United, Continental Agree To Merge Into World's Biggest Airline

Continental Airlines and United Airlines today delivered the definitive merger agreement they failed to consummate two years ago, advancing the plan, rumored for weeks, to unseat Delta Air Lines as the world's largest carrier.

The carriers expect to close the deal by the end of this year and complete integration in 2013, though getting to that point is predicated on shareholder approval, expected in September, and the more difficult hurdle of regulatory approval, targeted for completion by November or December.

Unanimously approved by the boards of each carrier, the all-stock transaction, valued at more than $3 billion, would give United shareholders 55 percent of the company, with the remaining 45 percent going to Continental shareholders, who will receive 1.05 shares of United common stock for each share they hold.

United CEO Glenn Tilton will become non-executive chairman of the combined entity, while Continental's Jeff Smisek would carry the CEO crown he inherited at the beginning of the year.

Both Smisek and Tilton during a press conference today both at times invoked the phrase, "merger of equals" to describe the deal. However, United—the larger airline and acquiring company—will keep its home base in Chicago and prevail as the brand under which the combined carrier will fly, though the holding company will be dubbed United Continental Holdings Inc. Still, Continental's globe logo and brand name font will grace airplanes, and the respective chiefs of each airline promised "an equitable and balanced selection of executives from each company" with the goal to populate the new airline with an equal number of employees from either carrier. Beyond the top executive spot falling to Smisek, no decisions on the executive team have been made, the carriers said.

Continental's choice two years ago to not merge with United was "a point-in-time decision," Smisek said earlier this year, calling it "the right decision at the time." Still, in the two years that has passed since Continental iced those plans, the carrier ditched SkyTeam in favor of United's Star Alliance, and the two carriers, with other partners, formed a transatlantic joint venture. Those interactions, executives said today, spotlighted further revenue opportunities and other synergies in a deal. "I think the two-year experience has really been good for both companies to see opportunities that we previously imagined weren't there," Tilton said.

The combined entity would combine Continental's international strength in Latin America and Europe and United's strength in Asia. Meanwhile, United has strength in the West Coast, while Continental's Newark hub would retain its role as a powerful international gateway.

Four of its 10 hubs would be near four of the largest cities in the United States: New York, Los Angeles, Chicago and Houston. Still, facing questions on plans for the Cleveland hub, Smisek called it "premature to talk about Cleveland, or any hub for that matter, as to how things will shake out in the next few years." Though it would lose its Houston headquarters, Continental would still maintain "a significant presence" in the city, which would remain the combined carrier's largest hub.

The carriers, which combined would serve 370 worldwide destinations in 59 countries, claim "minimal domestic and no international route overlaps." The carriers plan to maintain service to all destinations. "There are no two carriers that you could put together in a more complementary way than United and Continental," Smisek said today.

As with any merger, the respective CEOs said jobs would be lost as duplicative roles are rationalized. "The companies believe the effect of the merger on front-line employees will be minimal, with reductions coming principally from retirements, attrition and voluntary programs," the carriers said in a joint statement. As the carriers await the necessary approvals, Tilton said he and Smisek would immediately establish "an integration planning council" to determine the management structure.

The companies expect the merger to deliver up to $1.2 billion in annual synergies by the time the two carriers are integrated as one in 2013, with up to $900 million in annual incremental revenue synergies and up to $300 million in cost synergies on a run-rate basis. Those potential synergies through 2013, however, largely are outweighed by one-time transaction costs totaling around $1.2 billion.

Based on U.S. Bureau of Transportation Statistics data for the 12 months ending in January, the combined carrier would carry just over 18 percent of the revenue passenger mile share in the domestic U.S. market, compared with Delta's 10 percent.

Addressing concerns that the merger is predicated on raising fares, Smisek said, "There is not an airfare increase built into the synergy assumption." Tilton added, "Airfares are not something we set. If we could, it would be different, but the world is not like that. This is a brutally competitive industry. There is no carrier in the world that can set airfares. We couldn't set airfares before this; we couldn't set airfares after this. We are responsive to demand; we're responsive to capacity. This is not a cost-driven business, this is a demand-driven business and a capacity-driven business," Tilton said. The carriers also noted that a low-cost carrier would compete with the merged airline in 76 percent of combined domestic markets, which further helps to pressure fares.

Though Tilton claimed to be unable to set fares, the carriers can set capacity, and one analyst expects a decline upon integration. If the deal moves forward as the carriers expect, JP Morgan aviation analyst Jamie Baker said the carriers in 2011 would cut system capacity by 8 percent once merged and reduce operating expenses by 5 percent, which when combined with revenue changes would yield $600 million in incremental operating profit in their first year of operations.

Smisek shrugged off the rigid U.S. Department of Justice regulatory review that awaits the agreement as "absolutely not a major concern. Recognize that antitrust analysis is done on relevant markets; it's not done on such an aggregate statistic as marketshare across a geography the size of the United States. The DOJ does a market-by-market analysis, and we are highly confident that there are no material antitrust concerns with this transaction, and this transaction will close."

Playing odds-maker, Baker said he is giving the deal a 75 percent chance of regulatory approval, noting there are only 13 overlapping nonstop routes—"11 of which would be reduced to monopoly or duopoly status." Delta and Northwest at the time of their merger agreement operated 12 nonstop overlapping routes.

If there was any doubt the U.S. Departments of Transportation and Justice have been more aggressive under the Obama administration than the Bush administration in blessing deals between airlines, Delta CEO Richard Anderson offered this little nugget during the carrier's earnings call last month: "Our slot-swap transaction has actually been pending longer than the merger of Delta and Northwest." The slot transaction Anderson referred to is a deal announced last August to trade some of its Washington National slots in exchange for US Airways' slots at New York's LaGuardia. After an analyst asked what that says about the regulatory appetite to approve a bigger transaction like a merger, Anderson said that the Delta-Northwest deal "was probably the quickest transaction of its size that's ever gone through the Justice Department," and "it went through smoothly, and at the end we had a judgment that the transaction was pro-competitive. I don’t think this environment is the same."