US Airways this month upped its bid for Delta Air Lines and AirTran raised its offer for Midwest Air Group, as the list of potential airline merger candidates continued to grow. The developments underscore the rising odds of domestic airline consolidation.
Sources said US Airways's intensified hostile bid for Delta remains the linchpin for further merger activity, and the next two weeks are critical in shaping its outcome: US Airways set a Feb. 1 deadline for its sweetened offer to Delta creditors, and the U.S. Senate this week is scheduled to hold a hearing to explore the ramifications of airline consolidation.
With the potential for airline consolidation growing, so have fears among corporate travel buyers of higher prices, fewer flights and declining corporate receptivity from domestic carriers. However, consolidation also could strengthen the long-suffering airline industry and improve service levels, analysts and merger proponents noted.
US Airways this month adjusted its bid for Delta by about $2 billion, noting that the revised offer would expire Feb. 1 to build in a "sense of urgency," CEO Doug Parker said this month. Parker said if creditors support the deal, Delta's management would follow. Analysts predict even if Delta's creditors decline the deal, US Airways would raise the offer again, and other carriers would make merger moves.
"I would bet that there is going to be consolidation within the next 12 months," said Scott Gillespie, TRX's Travel Analytics vice president and general manager. "It's so hard to predict who might end up with who, but US Airways has put a very serious plan on the table that will force some very hard decisions. This is going to be a bit of a domino."
As consolidation speculation gains momentum, the Senate Commerce, Science and Transportation Committee has scheduled for Wednesday a hearing to "examine the state of the airline industry, focusing on the potential impact of airline mergers and industry consolidation."
Bob Brindley, vice president of the Americas for Advito, BCD Travel's consulting division, said resulting consolidation would lead to greater travel expenses for corporate travel buyers.
"The big implication, obviously, is any time there's consolidation if there's fewer people to talk to and less negotiating leverage, it eventually will mean some form of higher pricing because you're shifting more power from the buyer to the supplier."
Travel Analytics analyzed Delta and US Airways markets and the impact on corporate travel pricing should the two carriers merge. "For a company that has a lot of activity in the Delta and US Airways hubs, it's really going to decrease their buying power," Gillespie said, "but for other companies, it simply reduces the number of competitors in some markets and only alters the buying power a little bit."
In its analysis of a merged carrier, Travel Analytics said it assigned a "buyer power score" that illustrates how buying power would shift post-merger. Gillespie said that on a domestic national basis, Delta customers' buying power score would decrease by 13 percent. As many markets also would lose a competitor, corporate travel buying power across many of the other network carriers also would decrease 2 percent for American and Northwest, 3 percent for United and 4 percent for Continental, Gillespie said.
"If you simply combine US Airways and Delta and call that one airline, it reduces the number of competitors in a bunch of markets and as you reduce the number of competitors, then buying power erodes," Gillespie said.
While noting price-sensitive buyers generally fear consolidation, there are possible upsides, Gillespie said. "Hopefully, in a merger you'd get the best of both management teams and really help the consolidated airline be more service-oriented and have a better quality product and stronger fleet. There definitely are non-price benefits, but pricing would likely go up."
At press time, Delta creditors had yet to signal how they will respond, but Delta management held firm to its anti-merger stance, noting in a statement that the offer "does not address significant concerns that have been raised about the initial US Airways proposal and, in fact, would increase the debt burden of the combined company by yet another $1 billion." Delta last month in a rebuttal to US Airways claimed the proposal to be "structurally flawed," as US Airways faces antitrust hurdles, has "overwhelming labor issues" and still is integrating America West Airlines, adding that the deal is premised on "faulty economic assumptions" and would "erode" the Delta brand
(BTNonline, Dec. 19, 2006).Parker reiterated the benefits US Airways sees in merging with Delta, including a level of synergies, a strong brand, a complementary route structure and resulting consumer benefits
(BTN, Dec. 4, 2006), adding that he is confident that regulators would approve the deal.
With its new offer surpassing the range Delta outlined in its stand-alone plan, US Airways showed optimism for creditor support, the first step in a merger with Delta. If creditors jump on board, US Airways would need to enter a merger agreement, file with the Department of Justice, submit a reorganization plan with Delta's bankruptcy court, gain approval from Delta's creditors and get the nod from US Airways shareholders. Parker estimated it would take four to six months to close the deal and begin integration.
"Delta's management and advisors are currently evaluating the Revised US Airways Proposal, in anticipation of making a further presentation to Delta's Board of Directors in the near future," Delta said last week in a court filing.
Anthony Sabino, business law professor at New York's St. John's University, this month said if creditors don't bite, "It's almost certain US Airways can and will increase its offer yet again, specifically the cash component, assuming it can get funding."
Sabino said Delta would "have to work even harder to convince its creditors that they should take Delta's reorganization plan and its purported $13 billion payout over what US Airways is offering."
However, with the carrier's reorganization plan set, "there is only so much it can do to sweeten" the deal for creditors. "Here's a not-so-wild guess—expect US Airways to go to $11 billion, and the creditors to turn down Delta's plan and go for the merger." Or Sabino said, a third carrier could join the fray for Delta—perhaps United, Continental or Northwest.
Calyon Securities airline analyst Ray Neidl cited news reports that executives at United and Continental are in talks and likely are awaiting the outcome of US Airways' bid for Delta—which perhaps accelerated their discussions, he said. If talks progress, a merger would have to satisfy "a series of operational issues as well as antitrust concerns," Neidl said.
United has been a vocal proponent of airline consolidation, and the industry for some time has pointed to Continental as a good fit with the carrier, given complementary route structures and fleets. Should talks progress between Continental and United, Northwest Airlines would have a major say in the deal's fate. A Northwest spokesperson last month said the carrier "has a share of Continental Airlines preferred stock giving the airline certain rights regarding certain merger activities."
Neidl referred to Northwest's stake as the "golden share" that would enable the carrier "to block a merger of Continental with another carrier, if the merger requires CAL's shareholder vote."
Northwest in December disclosed that it has hired financial advisor Evercore Partners to work on contingency planning. The carrier said it had selected the company for "its experience and qualifications in providing financial advisory services and strategic advice in complex restructurings, mergers and acquisitions," but in a statement a spokesperson said the move, "does not mean that the company has received or is looking for a merger or acquisition opportunity." Rumors, however, of a possible Delta-Northwest pairing abound.
"According to reports, United may also be looking at Delta, which makes sense in our opinion," Neidl said in a research note. "Both Delta and Continental fit in well with United. This leaves American and Northwest out of the current scenarios."
Meanwhile, AirTran raised its offer to $345 million for all of Midwest Air Group's outstanding shares, following last month's rebuffed $290 million offer for the carrier. Like Delta management, Midwest management has maintained a commitment to its plan as a stand-alone carrier. Through its newly formed subsidiary, Galena Acquisition Corp., AirTran would pay $13.25 per share, consisting of $6.625 in cash and .5884 shares of AirTran stock based on Jan. 8 closing prices. AirTran said the offer would expire Feb. 8 at midnight.
Much like US Airways' bid for Delta, AirTran is foregoing direct engagement with a reluctant management team and appealing directly to Midwest investors.
Midwest management, however, this month released its own growth plan to investors—one that has no room for a merger partner. Midwest said AirTran's initial offer "significantly undervalued Midwest and did not reflect the long-term opportunity inherent in its strategic growth plan," noting that its own business plan would offer "superior value to shareholders."
Neidl said that the deal would make sense due to complementary route networks and a common fleet that would yield cost synergies, among other factors. Neidl wrote that the deal would face "minimal regulatory resistance" and create a new national low-cost carrier. "We believe that the increased offer will make it more attractive to Midwest stockholders," he said. "As a result, we expect shareholders to put increasing pressure on Midwest's management."
Midwest could try to block the takeover by issuing preferred stock that would help inflate the cost AirTran would pay, but Neidl said, "the chances of a deal going through are better than 50/50, in our opinion."