United, Continental unite
Rep. Oberstar tries to stop merger, which would create world's largest airline.
By Eric Kulisch
The consensus among aviation in-dustry analysts is that regulators will look favorably on the planned merger between United and Continental airlines.
But a powerful House committee chairman says the deal is bad for consumers and that the Justice Department should block it.
'This merger is in the interest of United and Continental. It is not in the best interest of the traveling public,' Rep. James Oberstar, who heads the Transportation and Infrastructure Committee, said in a teleconference with reporters. 'Airspace is not the private domain of corporate executives in the airline sector. It's a public trust.'
United Air Lines and Continental Airlines announced May 2 they have agreed on a merger that would create the world's largest airline.
The proposed merger makes economic sense and should sail through the regulatory approval process, said Helane Becker, managing director of transportation research at Jesup & Lamont Securities, at the Cargo Network Services conference in Miami.
The tie-up between the two U.S. carriers is a reaction to the successful merger between Delta and Northwest in 2008. Delta, she said, has become a threat to Continental in the New York region as it gains market share through growth at John F. Kennedy International Airport.
Under the $3 billion stock swap, United shareholders would own 55 percent of the company and Continental shareholders the remainder.
Combining the two carriers would create an airline with an enormous global route structure serving 370 destinations in 59 countries, complementary hubs and minimal domestic overlap. United has a huge presence in the Asia-Pacific market and Continental is strong in the eastern half of the United States, Latin America and Europe. United's U.S. hubs are in Los Angeles, San Francisco, Denver, Chicago and Washington, D.C. Continental has hubs in Houston, Cleveland and Newark, N.J. Their reach is further enhanced by the 24 other members of the global Star Alliance, which accept bookings from partner customers.
The extensive network and frequencies between major markets are expected to appeal to large corporations seeking volume travel deals for their employees who tend to pay a premium for last-minute travel and higher-class sections.
The deal also could provide a boon to all-cargo carriers as the new United cuts back flights to become more efficient, in the process reducing available space for freight on certain international legs, Becker said.
But air freight industry executives at the CNS conference dismissed the notion of a mode shift. Freight forwarders, which are the primary customers of passenger airline cargo divisions, will not be willing in most cases to pay up to 60 percent more for space on a freighter and will simply switch to another passenger airline unless there is no available service to a particular destination. Shippers that use passenger airlines typically have smaller shipments and don't require the main-deck capacity of an all-cargo carrier. And, if United pulls out of a market or downsizes its aircraft, other airlines may step in to fill the market vacuum, they said.
Many airline analysts and economists say the new United Airlines, which would displace Delta as the world's largest, would inevitably pare some redundant routes or reduce flights to smaller cities, resulting in higher fares for consumers. Many airlines view consolidation as the best hope to stem huge losses and become more competitive with so-called discount carriers.
The new company will operate under the brand name United Airlines, but incorporate the Continental logo and livery on its planes. The holding company will be called United Continental Holdings Inc. and be based in Chicago, where United is headquartered.
Glenn Tilton, chairman and chief executive officer of United, will become chairman of the new company and Jeff Smisek, Continental's chairman and CEO, will be its chief executive. Smisek will become executive chairman of the board after Tilton ceases to be non-executive chairman in two years.
Tilton has been a major proponent of consolidation in the airline industry, saying it's the only way carriers can survive because there is too much capacity to maintain sustainable fares.
Last year Continental lost $282 million as revenue tumbled 17 percent to $12.6 billion. United parent UAL Corp. lost $651 million as revenue fell 19 percent to $16.3 billion.
United reported a net loss of $92 million in the first quarter, but it had an operating profit of $58 million. It is the first time the company has had an operating profit since the first quarter of 2000.
'Building on our Star Alliance partnership, we are creating a stronger, more efficient airline, both operationally and financially, better positioned to succeed in a dynamic and highly competitive global aviation industry. This combination will provide a strong platform for sustainable, long-term value for shareholders, opportunities for employees, and more and better scheduled service and destinations for customers,' Tilton said in a statement.
Robert Crandall, former president and chairman of American Airlines, criticized the notion that airlines need to consolidate to improve service and profitability. Speaking at an aviation industry summit hosted by the U.S. Chamber of Commerce, the chairman emeritus of AMR Corp. said consolidation is 'antithetical to the interests of consumers and providers' and that mergers 'masquerade as innovation.'
Tilton was supposed to attend the event, but was noticeably absent as rumors about the United-Continental deal swirled among aviation stakeholders.
The carriers said the merger is expected to deliver $1 billion to $1.2 billion in new value per year by 2013, including $800 million to $900 million of incremental annual revenues from additional international services and corporate travelers, and up to $300 million per year in savings from cutting redundant costs. The companies intend to reduce headcount through retirement, attrition and voluntary programs. The greatest efficiencies are expected to come from greater ability to put the optimal aircraft in each market that best utilize capacity and maximize revenue.
'Consolidation is the only way forward for airlines to survive in a tough, competitive market, with declining yields, and rising costs,' said Max Sukkhasantikul, commercial aviation consulting analyst at Frost & Sullivan, in a news release.
A possible United-Continental combination has been under consideration since 2008. The two airlines first began merger talks two years ago when oil prices skyrocketed past $145 per barrel. After oil prices subsided, another motivation for linking up was the financial crisis as executives worried that access to capital markets would dry up and they needed ways to preserve cash to finance liabilities, such as Continental's order book for new aircraft. Ultimately, Continental decided a deal had little value because of United's poor finances.
Continental's thinking began to change as it witnessed the results of the Delta-Northwest merger, according to analysts. It pulled out of the SkyTeam alliance that includes Delta because of reduced code-share opportunities and joined the Star Alliance, of which United is a member. Continental pulled the trigger on a deal after US Airways, a fellow Star Alliance member, courted United about joining forces.
'It resulted in Continental having to react to maintain its relevance in the market after having suffered from the Northwest-Delta merger. It was either now or never as United is the best possible fit for Continental on a strategic level, and regulatory perspective,' Sukkhasantikul said.
The merger could be negative for European manufacturer Airbus, which may have difficulty securing further orders from United as the new company will be more inclined to buy Boeing aircraft to achieve economies of scale given that Continental is a pro-Boeing airline, he added.
Analysts said investor pressure is on American and US Airways to consider a merger, but that the two carriers do not necessarily complement each other very well. Experts say the U.S. travel market probably can't support more than three main network carriers as low-price discount carriers continue to take more market share. American officials, influenced over the years by Crandall and by several poor acquisitions (TWA and Reno Air), don't view consolidation as a panacea. American's high costs, large debt and poor labor relations also make a deal more difficult.
United and Continental said they hope to finalize the merger by the end of the year, but it must first receive antitrust approval from the U.S. Justice Department. The Bush administration approved the Delta Air Lines acquisition of Northwest Air Lines two years ago, but it is unclear if the Obama administration will be as receptive to a merger that would leave the industry with just three major international carriers, including American Airlines. Consumer advocates are expected to argue that fewer air travel choices will lead to higher fares.
The Justice Department last year rejected United and Continental's request for antitrust immunity to collaborate on rates and fares in Canada, South America and China due to concern that diminished competition would cause fares to increase up to 15 percent. In 2001, it stopped a United-US Airways merger attempt because of severe antitrust concerns.
Meanwhile, Oberstar, D-Minn., quickly announced his opposition to the United-Continental merger and asked the Justice Department to reject it on antitrust grounds.
In a letter to Christine Varney, assistant attorney general for the antitrust division, Oberstar expressed concern that a combination of domestic consolidation and international alliances that enjoy antitrust immunity would create an airline system dominated by three international mega-carriers.
'In this environment, the carriers will concentrate their efforts on fortress hubs and on the routes they dominate. There will be strong incentives to refrain from competition. There will be less service and fares will rise,' Oberstar wrote. 'This is the antithesis of the structure Congress anticipated when we deregulated the industry in 1978' to free up market entry, reduce prices and provide more travel options.
Oberstar, who also opposed the Delta-Northwest deal in 2008, asked the Justice Department to consider as part of its review whether more consolidation is likely to follow a United-Continental merger, the extent to which the new United will eliminate capacity between certain city pairs, and whether it would structurally change the aviation industry to give the largest carriers enhanced market power.
The presence of discount carriers in certain markets doesn't mean they will provide the necessary competition because they do not serve many of the markets the hub-and-spoke carriers do, he cautioned.
Oberstar compared the consolidation impulse in the aviation industry to banks that argued that they could compete better by containing their costs and being too big to fail. He said airlines are only marketing to the largest companies for business travelers on main routes instead of going head-to-head in smaller markets.
'Bigger doesn't mean less cost. It just means you've accumulated more debt. Then when there is a downturn or increase in fuel those costs become a huge burden,' Oberstar said on the conference call.
'There will be other crises we'll have to deal with, like 9/11, and those big carriers will say, 'if you don't rescue us we'll lose out in the marketplace and be at the mercy of big foreign carriers.' '
Asked if the United States should consider relaxing rules that limit foreign ownership so that airlines can raise more money, Oberstar replied airlines have never been constrained from accessing capital markets and that the giant alliances make foreign ownership irrelevant.
'These carriers are already in the thrall of foreign economic forces. The shots are being called in Paris and Amsterdam, and in Frankfurt and London,' he said.
Becker predicted the U.S departments of Transportation and Justice, as well as the European Union, will approve the deal within six months because there is no overlap in their international route structures and only a handful of domestic routes that overlap. United and Continental are both members of the Star Alliance, which means regulators have already closely reviewed their business plans and impact on the market.
The next step in the process is a vote by shareholders in September.
The airlines should close on the merger by December and will then spend 2011 optimizing their networks and integrating information technology and other systems while they continue to operate as separate companies. The aviation and air freight analyst predicted they would obtain a single operating certificate from the DOT by January 2012 and realize 75 percent of the merger's benefits in the first year.
The merger is aided by the fact that both airlines have open labor contracts, which makes it easier to get unionized employees on the same plan. The combined airline would have more than 700 aircraft and one of the industry's youngest fleets, with an average age of 11.5 years.