Continental expected to make United bid
By Linda Loyd
Inquirer Staff Writer
Posted on Tue, Apr. 13, 2010

A Wall Street analyst expects Continental Airlines to bid to acquire United Airlines, after reports that United and US Airways were in merger talks.

Stifel Nicolaus airline analyst Hunter Keay said in a client note Monday that a United-US Airways merger is "a suboptimal scenario" because of pilot labor issues, revenue risks, and "problems with regulatory review due to higher domestic overlap" on routes United and US Airways have in common.

"We expect Continental to respond to reported United-US Airways merger plans with a bid for United," Keay wrote, "partly as a defensive maneuver. . . .We expect Continental to respond relatively quickly." Keay said he had no knowledge of merger negotiations or discussions between Continental and United.

Industry observers acknowledge that Continental is a better match for United. "But it takes two to agree," said aviation consultant Robert W. Mann, of Port Washington, N.Y.

Continental and United discussed merging in 2008, until Continental walked away.

A combined United-Continental would create the world's largest airline, ahead of Delta Air Lines, now the largest after acquiring Northwest Airlines in 2008. A combined US Airways-United would be the second-biggest U.S. carrier. Delta and Air France-KLM are larger worldwide.
Continental's strong presence in New York and in Pacific markets would complement United, said Gimme Credit L.L.C. bond analyst Vicki Bryan in a client note.

A United-Continental combination "could generate nearly $2 billion in revenue and cost savings, perhaps twice the benefits" of a United-US Airways merger, she wrote.
Continental has more cash - $2.9 billion - vs. US Airways' $1.3 billion and "stronger free cash flow as a percentage of revenue, and slightly lower leverage," Bryan said.

Keay said a United-US Airways merger would "seriously jeopardize" the joint ventures Continental and United had been pursuing to coordinate on scheduling and pricing.

A United-Continental merger would face less regulatory scrutiny because the carriers have fewer overlapping city pairs - nine, whereas United and US Airways have 14.

Keay said that, in a United-US Airways merger, proposed service or job reductions at Philadelphia International Airport "would be met with pushback" by politicians, possibly including U.S. Sen. Arlen Specter (D., Pa.), who protested when US Airways closed its Pittsburgh hub in 2006.

"We see potential political and/or legal issues with the handling of US Airways' Philadelphia hub, given the relatively close proximity to United's Washington Dulles hub," Keay wrote.
"We see a high likelihood of forced asset divestitures at Philadelphia or Dulles, and Phoenix or San Francisco, given hub redundancy."

Gimme Credit's Bryan noted, "US Airways lacks the rich appeal of new markets."
United and US Airways' overlapping markets - such as Washington - could result in reduced market share "if the combined carrier was required to sell common slots, for example, before the merger could meet regulatory approval," Bryan said.

Most airline CEOs, including United's Glenn Tilton and US Airways' Doug Parker, have touted the benefits of more industry consolidation.

In 2002, Tilton was recruited to United, after nearly three decades in the oil industry, to turn around the troubled Chicago-based carrier. Hit by competition from low-fare carriers, United's labor costs were among the highest in the industry. Two United passenger planes were hijacked in the Sept. 11 terror attacks.

After United filed for Chapter 11 bankruptcy reorganization, management in 2003 eked out hefty concessions from unions that saved about $2.5 billion.

"United flight attendants and pilots have been at war with the company since the restructuring," said Mann. "It wasn't a small haircut. These were scalpings."

US Airways filed for bankruptcy protection twice in the last decade and was saved from liquidation in 2005 by combining with America West Airlines, of Tempe, Ariz.

Parker, with America West since 1995, became CEO of the new US Airways. Under his leadership, US Airways improved operational problems at Philadelphia International Airport - uneven baggage service, and one of the worst records for on-time flights.

Parker made an unsuccessful hostile bid for bankrupt Delta in 2006. US Airways tried to combine with United in 2008, but United walked away.

One of US Airways' biggest unresolved headaches from its 2005 merger has been integrating its pilots and flight attendants, which are split on seniority lines - with more-senior crews employed by the old US Airways and less-senior personnel working for the former America West.

"US Airways hasn't been able to run one airline," said Mann. "They still operate on two separate contracts. They still fly on two separate fleets."

If United and US Airways merge, seniority integration of the workforces will have to be resolved. Management has to be "willing to pay to play," Mann said.

"I think they could convince people who are today opposed to a merger to participate. They are going to have to share the economics," Mann said. "If they try to do it cheap, chances are they'll have a lot of resistance."