AMR and US Airways

The last great American airline merger

…and the last great American airline bankruptcy?
 Jan 12th 2013 |From the print edition of The Economist

The bankruptcy courts in America have had to restructure distressed airlines so often that they may as well have installed check-in desks and duty-free shops. Of surviving carriers, US Airways has been through Chapter 11 proceedings twice, and United and Delta once each.

Until recently AMR, the parent of American Airlines and its smaller sibling American Eagle, proudly resisted using insolvency to get out of trouble. It had also stayed out of the industry’s bout of mega-mergers, in which Delta has combined with Northwest,

Southwest with AirTran and United with Continental. But in late 2011, as it staggered through its fourth successive year of losses, AMR filed for Chapter 11, in the hope of emerging leaner, stronger and still independent. Now it looks like falling prey to a reverse takeover from the much smaller US Airways, creating one of the world’s largest airlines by capacity.

US Airways’ boss, Doug Parker, has won backing for the bid from AMR’s disgruntled labour unions, his own staff and Wall Street analysts, forcing AMR to negotiate. On January 9th its board met to examine US Airways’ proposal: there was no immediate announcement but earlier AMR’s boss, Tom Horton, had promised a decision in “a matter of weeks”.
High pay, low morale

Before its bankruptcy AMR somehow managed to combine some of the best pay and conditions in America’s airline industry with some of its worst labour relations. So its unions have warmed to being taken over by US Airways, even though it has still not got its own pilots to agree on a unified labour contract following its 2005 merger with America West.

AMR has had to cut pay and pensions and alter working conditions. But employees hope that any future pain will be less under a merger with US Airways than if AMR stays independent, says Helane Becker of Dahlman Rose, an investment bank.

The two airlines make a good fit, with little overlap, notes Henry Harteveldt of Hudson Crossing, a consultancy. They overlap on only a dozen routes, and on most of those there is already at least one other competitor. So antitrust regulators may have few objections to a merger.

Joining US Airways would fill some gaps in American’s coverage, especially in the eastern United States, that have driven business customers to Delta and United. Jamie Baker of J.P. Morgan, another bank, says American used to enjoy higher revenues per available seat-mile than other full-service airlines but now, as a result of its weak network, it does worse even than the low-cost carriers.

A merger would also benefit the oneworld global alliance, to which American belongs and which the merged airline would almost certainly stick with. US Airways (which would thus leave the Star Alliance) has a relatively modest international route network of its own, and will gain from taking over American’s more ample one.

Assuming US and American merge, the result will be that America’s skies are dominated by three full-service carriers plus a fourth, Southwest, that began life as a low-cost airline but has come to resemble its traditional rivals. Between them they will have about four-fifths of the domestic market (see table). So, says Mr Harteveldt, it will be “the last big airline merger allowed to happen” in America.

Whereas the best-run low-cost airlines have attractive profit margins, the full-service airlines’ returns have long been dismal. However, a drastic change is in prospect. The biggest carriers have all been through bankruptcy, wringing out many of their excess costs; they have learned just how much they can rake in from charging separately for baggage, meals and the like; they at last seemed to have learned not to overexpand in a mad dash for market share; and now the industry is consolidating to just four main participants.

Analysts are daring to dream of a golden age of airline profits. Mr Baker hopes AMR’s Chapter 11 may prove to be America’s last great airline bankruptcy too.

This sounds wonderful for investors; less so for passengers. Domestic air fares, having fallen by about a third in real terms in the decade to 2009, have since started rising. This is mainly due to higher fuel costs, though the industry’s increasing concentration may make it easier for price increases to stick. The airlines’ improved discipline on capacity means flights sell out more often—bad news for late bookers.

And then there are the issues of comfort and reliability. Skytrax, an influential rater of airlines, gives just three stars out of five to America’s main carriers, putting them on a par with Papua New Guinea’s national airline, Air Niugini. Delays and cancellations have decreased in recent years but still only four-fifths of flights arrive on time. In the short term a merger may make things worse: as shown by United’s recent computer failures and other glitches as it integrates Continental, airline mergers can inflict years of misery on passengers.

Given the volume of travellers’ moans, there ought to be a market in providing a better service at a slightly higher price. But, notes Mr Harteveldt, Virgin America is seeking to do just that, and is still losing money, five years after its inception. So travellers may find that for them, the golden age of airline profits will be a dark age of pricey tickets and poor service.