Are recent deals real consolidation or just opportunistic moves? A new US combination puts an old question to the test: can two fly more cheaply than one?
Merger and activity in the airline sector has often looked like something of a last ditch cure: by the time the treatment is applied, the patient is critical, if not already dead. Plenty of such medicine has been administered since September 2001. However, America West Airlines is the latest to talk up the prospects of growth and strength from its proposed merger with ailing US Airways. As America West’s Doug Parker said in unveiling the merger along with US Airways chief executive Bruce Lakefield: “These two airlines are so much stronger together. The real work begins now.”
The industry has been here before, though often such mergers have looked more like the administration of last rites than the application of a revitalising tonic. American Airlines bought the once mighty TWA in the months before the 9/11 attacks, but by then the airline was a mere shadow of its past glories and had effectively ceased to exist by the time the Twin Towers fell. And when Southwest Airlines took over whole chunks of ATA earlier this year, this low-fares carrier was already shrivelling in bankruptcy and had little to offer beyond airport gates.
Conventional wisdom suggests that such mergers are most useful as a potential cure for overcapacity in the heavily oversubscribed US airline market. Analyst Susan Donofrio at Fulcrum Global Partners in New York, is far from alone in lamenting that “there are too many hubs in the USA”. She adds: “We need more consolidation to happen so the airlines can run more efficiently.”
United Airlines too has long said the market needs to be more open to consolidation. As a carrier seeking an infusion of cash, it is not surprising to hear chairman Glenn Tilton repeatedly calling for an end to US foreign investment limits. However, that view has gained no traction on Capitol Hill. This leads Chris Avery, London-based analyst with JP Morgan, to argue that a transatlantic open-skies agreement looks as far away as ever.
The US travelling public also remains wary of the levels of service that emerge following mergers. Of the 18 major US mergers since deregulation in 1978, only one, by consensus, was successful. That was the 1987 integration of Western Airlines into Delta Air Lines. Standard & Poor analyst Phil Baggaley calls the track record of US mergers “dismal”, with few delivering on promised benefits.
The America West and US Airways merger would, in effect, join one entity in its second bankruptcy reorganisation since 2001 with a marginal survivor that went through four years of bankruptcy reorganisation before 2001. Benefits of the merger include little geographic overlap, with only four routes on which the two now compete, and a high degree of aircraft commonality. Despite revenues of around $9.5 billion, the merged carrier would still have a relatively modest 9% share of the massive US domestic market and as such is unlikely to spur further mergers among its rivals. Delta Air Lines, which Lehman Brothers analyst Gary Chase says is perhaps most vulnerable to the merger, has few options with which to respond.
High marks
Bankruptcy has been a new and essential feature of this consolidation, giving the merger an immediate advantage. Corporate direction is put in the hands of the bankruptcy judge, who has extraordinary powers to overrule the constituencies that could otherwise delay or override decision-making.
Thus US Airways, which re-entered Chapter 11 protection last September, can reject leases on aircraft and other major assets in order to negotiate down its costs, and shed pension obligations. United, its partner in a failed 2001 merger, has done this on a larger scale.
The combination of bankruptcy together with the government role as lender of last resort, through the federal Air Transportation Stabilization Board, has been hailed by some as a way to direct an orderly consolidation of the US market. The board’s loans and guarantees have propped up both US Airways and America West and it has blessed the merger. However, the deal was moved by a timely combination of individual drive and opportunism rather than federal wisdom. Parker says he expects consolidation to begin in the low-fares sector and insists the airline will be part of it. He had attempted as much late last year by bidding on the ATA assets that were ultimately won by Southwest. US Airways has searched for a larger partner as a safe home for a decade.
On their own, the two might not have had the weight to bring about a coupling that others took seriously, but they had other advantages, including federal support and the powers of bankruptcy. The two also have the backing of powerful manufacturers and lessors. GE’s finance arm, a lifeguard for US carriers through its vast leasing portfolio, supported the merger, as did Airbus, the major supplier to each partner.
That left an opening for another emerging player, Air Canada. It will invest $75 million in a deal that sees it winning significant maintenance work on US Airways jets. Robert Milton, chairman of Air Canada’s parent group, stresses that this “is really about a $75 million investment we believe in, but which will be repaid within two years based on all the insourcing of maintenance work”. Milton is optimistic about the venture’s future. “I believe in Doug Parker, who I know well,” he says.
Parker also wins high marks from consultant Mike Roach, an America West veteran, who is not alone in crediting Parker for creating that rare hybrid, a low-cost, low-fares network carrier. US Airways has in effect moved towards becoming one too by shedding costs. But while it may have boosted point-to-point flying, it is unable to leave its roots as a network carrier.
The merger is unlikely to face regulatory opposition of the sort that doomed the US Airways attempt to join United in 2001, but internal obstacles remain. Integrating the two pilot unions will be challenging if it is to be equitable to America West pilots – few of whom have more than seven years’ seniority, compared with an average of 19 years at US Airways. Importantly, the US Airways name under which it will operate is at best tarnished and, to many, is a marque of doom. Even Parker remarked in a recent employee newsletter that the name “has seen better days”.
Still, pricing trumps brand identification in the USA these days, and as Baggaley points out, it is revenue generation more than cost-cutting that makes a merger work. Parker sees $600 million in merger benefits, of which $200 million would come from revenue synergies and believes “this new airline can be profitable at $50 per barrel crude oil. The reason for that is no heroic assumptions whatsoever as to the economy.”
International experience
The US industry is not alone in witnessing a renewal of merger and acquisition activity since the shock of 9/11. In Europe, KLM finally ended its search for a long-term partner through last year’s Air France merger, while Swiss gave up on its failing battle for independence with the Lufthansa acquisition this spring. Low-fare start-ups too have merged through weakness, not strength, as indicated by their often-minimal price tags. Avery at JP Morgan prefers to term such moves as “agglomeration” rather than true consolidation, arguing that the larger deals have taken little capacity out of the industry. They represent a firming up of alliances using equity, he remarks.
In Latin America, consolidation has only come about in distress, as is the diagnosis of the Brazilian syndrome and the long-running saga around Varig – a patient now in bankruptcy that may still find its cure with TAP Air Portugal. In a development perhaps parallel to that in Europe, the emergence of large regional alliances such as the LAN, TACA or Synergy groupings may have brought strong management but these too are clearly cases of opportunism. In Asia, the largest consolidation has been by government behest when China, in a bid to end the “disorderly competition” that had produced large losses, forced the nation’s 10 major carriers into three groupings. Elsewhere, Japan Airlines has now completed the merger with Japan Air System announced in late 2001 and emerged profitably from the experience holding about half the domestic market. That is a dominance of which US majors may only dream.
DAVID FIELD WASHINGTON
Source: Airline Business
