The Brancatelli File
MERGER MADNESS EXPLAINED
BY JOE BRANCATELLI
January 11, 2007 -- We're not even finished with the week and we're already drowning in merger-related nonsense from the airlines. You can't pick up a paper or surf to a business-news Web site without being overwhelmed by point, counterpoint, strategies, analyses, talking-head expertise and, in a coup for the graphics geeks at USA Today, an interactive grid allowing you to mix-and-match your own merger partners.
As usual, however, most of the analyses are trash, filled with hype, hot air, hysteria, wishful thinking and, sometimes, total ignorance of the reality of air travel. So what I propose to do today is this: Answer all the logical questions you may have about this stuff as simply and honestly as I can and then ignore the merger madness until something actually happens.
I think the following eleven questions-and-answers pretty much cover it.
What's driving the merger mania of the Big Six?
An unwillingness to change the service and pricing model that the market is rejecting. In the almost 30 years since deregulation, the carriers that have coalesced into the Big Six have ceded around 30 percent of the U.S. passenger market to airlines like Southwest, JetBlue and AirTran. These alternate airlines offer rational one-way pricing--not always the lowest fare, mind you, but always a simple, understandable price structure--and a consistent and predictable in-flight product. By contrast, the remaining "legacy carriers" have clung to their Byzantine pricing model and wildly uneven in-flight products and services. At a rate of about one market share point for each year of deregulation, passengers have moved their business from the consumer-repellent Big Six to the alternate airlines.
What do the Big Six think consolidation will do for them?
The Big Six executives who preach the gospel of consolidation think that merging with each other will permit them to reduce capacity and increase fares, thus creating more profit.
Will it work?
Of course not. Industry-wide load factors and passenger traffic are at record highs. If some or all of the Big Six merge and reduce their capacity, alternate airlines will simply step in to fill the gap. And since fares, on average, tend to decline when alternate airlines add capacity and markets, the Big Six won't be able to increase fares, either. Moreover, legacy-carrier mergers have been so disruptive to the combining carriers that profits are scarce. So all the Big Six are really doing by pursuing mergers is collapsing in on themselves and speeding up the market realignment of the last generation.
Don't the Big Six see this?
Apparently not. The history of the legacy carriers since deregulation is a pattern of making the same mistakes over and over again. And there is always some fleet-footed boy genius--in this case, it's US Airways boss Doug Parker--who thinks he's smarter than the room. History has also shown that none of his smarter-than-the-room predecessors--Dick Ferris, Frank Lorenzo, Carl Icahn, Steve Wolf, Leo Mullin--have built stable or consistently profitable carriers. All of them personally made tens of millions for themselves, of course, but they did it by loading their airlines with debt, imposing brutal concessions on employees, slashing customer service, screwing stockholders and dumping many of their obligations on taxpayers.
Does that mean the Big Six shouldn't merge?
Since they refuse to change their pricing and service models, what choice do they have? Since they won't sell a product that passengers want to buy at prices that passengers can understand, they have no choice but to contract and combine.
Are all of the Big Six equally intent on merging?
Not really. US Airways obviously is the most interested in consolidation. Cynics would suggest that's because Parker and his team have grown bored of the hard, slogging work that still remains to be completed in the US Airways-America West merger. (The carrier has yet to integrate fleets, employee contracts or reservation systems and its two major attempts at organization--the unified Web site and the combined Dividend Miles frequent flyer program--have been plagued by problems.) United Airlines, laden with debt and mortgaged down to its air-sick bags, clearly wants to merge with someone, too. On the other hand, American Airlines, with little to show for its previous acquisitions of TWA, Reno and AirCal, seems intent on shrinking itself without the aid of a disruptive merger. Continental Airlines probably will resist any merger that won't leave its top executives in charge of the combined carrier.
Do Big Six mergers make financial sense?
Not in this fevered environment. US Airways' pursuit of Delta already shows that. US Airways made an $8.5 billion offer in November and Parker insisted the offer was fair. He repeatedly insisted that he wouldn't raise his bid. Parker then criticized Delta management last month for overpricing itself when it estimated its post-bankruptcy worth at a minimum of $9.4 billion. But this week US Airways upped its offer to $10.3 billion. What is most astonishing about all of this is that Parker and his team haven't even had a chance to do due diligence on Delta because Delta management has so far refused to open its books.
How serious are antitrust concerns about Big Six mergers?
That depends on the combination, of course, but, generally speaking, it would be hard for any fair observer to claim that mergers between the Big Six are inherently anti-competitive. Since they have shrunk so much in the last 30 years, the Big Six no longer have the power to dominate the market as they once did. Oddly, a US Airways-Delta merger is probably the most problematic from antitrust angles. It raises a lot of the same problems that doomed the United-US Airways merger in 2000. (By the way, the Senate Commerce Committee says it will hold hearings on airline mergers on January 24.)
Would any Big Six merger benefit frequent flyers?
Probably not. The history of major airline mergers since deregulation has been littered with operational and service disasters. Only the merger between Western and Delta worked comparatively well. The best we could hope for now would be a merger that is no more disruptive than that one. A Delta-Northwest merger, which has been suggested for years and is now under discussion by both managements, has that kind of potential. A merger between Alaska Airlines and any of the Big Six could also be minimally disruptive.
Would there be any winners in Big Six mergers?
Since the airlines involved are all rigidly opposed to making the service and pricing changes that would make them compelling to the market again, I'd say no. One combination or another may see some short-term gains, but only in the overall context of a declining share of the total air-travel market. The real victors, of course, would be the investment houses that are bankrolling the deals. They'll get their fees no matter what. A few top airline bosses, most notably Glenn Tilton at United, would reap windfalls if they can sell their airlines. A few investors who dump their airline stocks now, while they are at or near their post-9/11 highs, could make a profit. And Gordon Bethune, the former chief of Continental who was recently hired by Delta's creditors' committee, is already a winner. He's making $25,000 a day to sift through the US Airways bids and Delta management's reorganization plan.
What about that proposed AirTran-Midwest Airlines merger?
Unlike the Big Six, which are forced to consider mergers because their market shares are shrinking, there are some combinations between alternate carriers that could make sense and could strengthen them into even more formidable competitors. At least on paper, an AirTran-Midwest deal--AirTran upped its offer for Midwest this week to about $345 million--could be one of those positive mergers. But Midwest management is opposed to the deal and hostile mergers of any kind are rarely long-term winners.
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