Nagin's remark came two days after Continental Airlines and Northwest Airlines revealed their codeshare pact. As the US industry digested the news, the consensus was that it should prepare itself for more of the same - and soon. 'This is the opening gun. There are a number of airline managers who are burning the midnight oil right now,' says Julius Maldutis, analyst at Salomon Brothers in New York. 'I think we will see other similar agreements happen very quickly; certainly before mid-year.'
So, in this game of take-your-partner, who will save the last dance for whom? Most attention is focused on a possible waltz between US Airways and either American Airlines or United Airlines. US Airways' stock was buoyed by merger speculation on the day of the announcement, climbing three points on the New York Stock Exchange. The airline is making no comment, but it has paid down a large portion of its debt, making it a more attractive proposition. And, analysts say, chairman and chief executive officer Stephen Wolf has acknowledged the pressure to find a US partner. 'If you look at United, it has a strong west coast presence and has been able to leverage that in its expansion across the Pacific. US Airways has a strong presence on the east coast, but has not been able to leverage that. They have got to find another way to do that by either creating a midwest hub on their own or by alliances - not necessarily mergers - but alliances similar to the Northwest/Continental deal,' says Glenn Engel at New York's Goldman Sachs. That need for a midwest hub points most obviously to United and Chicago O'Hare, but American also hubs out of Chicago and Trans World Airlines' homebase is in nearby St Louis.
Not everyone agrees, however, that US Airways' dance card is filling up. 'I'm sure those at US Airways are beside themselves,' says Joseph Berman, analyst at Avmark in Washington DC. 'But there is an image problem associated with taking on US Airways and, quite frankly, management there has hacked off too many people in this industry.' However, Philip Baggaley at Standard & Poor's says that US Airways' recent sharp turnaround in earnings and share prices makes it a more attractive partner for either United or American, particularly if they follow the blueprint of an alliance rather than a merger.
Delta Air Lines is left looking like the reluctant wallflower in this alliance ballroom. Delta's president and chief executive officer, Leo Mullin, is still steaming at the way the airline was dropped just when he thought it was on the verge of a tie-up with Continental. His anger seems directed not so much at the way the deal fell apart at the eleventh hour as at the missed opportunity months earlier when Continental first approached Delta. Mullin, who replaced Ron Allen in September, says one of the first questions posed to him by Wall Street was why Delta had not pursued a merger with Continental proposed in 1996 by Continental's chairman and chief executive officer, Gordon Bethune? Mullin looked at the synergies and the numbers involved, particularly the anticipated annual benefits of $800 million, and agreed that Continental had been right. 'The Delta/Continental merger would have been terrific for the employees, for the shareholders and for customers,' says Mullin. 'So we decided to take a shot at this again.'
That shot took the form of a full merger proposal under which Mullin would have been CEO of the combined company, but which included job offers to most of Continental's senior directors. It was, Mullin concedes, something of a shock to have his 'comprehensive and outreaching' package turned down.
Mullin plays down the question of whether that rebuff leaves him with any appetite for a new courtship. He describes the Northwest/ Continental codeshare as an 'interesting experiment' which does little to change fundamentally the hub-and-spoke operations of the US majors. 'The degree of disturbance to the balance of the industry is relatively weak,' he says.
However, the codeshare will strengthen each airline's overall position and particularly helps to bolster Northwest's domestic presence. As the most internationally-orientated of the US majors, only about 60 per cent of Northwest's capacity is deployed in North America. In contrast, Continental is much stronger domestically.
Northwest has key hubs in Minneapolis/St Paul and Detroit, and a smaller hub in Memphis, while Continental's major hubs are in Houston and Newark/New York, with a smaller hub at Cleveland. The US route structure of each airline is complementary, say analysts, with overlaps on just eight routes. The only concern focuses on the future of Cleveland, which is just 150 miles from Detroit, but has strong business class traffic.
The likelihood is that Delta will be caught up in the scramble to find partners, although a tie-up with US Airways is unlikely because of overlap on the east coast. Each operates hourly shuttle operations out of Washington National airport, ferrying business passengers to New York and Boston, and US Airways' planned low-cost airline, which will begin operations out of Baltimore/ Washington airport in June, will compete with Delta Express. America West is also an unlikely partner because the Phoenix, Arizona-based airline already has codeshares with Continental and Northwest.
'Our codeshares with both airlines are unaffected,' says America West's chairman Bill Franke. 'I have had talks with both Mr Bethune and Mr Dasburg and they have emphasised that to me. In fact, I see possible growth, particularly with the Northwest part of the codeshare. The Continental codeshare is mature, but there are opportunities for the Northwest relationship to expand with feed from the Pacific to our Las Vegas hub.'
Another potential partner for Delta, Alaska Airlines, also has a major codeshare with Northwest. The dilemma for Delta is obvious - who's left? 'I think Delta is stunned by this,' remarks Avmark's Berman.
Along with the other majors, Delta might still be forced to the floor for three reasons. First, each is entrenched in its fortress hubs, from where each is comfortably profitable. But that leaves little room for future domestic growth. 'The only way forward for growth is through what I would call a revenue merger like that of Northwest and Continental,' says Maldutis. Second, US airlines are under pressure to meet the year 2000 stage 3 noise regulations, but many aircraft production lines are sold out for two or three years. Alliances provide a way of accessing new aircraft quickly and cheaply. Third, the majors are becoming nervous about possible governmental intervention on competition issues.
The Department of Transportation will soon release a document which will define predatory practices. Already DOT Secretary Rodney Slater has made it clear that those who step on the wrong side of its boundaries will be vigorously pursued. 'The government is making ugly noises about competition and high air fares,' says Maldutis. 'If I were an airline manager, I would be thinking I'd better get these revenue mergers under way before the barn door closes.'
Certainly, Northwest and Continental themselves seem to anticipate a reaction. 'We believe these types of alliances are the future of the industry,' says Bethune.
The airlines say they have no plans to merge and will retain separate boards, managements and headquarters. Nor are they seeking antitrust immunity other than for the transatlantic operations with KLM (see box). However the codeshare does require government approval - a process which may take at least two or three months. 'They will be looking at it pretty seriously, we expect,' says Northwest.
No layoffs, workforce mergers, transfers of flying or assets, or closures of facilities are planned, says Northwest. That virtually eliminates the opportunity for any cost savings, which would have been available under the Continental/Delta merger. But the similar financial profiles of Northwest and Continental, combined with the virtual lack of overlap on routes, have analysts declaring it a well-matched marriage.
In revenue terms, Northwest and Continental rank fifth and sixth respectively in the US, with Northwest reporting $583 million net income on $10.2 billion in operating revenues in 1997; and Continental reporting $385 million net on revenues of $7.2 billion - records for each company. The two carriers' combined revenue of $17.4 billion puts the partnership in second place, a whisker ahead of United's parent UAL and $3.5 billion ahead of Delta. By the third year of the alliance, the airlines estimate it will be making more than $500 million per year of extra pre-tax income, with Continental receiving some 45 per cent of the benefits.
Northwest will take a 14 per cent stake in Continental by buying 5.3 million shares from Air Partners which carry voting rights of 51 per cent. But those shares will be put into a voting trust for six years to protect the independence of Continental's board and management. 'It's quite an innovative deal and it strengthens both companies,' says Maldutis.
Airline alliance jittersPerhaps it should not have come as any surprise that it was Northwest Airlines which gave the global strategic alliance world a jolt. It was, after all, Northwest that started the ball rolling in 1992 by gaining US antitrust immunity for its alliance with KLM.
Now partners in competing global alliances are assessing how their arrangements stack up against the potential combined forces of Northwest and KLM with Continental Airlines, Alitalia, Air France, America West and Virgin Atlantic. The figures will make some very nervous.
In 1996, the Star Alliance headed the global alliance league table with some $46 billion in revenues for its members - chiefly United Airlines, Lufthansa, SAS, Air Canada, Thai Airways and Varig. At presstime a decision was expected by the European Commission on the American Airlines /British Airways alliance which could potentially produce close to that amount. The combined forces of the Northwest/KLM/Continental global tie-ups would put the alliance in third or even second place with revenues of over $42 billion, with the Delta group a distant fourth.
Most pressured must be US Airways, which remains at the global alliance starting post, and Delta Air Lines, which will be reviewing the relative strengths of its alliance with Swissair, Sabena and Austrian.
From the international perspective, the Northwest/Continental tie-up is almost void of overlap. Northwest is strong in Asia, but Continental's presence in the Pacific at Guam, through Continental Micronesia, complements Northwest's existing route structure. Conversely, Northwest has almost no service to Latin America, while Continental has been developing its presence there. Even on transatlantic routes, overlaps are almost non-existent. Continental does not serve Amsterdam, but has access to London/ Heathrow via a codeshare with Virgin, enabling higher frequencies on the New York-London route plus service to Heathrow from six US gateways served by Virgin. The Alitalia agreement allows it to serve Milan and Rome daily from its Newark hub and a codeshare is also planned with Air France.
'We have to look at the big picture here,' says Joseph Burman at Avmark. 'Northwest and KLM have their alliance in place now, and if you add to that Alitalia and Air France, plus the feed through Newark, you have a very nice alliance indeed. Then the feed through Air France into the restricted markets of Africa and the Middle East adds up to huge potential.'
'There is certain to be a major impact on the international arena,' agrees David Ulmer at Roberts, Roach & Associates, who believes this pact puts Northwest and Continental on a more even footing internationally with United and American.
Excitement could fade, however, if antitrust immunity is slow in coming. The US airlines are seeking to add Continental to the immunised deal that already enjoyed by Northwest and KLM on transatlantic routes, but US Government concerns about competition could stall the process.
The next moves in this international chess game, will probably come from Japan Airlines and All Nippon Airways, now free to codeshare with US carriers since the January signing of a new US-Japan bilateral. 'They must be in a mad scramble now to get their US partnerships in place,' says one analyst, who believes that JAL will follow through with American and ANA with United.
Source: Airline Business
