Buyers Air Merger Concerns: Carrier Consolidation Likely To Further Cut Capacity

As the likelihood of major domestic airline consolidation loomed larger this month, corporate travel buyers voiced concern that mergers would drive capacity down and fares up, and further degrade service.

The consensus on Wall Street is that at least one major domestic merger will take shape this year, and analysts agreed that consolidation almost certainly would lead carriers to shed more domestic capacity to address overlap, creating further pricing power for airlines.

UBS analyst Kevin Crissey this month polled 46 airline investors, and 93 percent expected major airlines to announce a merger in the next two months. Crissey agreed that a major merger announcement is more likely than not, as several large carriers, most notably Delta, Northwest and United, have adopted an open stance.

"Investors are anticipating a deal that promises a reduction in seats and better pricing," Crissey said. "This time, however, it appears management teams and company boards also find the idea compelling."

Noting "big deals beget big deals," JP Morgan airline analyst Jamie Baker agreed that consolidation is probable, with "three deals more likely than one."

Though airline investors are salivating at M&A activity, many corporate buyers voiced concerns about the implications for their travel programs, including the prospect of higher prices, fewer frequencies, less competition and declining receptivity to negotiating, among others.

An aide for Rep. Jim Oberstar (D-Minn.) confirmed that two Northwest executives approached the congressman to discuss merger talks with Delta Air Lines and that United and Delta also are exploring consolidation. The aide said Oberstar, chairman of the House Committee on Transportation and Infrastructure, remains opposed to airline mergers in principle, "because they do shrink competition, they tend to curtail service to smaller communities, they tend to increase fares and decrease choices for consumers and end in layoffs for many workers."

Nearly 80 percent of travel buyer respondents to a Business Travel Coalition survey said industry consolidation would yield higher business airfares. That survey of 219 travel executives, half of them corporate travel buyers, was part of a broad, yet-to-be-released study on the impact of potential consolidation on airlines, consumers, businesses and other stakeholders that the U.S. General Accountability Office commissioned late last year.

While buyers would be impacted differently depending on the markets in which they are most active and which carriers would merge, the aggregate view of consolidation points to domestic fare growth.

Rick Seaney, CEO of airfare watcher FareCompare, said, "Competition fosters cheaper prices, so any merger is bad news for consumers—good news for investors, but bad news for consumers."

Baker noted, "Consolidation is about cutting supply, little else."

UBS' Crissey expects a merger to cut another 4 percent in domestic capacity, on top of the 2 percent targeted for 2008. "This would support a much better pricing environment than currently expected and should benefit all carriers," Crissey said.

Scholastic corporate travel manager Susan Story said, "The system is already at loads that are stretched. How much lower can it be? If they start dropping capacity, that's where we're going to run into issues where rates will skyrocket. It's Business 101: supply and demand."

Travel buyers were mixed on which communities would bare the brunt of service reductions, though several said smaller cities would be hit hardest by consolidation. Others said some hub markets would be among the first targeted for cuts, depending on which carriers pair.

Nearly 60 percent of travel manager respondents to BTC's survey are concerned about a merger's impact on discounts. "Any reduction in competition will ultimately impact ability to negotiate favorable discounts," said one travel buyer.

"A lot depends on who merges and whether that directly impacts your individual contracts," Scholastic's Story said. "It means going back to renegotiate routes and exploring what discounts are applicable and what marketshares are now being sought. I'm of the opinion that at the end of the day, no matter who is flying, the routes are still going to be covered. It's the competitive nature of the business that the rates are going to be competitive with one another. It's going to be a time-consumption thing, depending on the players."

Sixty percent of the travel buyer respondents to BTC's survey shared concerns that a merger could bring about further deterioration of airline customer service, though one asked, "Can it get any worse?"

BTC chairman Kevin Mitchell said, "It is extremely likely that we could go from these six network carriers to three gigantic dysfunctional families. We're talking customer service problems for a long time." Mitchell said a major merger would result in such problems as systems integration, labor strife and exceedingly packed planes, with little recourse for service recovery. "Every point along the continuum is likely to get worse," Mitchell said.

UBS's Crissey said a merger also would allow deal-making carriers to broaden their networks and fill geographic holes in services, which could be appealing.

"Consolidation will reduce our airline choices, but it could also increase routes we are able to have under contract," said one travel buyer. "It depends on the consolidation."

At press time, Delta would not confirm news reports on specific carrier pairings, but stressed it is exploring "strategic options."

Delta executive vice president of network planning and revenue management Glen Hauenstein in a BTN interview this month said, "We've been quite public that our board has authorized a special committee to look at what's going on in the industry and how Delta can maintain a long-term leadership position. There are a lot of options and we're examining them all very carefully."

Northwest CEO Doug Steenland this month sent an internal memo to management saying the carrier would "analyze any possible transaction very carefully" and the right deal could be a boon to employees, customers and stockholders. Steenland, however, did not address specific consolidation scenarios.

"Further, we cannot control or predict what other airlines or airline shareholders may do," Steenland's memo said. "Doing nothing could be our worst alternative. If we wait to react to what others do, we could be left with options that are undesirable or with no options at all."

United CEO Glenn Tilton has been a vocal proponent of airline industry consolidation, as has Delta CEO Richard Anderson—the former CEO of Northwest—since taking the helm at Delta in August. United in a statement said, "We have said for the last four years that we believe consolidation is necessary for the industry, and others independently are reaching the same conclusion."

Calyon Securities airline analyst Ray Neidl said that merger speculation is accelerating as airlines are testing the market and eyeing signals from regulators on merger stances. Though some have claimed that airlines are rushing to get a deal done under the current presidential administration, Neidl said, "I don't buy that."

Morton Pierce, chair of law firm Dewey & LeBoeuf's Mergers and Acquisitions Group in New York, said, "The sense is that a Republican administration is going to be friendlier to large combinations than a Democratic administration. It depends on how you handicap the election."

Pierce and Neidl agreed that a high level of scrutiny would meet any blockbuster airline deal and that such a deal would be the first in a series of steps toward consolidation.