Merger Fervor Hits Airways

Merger Fervor Hits Airways
UAL Pitch To Buy US Airways Sparks Consolidation Fever

By David Jonas

The proposed merger of United Airlines and US Airways may have the industry buzzing about the next wave of airline consolidation and diminishing competition, but for many corporate buyers who do business with either or both it raises the serious prospect of having to totally restructure their airline agreements.

The short-term outlook for those buyers may look appealing in many instances in light of United's reputation for being a more aggressive discounter. Negotiations down the road, however, may become more difficult with one less competitor in the market, and even more so if further consolidation of the industry occurs. In fact, numerous reports surfaced last week regarding American Airlines's interest in purchasing Northwest or merging with Delta.

But regarding the United-US Airways combination, buyers have reason for both optimism and pessimism. On the one hand, complementary route networks mean greater opportunity for larger, more inclusive deals and increased convenience for travelers. It also means the chance for some buyers to leverage transcontinental and international traffic for new or better discounts along the East Coast, and vice versa.

On the other hand, a dominating United, would have less motivation to offer deep discounts in the future as competitors fail to provide as much network coverage. It would control many more airports and city pairs coast to coast and essentially serve as the only transatlantic choice for corporations in numerous markets, particularly along the Midatlantic Coast. Its enormous share of the domestic market would protect it from competitive backlashes against fare hikes and assure its position as the industry's trendsetter in many other areas.

If the $11.6 billion transaction is completed, the merged airline will retain the United Airlines name, sport a fleet close to 1,000 planes, operate 65,000 daily flights and field a workforce of 145,000 employees. Total global revenues for the new entity would top the $25 billion mark.

More importantly, the result would be an immense, dominating carrier that would hold monopoly positions in numerous city pairs and at several U.S. airports, notably in the eastern United States. According to Deutsche Banc Alex. Brown analyst Susan Donofrio, the combined entity would control 28 percent of U.S. market share.

The carrier's network would include US Airways' hubs at Charlotte, Pittsburgh and Philadelphia, sizable operations in Baltimore and Washington, and the US Airways Shuttle in the Northeast corridor. UA's comprehensive transcontinental network, which includes hubs on each coast, Washington Dulles and Los Angeles, and a pair spaced evenly between, in Denver and Chicago, would be augmented beyond reach for all competitors. "This transaction fulfills a geographic gap in our network," said United chief James Goodwin at a press conference announcing the proposal. "It creates the first truly efficient nationwide network in this country."

Indeed, the network easily would meet the travel needs of more U.S. corporations, but the ramifications in some markets are severe. Travel Analytics, using its Tango airline program analysis tool and basing its data on current flight schedules, found several markets would become drastically less competitive. Fare market shares between Washington Dulles and Boston, Raleigh/Durham, and New York LaGuardia would be 100 percent. A few other dominated markets would include Charlotte, N.C.-Chicago O'Hare (94 percent), Fresno-Manchester, N.H. (94 percent), Richmond-Roanoke, Va. (90 percent), New York LaGuardia-Roanoke (89 percent), Hartford-Richmond (89 percent).

Travel Analytics also determined that overall operations at several airports would be affected as the combined entity takes a firmer hold of gates, facilities and flight operations. Combined total passenger lift at Dulles would reach 71 percent, while Rochester share would reach 58 percent. Travel Analytics concluded that "United would reach anchor tenant status at a cluster of other airports, including Boston, Washington National, New York LaGuardia, Indianapolis, Buffalo, Hartford and Providence."

Meanwhile, in a letter to U.S. Department of Transportation secretary Rodney Slater, Business Travel Coalition chairman Kevin Mitchell wrote that the proposed deal "would put additional fortress hubs into the hands of a single decision maker--one who argues that there is no 'competition problem' in domestic U.S. air transport." Mitchell added that the loss of US Airways means one less airline that can "break ranks with industrywide fare hikes," and that the business customer will pay even higher fare premiums as a result of United's "new found pricing power."

For the buyer, the merger could mean more opportunities at first and fewer down the road in what would become much more of a seller's market. There would be one less competitor going after corporate business and less leverage at the negotiating table for buyers, depending on a corporation's travel patterns and volumes.

"In the short-term, it may actually be good for at least some travel purchasers because United has always been much more aggressive in seeking corporate business than US Airways," said John Heilner, a consultant with Management Alternatives in Princeton, N.J. "In cases where United is now taking over US Airways routes that are relevant to a given travel manager, that manager may see better deals forthcoming from the combined carrier. They want to make sure they solidify their position and get into bed with the key travel managers to ward off further competition."

Heilner added that United's approach--looking at both share and dollar volume--has been simpler than US Airways' stricter share-only commitments and has resulted in deeper discounts. "So, the prescription for travel managers is to go out now, be proactive with the United sales reps and see if you can get a current United deal to include all US Airways routes or try to create a new deal," he said. However, he added that the long-term outlook of less competition only can have negative consequences for travel purchasers.

Echoing those sentiments, Harry Harteveldt, senior travel analyst at Forrester Research, said, "Less competition means fewer discounts and reduced value for corporate accounts." He added that while United likely would honor existing US Airways corporate deals, it is unlikely that buyers and their agency partners will strike such strong agreements in the future.

"It's the whole idea that corporations have experienced higher prices as competition declines and hubs become more concentrated," Mitchell said. "There is an overarching concern that this will trigger a chain of events that will result in only three domestic major airlines that will really drive prices up."

Indeed, there is a general consensus that an approved United/US Airways merger would lead to further industry consolidation. "If you look back at history, merger activity in the airline industry never benefits Corporate America," said Mark Walton, principal at Consulting Strategies, Rolling Meadows, Ill. "The issue is one of smoke and mirrors. If you somehow manage to move your discount up five points but base fares increase 10 percent, you have lost out in the end." Therefore, Walton suggested buyers go after city-pair-specific deals, zone fares where possible and some guarantee against the baseline.

However, at least one travel manager who has deals in place with both carriers is not concerned. "If you have a good relationship with the airlines and they understand you can bring compliance to the table, you can still get a good discount, regardless," said the buyer, speaking on the condition of anonymity. "Even if the industry consolidated all the way down to two airlines, say United and American, you would still get a heck of a deal if you can push compliance. It all comes down to whether the big guys who make the decisions respect you."

Furthermore, the complementary nature of the two carriers' route networks--a main plank in their campaign to obtain approval--means they have not often been directly competing for corporate accounts, with the exception of the D.C. area. In fact, PaineWebber airline analyst Sam Buttrick in a research note last week said that while network overlap "only scratches the surface in describing the totality of network competition," the two carriers last year competed head-to-head on only 13 nonstop city pairs.

"Change can be good," said Cyndi Perper, Colgate-Palmolive director of corporate travel services and president of NBTA. "UA with US Airways routes could be a more viable player for some corporations and allow for more single carrier negotiations. If you like to put all your eggs in one basket, it is sometimes very lucrative to do that."

In another statement, Mitchell posed questions that may bode well for buyers in certain areas: "What is the economic significance for smaller businesses in the Northeast that are US Airways customers and currently have insufficient east-west traffic to qualify for a discount on United, that might now have such an opportunity?" he asked. "What procompetitive negotiating opportunities might Northeast-based businesses have with a carrier that could provide combined offerings that are superior to American, Delta and Continental?"

Conversely, the scenario presents new opportunities for corporations to leverage international and transcontinental traffic currently on United to get discounts on East Coast routes. High-yield international routes, in particular, have many more competitors vying for business. Of course, it's a two-way street. A merged United/US Airways could play hardball, denying attractive discounts throughout its vast domestic and worldwide network in order to secure business in certain targeted regions.

Meanwhile, a successful takeover of US Airways by United would further tip the scales toward United and its Star Alliance brethren in the international arena. While Star gains a valuable East Coast feeder, the other alliances lose the opportunity to secure another transatlantic foothold on the U.S. side of the pond.

"International routes are a big question," said Rolfe Shellenberger, senior consultant at Runzheimer International. "With US Airways dominant on routes between Philadelphia and Charlotte to Europe, and United dominant on routes between Washington and Europe, travelers who live north of Georgia and south of New Jersey will have only one U.S.-based airline for convenient transatlantic options." Because of the potential to further dominate the transatlantic market, the European Commission is planning to review the merger in the context of a stronger Star Alliance.

Of course, the merger needs approval from various groups here before it can go forward, notably from the U.S. Department of Justice, which thus far has been less than supportive of large scale M&A activity in the airline sector--just ask Northwest and Continental. Also, both the House and the Senate have planned hearings while attorneys general of several states said they would be investigating the situation. Still, some analysts expect the proposal to survive the regulatory process because of the complementary nature of the networks. Very few pairings of major carriers--particularly if United, American or Delta is involved--could make such a claim.

Nevertheless, recognizing the competitive concerns, UAL Corp. will attempt to tip-toe past rejection by DOJ. It plans to sell significant assets at Washington National Airport to Robert Johnson, chairman of Black Entertainment Television and a US Airways board member. The divestiture would create a new Washington-area airline and preserve competition. That new entrant, dubbed DC Air, would serve 44 routes with 122 daily departures from National, many of which now are served by US Airways. But United will hold on to some of US Airways' operations at National, including the US Airways Shuttle and equipment and facilities necessary to maintain routes to US Airways' hubs in Charlotte, Pittsburgh and Philadelphia.

Fare, Commission Freeze

To further improve its chances at getting the go-ahead from regulators, United said it would enact a domestic fare and commission freeze for two years. The fare freeze would not include adjustments for fuel and consumer price index increases. "We wanted to make a positive commitment so we can get this transaction done," Goodwin said. Needless to say, many in the industry are skeptical. Harteveldt, for example, said the promise of a fare freeze with the caveats of fuel costs and CPI increases is "hollow," citing two "fuel-related" fare hikes this year that have remained on the books despite a subsequent drop in oil prices.

Should United's attempts to pacify Justice with concessions--as well as intense lobbying efforts on Capitol Hill--pay off by gaining approval, it only would be a partial victory. Labor issues could further jeopardize the deal. The Air Line Pilots Association representing United's pilots promptly released a statement expressing strong concerns, including doubt over the ability to integrate US Airways pilots into seniority ranks. In fact, it was United's pilots who shot down a 1995 attempt to merge the two carriers. At US Airways, chairman Stephen Wolf said he met with union leadership the night before the announcement and summarized the mood as bittersweet. "Bitter because the US Airways name will disappear entirely," he said, "but sweet because they will become part of a stronger airline."

Speculation regarding competitive responses from the other majors began swirling immediately. Though there have yet to be any official responses from the other majors, it is clear that an approved United-US Airways merger would leave the door wide open for further domestic consolidation.

In fact, reports already have surfaced regarding an American-Northwest link up, which interestingly would relate to AA partner British Airways discussing a full merger with full-fledged Northwest partner KLM. Donofrio called Northwest an "ideal takeover candidate" for AMR, citing the ability to provide greater presence in the north central U.S. and across the Pacific. Together, American and Northwest would account for 31 percent of total U.S. market share.

Further confusing the situation, AMR and Delta reportedly held preliminary merger talks last week, a combination foreseeable in the event of United-US Airways approval. However, industry insiders suggested that AMR's interest in either Delta or Northwest is meant to scare DOJ into rejecting its mergers as well as the UAL-US Airways merger, and leaving the balance of power in the industry untouched. An AMR counteroffer for US Airways is unlikely since United's proposal already is considered very high.

Aside from discussions with AMR, many suggest Delta would join the trend and look to join up with Continental. Of course, Continental is partly owned by Northwest and has made no bones about its desire to regain full ownership and complete independence.

Regardless of the impact on competition in existing markets, United plans to launch new routes from existing US Airways cities, and many other domestic city pairs will see expanded service. New international nonstop flights also could be added. United said the combined airline would offer 650 new city pairs.

Another interesting facet to the proposed merger is US Airways' recent agreement with Sabre. It is unclear how United will integrate IT, reservations and other back-office systems since it has signed an extension with Galileo, or if it eventually will choose one or the other. However, what is clear is that the merged company would be headed by Goodwin. Wolf said he would remain at US Airways until the transaction is completed.