US Airways’ hostile bid to acquire bankrupt Delta Air Lines would result in a strong combined company and would be a feather in the cap of the chief executive of US Airways. But it would also be a mixed blessing for passengers, resulting in more flight choices but most likely higher fares as well, according to faculty members at Wharton and industry analysts.
These experts add that a merger is far from being a done deal, but that US Airways’ overture could spark further consolidation in the industry. One analyst says a third airline might enter the picture and make a run to acquire Delta. In addition, some say US Airways might be biting off more than it can chew in bidding for Delta, since last year’s merger of US Airways with America West, which resulted in the combined company using the US Airways name, has yet to be fully ironed out.
W. Bruce Allen, professor of business and public policy and director of the Wharton Transportation Program, says investors would love to see a US Airways-Delta combination. Wall Street feels that the industry needs fewer big airlines and that it would benefit from capacity reduction in an industry that has shown signs of renewed strength of late after struggling financially for years. But while capacity reduction may help the carriers’ bottom lines, it would not necessarily be good news for fliers.
“Demand is growing nicely and this would take more capacity out of the marketplace,” Allen says. “If you take capacity out of the market when demand is robust, it’s a recipe for raising fares. You’re taking away supply when demand is increasing.”
For the airlines, “a merger would be sanguine in terms of higher fares and higher load factors,” Allen adds. “Higher load factors are nice for them because the marginal cost of adding additional passengers on planes is so low. Consumers hate it, of course. The wait for the bags is worse under those circumstances and the planes are more crowded. You and I liked the old days, when planes were 50% full and we could stretch our legs.”
Serguei Netessine, professor of operations and information management at Wharton, agrees that a combined US Airways-Delta would hold serious downsides for passengers. In addition to higher ticket prices resulting from lower capacity, Netessine adds that, in many markets, a merged Delta-US Airways would have “more than 50% market share, and that’s never good for ticket prices. There are some cities where both Delta and US Airways have significant representation, and in those markets there will be something close to a monopoly.”
But a deal would make sense from the point of view of US Airways and its investors, says Netessine. The reason: Many airlines, including Delta, are in terrible financial condition, and part of the reason is strong competition.
“You need some kind of consolidation for those companies to start making money,” he explains. “For US Airways, this merger looks logical to me. They want to increase access to routes and reduce coverage of local markets where they compete intensively with local carriers. Delta has a lot of international routes. They have a dominant position over the Atlantic. Those routes are much more lucrative than local routes and there is less competition. Presumably, a merged airline would rely more on international routes to make money than on local routes where they compete with low-cost carriers like Southwest Airlines.”
US Airways’ CEO Doug Parker sent a letter on November 15 to Delta CEO Gerald Grinstein suggesting a merger valued at more than $8 billion. US Airways offered $4 billion in cash to Delta’s creditors and 78.5 million shares of US Airways’ stock. The stock closed at $58.18 per share on November 28, making the equity portion of the offer worth $4.56 billion on that date.
A “Premium” for Creditors
In his letter, Parker said the offer represents a “premium” for Delta’s creditors, whom he said stood to get more money under a merger than under a stand-alone plan by Delta. He added that the combined company, which would use the Delta name, could achieve $1.65 billion in annual cost savings as the new company reduces capacity, combines facilities in airports served by both companies, and eliminates redundant systems and overhead. Parker stressed that “the opportunity to generate more than half of these synergies could be lost if a merger is delayed until after Delta emerges from bankruptcy.”
According to Parker, a merger would result in a 10% reduction of the combined airlines’ capacity, “reducing unprofitable flying and improving the mix of traffic.” But even with a 10% capacity reduction, all existing U.S. destinations served by US Airways and Delta would be retained. “Consumers will have the advantages of a larger, full-service airline with the cost structure of a low-fare carrier,” he wrote.
It was the second time that Parker, who successfully shepherded the 2005 merger of US Airways, based in Tempe, Ariz., with America West, has approached Atlanta-based Delta with an offer. Parker called Grinstein in the spring to suggest merger discussions, but Grinstein rejected the idea. Parker followed that phone call with a letter in September, which also was rebuffed.
After receiving the most recent letter, Grinstein issued a statement saying that while Delta would “review” the offer, Delta’s “plan has always been to emerge from bankruptcy in the first half of 2007 as a strong, stand-alone carrier. Our plan is working and we are proud of the progress [we] are making to achieve this objective.”
Jim Corridore, Standard & Poor’s airlines equity analyst, says there is “good logic” behind a Delta-US Airways merger. “There is some overlap of assets and some non-overlap, and both those things are positives,” he explains. “They can eliminate redundant costs. There are definitely synergies in the deal, particularly on the East Coast. Delta brings a strong international network that US Airways doesn’t have. So I think a combined US Airways and Delta — and America West — is a stronger carrier in terms of a domestic and international footprint.”
Corridore praises the way that US Airways handled its integration with America West in the past year, calling that merger a success. “You have to give executives of US Airways credit with America West,” he says. “They have made strategic reductions and have [enjoyed] synergies as well.”
Kwame Webb, an airlines analyst at T. Rowe Price, agrees with Wharton’s Allen that Parker, the US Airways CEO, sees a need to wring out capacity — just as he did when he made the move to acquire US Airways when he was chief executive at America West. “When the industry gets into trouble, capacity never comes out, so losses become worse and worse,” Webb notes. “The thing I like about this deal is [that] Doug Parker says, ‘this industry has a lot of capacity [and] a lot of us are fighting a bit too hard.'”
One benefit to consumers from a merger would be service to more cities and increased opportunities for non-stop flights, which are especially desired by frequent fliers, notes Webb, adding that “this would be a godsend for business travelers.”
Corridore says a merger would provide new opportunities for some travelers to get from smaller to bigger markets. Moreover, international fliers would be able to use the new Delta “to get from one market to another without changing airlines.”
Too Much, Too Fast?
Allen, however, points out that Parker may be moving too soon, because all the kinks stemming from the America West-US Airways merger have yet to be ironed out. “Parker seems to have done a great job [with the merger] but he hasn’t digested everything yet,” says Allen. “So one question is, ‘Is this too much, too fast?'”
Netessine agrees. “US Airways still hasn’t finalized its merger with America West. If you fly US Airways, you’ll find they are still struggling with combining frequent-flier-mile systems and that sort of thing. If they get into another merger too soon, that might amplify the overall confusion of the staff, and there would be three systems they would have to combine.”
In addition, he says, Delta and US Airways belong to different worldwide airline alliances, which, among other things, allow customers to credit flier miles from one alliance carrier to another. US Airways has said that if the merger takes place, customers would be able to apply their frequent-flier miles to other airlines. “But since those companies belong to different alliances, the [new Delta] would have to exit one alliance and enter another,” Netessine says. “That would mean fewer choices for consumers. Somebody would have to suffer because of that.”
Another issue that the executives of a combined Delta-US Airways would face is its relationships with the world’s two largest aircraft manufacturers — archrivals Boeing and Airbus. Delta buys most of its planes from Boeing and already has placed an order for the Chicago company’s new Dreamliner aircraft. US Airways, by contrast, is a big customer of France’s Airbus. “What will they do if they combine two airlines?” asks Netessine. “Are they going to go all the way with Boeing or Airbus? Will they stick with two different types of planes? If so, that would seem to preclude efficiencies in operating aircraft [that a merger would hope to achieve]. And it will have some implications for the manufacturers.”
All of those interviewed by Knowledge at Wharton agree that it is impossible to say with certainty whether US Airways will succeed in its takeover bid.
For one thing, Delta management appears firm in its resistance to the overture. Parker’s challenge is to convince Delta’s creditors that his offer would leave them better off than a solo Delta emerging from bankruptcy. In addition, Corridore notes that Delta management has the exclusive right to present restructuring plans to the bankruptcy court through February 15, 2007. “As long as Delta remains resistant to the idea, it will be months [before a deal is definitively culminated or rejected],” Corridore says.
Those interviewed do say, however, that US Airways’ move may spark other merger proposals. Some observers have talked about a possible merger of Northwest Airlines and United Airlines. But Corridore says it is possible that United might enter the picture and bid for Delta.
The likelihood of Delta being acquired is hard to gauge, he adds. “If Delta continues to fight it, maybe a 25% chance,” he predicts. “If Delta agrees, but another party enters the fray and bids on assets, maybe 50%. But if all parties agree, there’s a 75% chance. I am thinking United will probably come in. A United-Northwest merger doesn’t make as much sense as a United-Delta merger.”
Webb of T. Rowe Price says the time appears ripe for further consolidation. “I had sort of given up on airline consolidation in the near term; you don’t generally have these guys consolidate until things get bad, to get rid of overhead and overlapping lanes and to get costs under control. That’s when you expect mergers to come — when [companies] are having a hard time.”
Webb figures there is a 50% chance of a proposed merger involving carriers other than US Airways and Delta. “I can’t say who the acquirer would be, but I think it’s a pretty safe assumption that Northwest Airlines is pretty attractive to a number of people,” he says. “The view now — the magic formula in the whole airline-merger space — is you want a strong carrier merging with weak carrier.”
Antitrust Issues
Corridore says the Justice Department would take a serious look at a US Airways-Delta merger, but would probably approve it since many carriers have suffered as a result of the terrorist attacks of September 11, 2001.
According to Wharton’s Allen, the biggest antitrust hurdle is the fact that both US Airways and Delta operate shuttle services in the Northeast corridor, but such an overlap could easily be dispensed with through a sale of one of the shuttles. The government could also be concerned that Delta and US Airways compete up and down the East Coast and that each carrier has a presence in New York. But he says there are so many competitors in New York that it “might not be a major concern.”
In the meantime, though, US Airways’ Parker has before him the difficult task of convincing Delta’s creditors that his deal is better than the one they could get from a stand-alone Delta. This, according to Allen, is no slam dunk.
“The game Parker’s playing is the same game he played at America West,” Allen says. “What he’s bargaining for is [that] the creditors will accept his deal as a better deal than having Delta emerge by itself. What typically happens in a bankruptcy proceeding is that holders of debt receive stock in the new corporation. Parker is offering $4 billion in cash and $4 billion in US Airways stock. If Delta emerges from bankruptcy, what will Delta’s stock be worth? With Parker’s offer, Delta’s creditors would get cash plus stock that the market right now values quite nicely.
“The question is, how will creditors react?” he asks. “Is the sure thing a good deal? Or do the creditors hope that Delta will issue new equity [that will increase in value]?”
