Airline Mergers: Ready for Takeoff?


A fresh round of consolidation talk has the U.S. airline industry abuzz, but such deals are far easier to propose than to complete

It happened with railroads, cars, and then oil. Steel followed in the 1980s and 1990s. Now many people are pressing for consolidation of the U.S. airline industry, where they see too many seats, too many redundant operations, and fliers chasing too many cut-rate fares.

After a four-year struggle to survive billions in losses, the industry has finally gained a little breathing room, thanks to fundamental restructurings and somewhat higher fares. That, in turn, has more than one airline executive mulling long-term structural fixes—and less competition via consolidation might just fit the bill. "It's the lemming nature of the airline industry that when somebody does something everybody else wants to do the same thing," says Joe Leonard, chief executive of AirTran Airways (AAI), one of the carriers in the current mergers and acquisition hunt. "I think there's a real fear of being left out."

As 2006 draws to an end, there are three main deals in play. And if one of the major carriers strikes a deal, expect others to follow, as none really wants to take on a rival that just got bigger.

Struggling Over Delta

The largest proposal, and the one that will set the tone for whether the industry sees any wholesale consolidation, is US Airways Group's (LCC) $8.5 billion hostile offer for Delta Air Lines (DALRQ). Delta wants to leave bankruptcy court protection as a standalone carrier by late spring or early summer. Both sides are girding for a fierce public battle, while also pitching Delta's creditors on their vision for how the company would best succeed.

At issue will be whether such a combination—which would create one of the world's biggest airlines—can be made acceptable to regulators. Moreover, US Airways says it can squeeze $1.65 billion in annual cost savings from a merged entity and is offering creditors a juicy incentive: Nearly half its bid, $4 billion, is cash. Delta contends that such a behemoth airline would never pass regulatory muster and has assembled a detailed PowerPoint scenario of job cuts, reduced flights, hub domination, and higher fares that would make almost any consumer advocate cringe. In its reorganization plan filed Dec. 19, Delta calculates its standalone value as high as $12 billion. Two days later, Doug Parker, US Airways chairman and chief executive, called the math "way out of whack."

The issue also presents a personal dimension for employees of a paternalistic Southern company that goes to great lengths to imbue workers with the idea of family. Delta workers have begun wearing "Keep Delta My Delta!" buttons and ribbons, and the airline has launched a petition drive on its Web site to gather supporters for its side. For 74-year-old Delta CEO Gerald Grinstein, a Harvard-trained attorney and accomplished executive who is retiring after the Chapter 11 case, the issue may also be a matter of legacy.

"You really want to be the guy who sold Delta?" says Gordon Bethune, the retired chairman and CEO of Continental Airlines (CAL). Still, he gives the deal "60-40" odds of happening because Delta's creditor committees will determine what's likely to return the most financial value. "They do math real well. And the judge is likely to go along with the mathematics," Bethune says.

AirTran Tries Again

In a second firm bid, the parent of AirTran Airways has submitted a $290 million offer for Midwest Air Group's (MEH) Midwest Airlines, its second overture in a year. AirTran's Leonard says he's ready to pay up to get a deal done, but Midwest has rejected the latest offer as too low and sounds disinclined to cooperate. "I would rather manage a company going forward, even if it was small, that had a real special niche, that was a product that people deliberately chose," says Midwest Chairman and Chief Executive Tim Hoeksema. A combination of these two smaller players would, of course, signify little for the industry's ultimate configuration, but such a deal could provide a catalyst for other talks and allow regulators—not to mention politicians—to weigh in on their parameters for other pairings.

On Dec. 13, there were reports that UAL's (UAUA) United, the second-largest U.S. airline, has been talking with Continental about a merger. United left bankruptcy in February, 2006, its share price has nearly doubled over the past four months, and CEO Glenn Tilton has been among the industry's most outspoken advocates for consolidation. Such a combination would produce little route overlap, as Continental operates heavily in Latin America and Europe, and United is strongest in the Western U.S. and Asia.

The thorniest sticking point? Management control. United is bigger, with a broader global reach, but Continental executives consider their track record far superior and have little regard for United's strategy, according to a person familiar with the discussions. A Continental spokeswoman declined to comment. In a sense, every airline chief would love to see a smaller industry, but none is quick to relinquish his own job.

Looks Easy on Paper

Consolidation talk surfaces every few years, but the most recent deals that have been consummated have come largely through bankruptcy proceedings. United tried to buy the former US Airways Group in 2000, but later abandoned the bid after wary antitrust regulators made it clear that any such deal would require too many conditions to make it feasible. American (AMR) purchased TWA out of bankruptcy in 2001, and America West acquired US Airways after the latter's second trip into Chapter 11 in 25 months. Now Delta and Northwest are reorganizing under court protection and both are drawing sharp scrutiny. Add to this mix private equity coffers that are bulging with cash for deals, and the array of powerful reasons to consolidate becomes clearer.

But airline combos are notoriously messy, laborious, complex affairs that give even the most seasoned industry veterans headaches. US Airways still has a long path toward integrating its two stitched-together operations, with workers' seniority high atop the list of unfinished business. And despite its appeal on paper, not everyone among Wall Street's finance wizards is convinced that consolidation can provide the sorts of solutions many in the field are seeking.

"I'm not a big proponent of consolidation," says Helane Becker, an analyst with the Benchmark Company, who is quick to add: "I very much understand why my peer group wants it to happen." The most cited reason is capacity reduction. Yet Becker contends that the industry has culled capacity by 15% this year—equal to "an airline the size of Delta"—on its own and that the public is unlikely to abide by a process that cuts jobs and flights while boosting fares.

Bethune, who helped lead Continental's resurgence until his retirement two years ago, calls consolidation "inevitable" because overall finances are shaky and the cyclical industry can't weather prolonged downturns. In a recent interview with BusinessWeek.com, he said many people—especially politicians—must stop viewing airlines as a public utility and more as a business that's allowed the same tools other industries use. He sees a day when the country has a trio of large carriers like Detroit's Big Three and a slew of smaller discounters. His rationale? "If it worked the old way, those guys wouldn't be in bankruptcy!" Bethune said.

Small Carriers Cash In

The new twist in consolidation circa 2007 could well be the rise of discounters such as Southwest (LUV), Alaska (ALK), Frontier (FRNT), JetBlue (JBLU), and AirTran. Collectively, such airlines now control more than a third of the domestic market, up from about 10% in 2001. Consumer groups and antitrust authorities once argued that combining major carriers would create too much market dominance, especially in hub cities, but the upstarts' success has muted that claim. JetBlue, for example, now flies to far-flung destinations such as Aruba and Cancun. The once-tiny AirTran has begun several nonstop flights to Florida from Boston and White Plains, N.Y., north of New York City, as well as numerous new routes to the West it now flies from Atlanta, where it's a firm rival to Delta. And like Southwest, both JetBlue and AirTran are now true national carriers. "There's a lot of ways to get from Miami to Seattle. There are 10 ways to do it. Now there'll be nine ways," Bethune says. "You can always say, 'There's less competition,' but then you get to the question, 'How much is enough?'"

The most interesting of the current deal batch is the wrangling for Delta. No matter how talented Parker and his US Airways team may be, they confront a long history of troubled airline mergers strewn with bitter workers and financial losses. Unlike oil rigs and steel mills, airlines literally live or die by the people who make them fly, both workers and passengers. They could pose the biggest hurdle in the consolidation game.

Click here to see where the large U.S. carriers stand in this latest round of airline merger-and-acquisition talk.


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