Tuesday, May 04, 2010

Could American, US Airways deal follow United-Continental?

Will American and US Airways be the next big U.S. airlines to merge?

The attention of investors shifted to the nation's last two stand-alone legacy carriers Monday after United Airlines and Continental Airlines announced they are merging in a $3 billion deal to create what would be the world's biggest carrier.

Those clamoring for yet one more merger may be disappointed, however. A union between American and US Airways doesn't appear imminent. If it was, it would create a company that would rival in size the giant that United and Continental just created.

If approved by regulators and shareholders, the United-Continental combination surpasses Delta Air Lines, which took over Northwest in 2008, to claim the title of biggest.

The new merged airline, which plans to fly under the United name, will have hubs in the major markets of New York, Los Angeles, Chicago, Houston and San Francisco. That will put it in cities with a large number of lucrative business travelers who pay higher fares.

The international network of the new United airline — the Continental name will eventually be dropped, though tails of the new airline's planes will have the old Continental logo on them — will stretch from Shanghai to South America, including 370 destinations in 59 countries.

Its reach will be even greater because its passengers will be able to book and fly with its partners in the Star global alliance. Star, the biggest of the world's three big airline alliances, has 26 member airlines.

The leaders of the two merging airlines — Continental CEO Jeff Smisek and United CEO Glenn Tilton— couldn't contain their enthusiasm Monday at what they have created. Smisek will be CEO of the new airline. Tilton will become non-executive chairman.

Smisek told USA TODAY that the size and breadth of the new United network should attract many more corporate travel contracts. Big corporations seeking to cut volume travel deals want a carrier that can provide the most service to the most destinations.

"We have just delivered to our salespeople the best network that any airline salesperson could ever sell," Smisek said.

Said Tilton in the same interview, "The people who are most excited about this deal are our respective route planners. They are ecstatic about all the possibilities they'll have to put the right planes on the right routes to maximize aircraft utilization and revenue generation."
Competing with giants

The new United's size and reach will only increase the agitation for American and US Airways to not be left in the dust in the trend toward consolidation of old network carriers here and overseas. That's a path that many industry analysts see as the way for chronically money-losing mainline carriers to eventually make a profit.

A merger of the two theoretically would seem the way to compete against the giants.
Investors think so. Shares of AMR, American's parent, and US Airways rose more Monday than did those of United and Continental. AMR shares rose 2.9% to $7.59. US Airways jumped 4.5% to $7.39. United's stock rose 2.4% to $22.11, while Continental's shares closed at $22.86, up 2.3%.

But don't expect a union — at least any time soon.

US Airways would jump at the chance. Its CEO, Doug Parker, has led the call for consolidation, and it was his airline that initially was in talks last month with United.

But officials at American seem disinterested. They don't object philosophically to a merger. But consolidation, they say, is not a cure-all for what ails the U.S. industry.

They also say they don't see any potential partners that interest them. American's high costs, large debt and sour labor relations would make it hard to cut any deal.

The agitation for merger was evident last month when some financial analysts and some industry consultants talked with American's officials about its lackluster first-quarter earnings during a conference call.

In the face of the merger mania, American CEO Gerard Arpey and Chief Financial Officer Tom Horton repeatedly defended their "corner-posts strategy" that calls for American to maintain and build on its market strength in five of the nation's six biggest travel markets: New York City, Chicago, Dallas/Fort Worth, Miami, Los Angeles and Washington, D.C.

Their plan, they said, is for American to use its strength in those markets to funnel more high-fare-paying business travelers into its already dominant Latin American route network and into its pending international joint venture partnerships with British Airways, Iberia, JAL and others in the Oneworld global alliance.

"We have a strong network today," Arpey said during that April 21 conference call. "I'm confident in our corner-posts strategy, because I think our footprint is in the most important business markets in the U.S. already. So we're not necessarily threatened by consolidation among our competitors."

'Is that all you got?'
For the most part, the analysts weren't buying American's argument — not then and not since.
In exasperation over the lack of a more-aggressive response by American to its competitors' big plans,
Jamie Baker of JPMorgan Chase asked the American executives in the call, "Is that all you got?"

A week later, airline debt analyst Vicki Bryan at Gimme Credit told investors in a note that in the wake of United-Continental merger, American "could find itself in a distant third place in the U.S. market with 30% less revenue than the two leaders, significantly higher costs by comparison ... and at least twice the (debt) leverage."

She added, "Delta and United-Continental also have a greater capacity to generate higher-quality revenue with more premium and international travel."

On Monday, industry consulting firm AirlineForecasts issued a position paper entitled "United + Continental is good news for all stakeholders: More mergers are needed."

Co-authors Paul Mifsud, Carlos Bonilla and Vaughn Cordle, AirlineForecasts' president, argued that the country's air travel market can't support more than three big conventional network airlines. The United-Continental merger would leave four.

Conventional airlines — those with hub-and-spoke route systems, multiclass service offerings and intercontinental flights — already have seen their share of the domestic air travel market shrink to 53% this year from 80% 10 years ago, according to the AirlineForecasts paper.

The continued growth and profitability of low-cost airlines, whose less-sophisticated but generally lower-price service offerings make them popular with leisure travelers and business travelers who work for smaller firms, will be an ever-growing problem.

The network airlines likely will see their share of the domestic market fall to about 35% to 40% in the years ahead, AirlineForecasts said.

That doesn't leave enough travel demand to support the enlarged United and Delta — and American and US Airways as stand-alone operations, according to Mifsud, Bonilla and Cordle.
Thus, "The odds of liquidation and/or bankruptcy for US Airways and American increase because it will be too difficult, if not impossible, for them to remain viable as stand-alone businesses. Without a new strategic direction and significant changes in the industry's structure, American and US Airways will continue on the slow liquidation path to failure," the trio wrote.

Antitrust review coming
The United-Continental merger must pass an antitrust review by the Department of Justice, but few analysts expect the agency to oppose it. United and Continental currently compete head-to-head on only 14 routes.

United has six hubs — Chicago, Denver, Washington, San Francisco, Los Angeles and Tokyo — and is strong in the Midwest, on the West Coast and in the Mid-Atlantic. It's one of two powerful U.S. carriers in the trans-Pacific and Asian markets.

Continental, meanwhile, has four hubs — Newark, Houston, Cleveland and Guam — and is strong in the South and the Northeast. It's strong in the Latin America and trans-Atlantic markets.
Congress, however, will likely examine whether the deal is in the nation's best interest, as consolidation often leads to higher fares and fewer routes in and out of some cities.
Jay Rockefeller, D-W.Va., chairman of the Senate Commerce Committee, said Monday he wanted to look at it.

And the Justice Department — which will have final say on the merger — last year objected to United and Continental's request for antitrust immunity to form a venture with Air Canada and Lufthansa that would effectively have allowed them to combine their trans-Atlantic operations.

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