United-Continental merger could be tough sell in Washington

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United-Continental merger could be tough sell in Washington

Unread post by bimjim » Tue May 11, 2010

http://www.travelweekly.com/article3_ektid214226.aspx

United-Continental merger could be a tough sell in Washington
By: Michael Fabey
May 10, 2010

A successful merger between United and Continental makes more airline consolidation likely — and in some cases, necessary, most industry analysts agree.

Which is exactly why the industry is casting nervous glances in the direction of the nation’s capital as they try to divine what regulatory bumps and legislative hurdles lie in the path of the United-Continental merger.

While it might be hard to argue the logic of the merger from the viewpoint of investors, Obama administration regulators have typically given consumer interests top priority, and lawmakers answer to myriad constituencies that might have reasons to oppose this particular merger or airline consolidation in general.

The bottom line, many observers say, is that United and Continental face a bigger challenge in Washington than Delta and Northwest faced when they merged in 2008.

As early as last week, Rep. James Oberstar (D-Minn.), the chairman of the House Transportation and Infrastructure Committee, said he opposed the merger: His office cited concerns that the combination could curtail competition and raise prices.

"This is anything but a done deal," said analyst Darryl Jenkins, founder of the aviation economic website the Airline Zone. "This administration is different; it’s a lot more hostile toward airlines."

One major concern is that the Obama Justice Department might be disinclined to approve another merger so close on the heels of the Delta-Northwest deal if regulators believe it concentrates too much domestic capacity in the hands of too few airlines.

If the merger is approved, the new United would control about 18.4% of domestic passenger traffic, topping Delta’s 16.8%. That puts more than a third of all U.S. air travel in the hands of two carriers.

Still, other analysts said that the administration and competing airlines might have little choice but to accept more consolidation as the industry’s survival plan.

Back on top

The deal would catapult United, which, until the Delta-Northwest merger had alternated with American for decades as the biggest U.S. carrier, to the top of the heap. With annual revenue of $29 billion and a network serving 144 million passengers a year at 370 points in 59 countries, it would be the world’s largest airline from Day One.

The plan calls for United to acquire Continental by issuing some $3.17 billion worth of stock to Continental shareholders, who would end up owning approximately 45% of the combined company’s equity.

Glenn Tilton, United’s chairman, president and CEO, would serve as nonexecutive chairman through 2012, or the second anniversary of the deal’s closing, whichever was later. Jeff Smisek, Continental’s chairman, president and CEO, would be the new United’s CEO and a board member. He would become executive chairman after Tilton leaves.

Though the merged airline’s name will be United, the marketing and branding would blend elements of both carriers.

Aircraft would carry the Continental livery, logo and colors with the United name.

The announcement campaign slogan is "Let’s Fly Together." The new company’s corporate and operational headquarters would be in Chicago, though it would maintain a significant presence in Houston, which would be the combined company’s largest hub. The CEO would maintain offices in both Chicago and Houston.

These and other aspects of the merger plan are outlined on a new website at www.unitedcontinentalmerger.com.

According to the two companies, the merger would deliver up to $1.2 billion in cost savings by 2013, including between $800 million and $900 million of incremental annual revenue.

One-time costs related to the transaction are expected to total approximately $1.2 billion amortized over a three-year period.

Domestically, it would continue to operate the same major hubs the individual airlines have built: Newark, Washington Dulles, Houston, Chicago O’Hare, Los Angeles, Denver, San Francisco and Cleveland.

Despite their extensive domestic route networks, United and Continental said they compete head-to-head on only 14 domestic nonstop routes, which could help the deal clear federal regulators. The deal, both Tilton and Smisek said, "is built to close."

Antitrust questions

But Jenkins and other analysts warn that Tilton and Smisek should keep the champagne corked until they hear from the Justice Department. "This administration prays to a different god," Jenkins said. "It’s one I don’t understand."

Christine Varney, head of the Justice Department’s antitrust division, has placed consumer concerns first and foremost, and the DOJ has come down hard on competitive issues in its dealings with airlines.

UBS Investment, too, has warned that DOJ approval for this merger will be "more difficult."

The prevailing view among analysts is that fares will rise as a result of this or any merger as the airlines cut capacity on overlapping routes. But others said the rebounding economy, not industry consolidation, will drive prices. Smisek told investors and analysts last week, "We couldn’t set airfares before this. We can’t set airfares after this. We are responsive to demand."

Such reassurances are likely to be met with some skepticism on Capitol Hill.

Oberstar has been calling for tougher antitrust enforcement in the aviation industry.

Sen. Herb Kohl (D-Wis.), who chairs the antitrust panel of the Senate Judiciary Committee, said he would likely hold a hearing to gauge the merger’s impact in pricing and service.

Jenkins predicted the deal would likely be approved but that United and Continental would have to make concessions and negotiate with regulators first.

For example, he said, the government could demand that the airlines give up slots at slot-controlled airports like Chicago’s O’Hare or those in the New York area to make room for low-cost carriers and other new competitors in those markets.

Excess capacity

Some analysts who support the merger said that cutting capacity, not shifting slots, is the way to rescue the aviation industry and that the only way to cut capacity is through consolidation.

By the end of 2009, U.S. airlines had built up, on average, 7% excess capacity, despite all their capacity-cutting over the previous 18 months, according to an analysis released last week by consultancy AirlineForecast and Paul Mifsud, an airline political strategist and former vice president of KLM.

As a result, the analysis concluded, the industry lost about $70 billion in 2009, having underpriced fares 11% over a 10-year period ending in 2009.

"If the industry is not allowed to consolidate in the most rational manner, the result will be a continuation of the slow liquidation and the inevitable failure" of US Airways and American, the analysis concluded. "The most likely outcome would be an AA bankruptcy and outright liquidation of US."

Wall Street analysts at Piper Jaffray and Jesup & Lamont Securities said further consolidation was likely and would be good for the industry.

"Allowing the network carriers to make their networks more rational is far preferable to continuing the hemorrhaging until one or two of the players wither on the vine," the AirlineForecast-Mifsud report asserted.

In memos to their employees shortly after the United/Continental deal was announced, American CEO Gerard Arpey and US Airways CEO Doug Parker sounded upbeat notes.

"The history of airline mergers suggests that in the process of merging, their labor costs will rise and move toward ours," Arpey said. "This convergence will strengthen our competitiveness."

Parker said, "We’re producing better stand-alone results than our peers like Continental."

But both also saw further consolation as a positive possibility.

Parker said more consolidation would make the industry "less fragmented and more efficient."

Arpey echoed those thoughts: "Today the airline industry is both highly fragmented and financially unhealthy. There are still too many seats available for sale in the marketplace."

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