesson of taking on too much debt at almost exactly the wrong point in the business cycle.

Yet the collapse in the share price and the current extended round of refinancing does offer some hope, although I’d wager that there’ll be a nasty sting in the tail.

First let’s step back from the mess and look at Thomas Cook from two different perspectives. The first is from existing investors and the second from potential new investors, especially trade or private equity buyers.

For existing investors it’s game over – the harbinger of even nastier things to come was the news that private investors piled into Thomas Cook stock last week via high street stockbrokers.

This is usually a contra-indicator that the end is nigh as private investors almost always misread these drastic situations, somehow confusing dire financial restructuring for a contrarian opportunity.

The key for this slightly jaded observer was the issue of warrants (representing just under 5% of the common stock) to bank creditors involved with stumping up more funding for the embattled group.

This is the thin edge of the wedge and will inevitably result in a massive debt-for-equity swap which will involve drowning private investors in a tsunami of new shares. This doomsday scenario for investors won’t happen for a few months because I’d be willing to wager that Thomas Cook is about to enter a new, potentially rather scary stage.

Thomas Cook isn’t too big to fail but it is absolutely valuable to the banks as a going concern, without pesky outside shareholders. It’s obvious that there’s a collection of good businesses within the group that will be put on the block and sold off.

But I’d wager that there’s a parallel process quietly at work here which is that the Thomas Cook relationship at the major banks is being passed from normal client liaison managers to the distressed/business workout desk.

The big banks, but especially the fallen giants such as BoS and RBS, have now built up extensive departments full of hard-as-nails bankers and former management consultants charged with figuring out why company/asset X fell into disaster and then work out how to slim the victim down ready for sale.

The key for this charming bunch of people is to work out how much more actual cash Thomas Cook is going to bleed over the next few months and then work out what went wrong in the first place.

In particular I’d suggest that they’ll look closely at the payment terms foisted on existing suppliers from the Autumn by Thomas Cook – they’ll be trying to figure out whether the stated cash position to the banks is the actual cash position based on normal terms of trade or whether these more onerous terms flattered the cash book.

The banks might also be keen to initiate some conversations with suppliers via Thomas Cook which might consist of an ‘offer’ to extend those onerous cash terms and possibly even insist on more worse terms.

At some point in March or possibly later, the banks will know the full damage and then the nasty haircut will come for shareholders as the banks effectively move in and take over via a debt-for-equity swap.

Looking on at this mess from a distance will be the potential trade-buyers (not that there are many of them) and the private equity guys.

In my last column back in November I mistakenly assumed that the boys with spreadsheets and fancy Return on Equity models would be interested in Thomas Cook after the initial, successful negotiations on debt but I was obviously far too optimistic.

Clearly there was more bad news to come, which scared off the private equity outfits. But by spring of 2012 most of the red ink at Thomas Cook should be declared and the company will start a painful process of cleaning up – at which point Thomas Cook or at least a large part of it, will be a tempting target.

Private equity love a mature industry where most of the hard work around capacity destruction and loan refinancing has been done, allowing the investors to swoop in late, recapitalise the business, and pump more new investment into the core trading concerns.

And that’s the potential for good news – that Thomas Cook may roar back in 2012 with new owners, a cleaned up balance sheet and a leaner structure. In fact I’d go so far as to say that the longer the negotiations drag on, the more Tui Travel should worry.

A nasty meltdown and sudden closure at Thomas Cook may cause mayhem in the industry but Tui would probably benefit from the removal of a major competitor over the long term whereas a new, revitalised Thomas Cook with ambitious new managers might be an absolute nightmare, perhaps even triggering a lower Tui share price and a much anticipated bid from German parent TUI AG.

Taken in the round, I think it’s reasonable to make the following assumptions about the Thomas Cook affair:

The first is that Cook is very much still in business and that the banks won’t want to let it fail. I’d also suspect that there might be even more tightening of trade terms with suppliers as everyone involved tries to stabilise what is obviously a truly dreadful cash position. There’s also a chance that a new, leaner, meaner Thomas Cook will surge back in 2012 and cause real problems for Tui.

Yet that last, optimistic, scenario is based on one central assumption – that’s there’s no massive deterioration in trading in key continental markets. And there’s the rub. 

Last week I spent a whole day with a truly dismal bunch of continental European banking economists – all I can say is that if these grim eggheads are right we haven’t seen anything yet in key markets such as the Netherlands, France, Sweden and, of course, Germany.

To a man and woman, every one of the economists predicted a precipitous drop in consumer confidence and thus discretionary spending in the core German market from December onwards with even bigger falls predicted in France.

When I mentioned the likely impact on the summer holiday big ticket spend, they nearly all shook their heads in despair and predicted a very severe slowdown.

The worry here is that Thomas Cook will attempt to sell valuable continental assets at exactly the wrong time and, in addition, find itself caught up in yet another consumer crunch first in France and then in Germany, with a nasty knock-on effect on that already precarious cash position.

Cue more injections of cash from increasingly exasperated banks, desperate to control their risk position.