The signals are flying around like a swarm of mosquitoes targeting a large picnic. Everyone has weighed in and analysts and the Wall Street press seem to be pushing it. Indeed, the “m” word is in high use as airlines acknowledge we are slowly crawling out of the recession. The “m” word is, of course, Merger.
The word has fallen in and out of use in the past few years, replaced last year and this with the “b” word – bankruptcy. Now, merger has once again eclipsed bankruptcy and nowhere is this more evident than in airline CEO responses to analysts' questions about whether it might be time to dust off M&A portfolios for some action next year.
Analysts have recently peppered both Delta and Southwest with questions on mergers, not to mention revisiting United and Continental. Delta CEO Richard Anderson sent the clearest signal yet last week, hoping his airline counterparts would pick it up.
“The airline industry is evolving,” he said, “and we have been aggressive and creative to get to that evolved state. The merger was a bold step. The evolution is underway around the world and consolidation will help with that evolution. This business has to get to a return on capital and we don’t think at this point acquiring more aircraft is a good expenditure. Instead, we will be getting the balance sheet less leveraged.”
Anderson also pointed to the Delta/Northwest merger as proving the success of such moves. But there has also been plenty of fits and starts in the past few years as at least one airline concluded opportunistic moves. In addition to Northwest and Delta, Republic Airways Holdings, in equally bold moves, acquired both Frontier and Midwest airlines and restructured them into a single branded subsidiary that will help at least this regional evolve in response to the signals from mainline partners that they take on more risk. The move certainly rationalized the two low-cost carriers and gave each what they needed most – business travelers for Frontier and leisure travelers for Midwest, balancing out their revenues to mirror what the rest of the low-cost industry is doing.
But other runs have not been so successful and certainly have not come since the recession took hold. Prior to the recession there was US Airway’s unsuccessful run at Delta.
Today may be different and it is clear analysts are already mentally working deals, suggesting that Alaska or JetBlue would be beneficial to Delta although it is unclear whether the mainline carrier has an appetite for more given what remains to be accomplished at Northwest and its efforts to get JAL into SkyTeam. Delta just cut a deal for Alaska to exclusively feed its passengers at its western gateways to feed its international flights. There has also been speculation on deals between United and Continental and American and US Airways. Continental switched to join United in the Star Alliance only two months ago.
The second signal came yesterday from Southwest CEO Gary Kelly, also in response to questions, that he was still open to the opportunity. He would have to get a pilot agreement to pursue anything. The failure to lock one in kyboshed Southwest’s bid for Frontier.
US Airways Chair Doug Parker, along with and United Airlines Chair Glenn Tilton and President John Tague have yet to miss an opportunity during an analyst call to push for more consolidation. Parker did the last big merger with the acquisition of America West. Shortly thereafter, he made a run at Delta in 2006.
"To Delta/Northwest's credit, they're proving that you can capture value and execute a successful merger," Tague said in an interview with TheStreet.com. "Obviously, it's not (completely) done, but you'd have to say that consolidation is going well. While TheStreet.com noted economies of scale being ‘an obvious value,” Tague discounted efforts to merge just for the heck of it.
"Acquisition for the sake of acquisition, if you're doing nothing other than buying revenues, doesn't make sense," Tague told the publication. "Clearly it's important that you get synergies out of the cost side. Look at any other industry that does mergers, you've got to be extremely effective on cost takeout while maintaining your improving quality levels."
United and Continental made a pass at one another in 2008. More recently, in-coming Continental President Jeff Smisek told Bloomberg that any decision to renew talks depends on whether or not Delta outperforms the Houston-based carrier. "To date they have not done so,” he told Bloomberg. “They've gotten bigger, they've gotten more complex, but they haven't gotten profitable." Well, yes, but then again no one else has been profitable either what with the recession and all.
Clearly Wall Street is interested. Wall Street is always excited by such talk, as stock prices explode in the run up to merger or even a merger announcement. So too are airline executives who see consolidation as the single most effective way to reduce capacity.
Certainly, Europe has seen its share of “consolidation” with British Airways-Iberia and Lufthansa acquiring a 42% stakes in Brussels and Austrian airlines, as well as the takeover of BMI. Since then, Virgin Atlantic and Lufthansa are talking about off loading BMI on to Virgin, while Air Berlin has been active in takeovers in recent years scooping up LTU and dba, as well as stakes in Niki and Belair and Tuifly's city network.
The opening round of European consolidation was the Air France and KLM combination in the 1990s. It has long been a foregone conclusion that it, Lufthansa and British Airways will be the surviving global carriers in Europe with both the strongest balance sheets and the largest fleets.
There is also the Vueling/Clickair merger, while a number of others have gone through state-sponsored rescues, including Olympic and Alitalia, both of which have flirted with bankruptcy. And, then there is the on-again-off-again Ryanair/Aer Lingus dance, with Ryanair CEO Michael O’Leary suggesting using Aer Lingus to buy BMI to carry out Heathrow expansion plans.
Even Latin America is getting into the act with the recent Avianca and TACA of El Salvador merger. In addition, just recently Spirit Airlines made a pass at Air Jamaica which was soundly rejected by Air Jamaica’s pilot union in favor of the government selling the airline to employees.
The Wall Street press is fanning the flames using the “if” tactics as in: if United and Continental joined it would overtake Delta as the world’s largest airline. It would also relegate American to third place “which has got to hurt its ego.”
For now, however, little action can be expected from either American or Delta as they complete their bidding war for JAL.
The biggest question is whether or not mergers will be replaced by alliances in the industry’s efforts to consolidate. Mergers may still have their place in the domestic market but, internationally it will likely be alliances that will win the day given the stubborn reluctance to change foreign ownership rules.
Noting the merger activity in Europe, Anderson pointed to international alliances as the closest thing to a merger. It is the alliances that will usher in the next evolution, according to Boyd Group International, which predicted a slow end to individual branding in favor of the alliance brands that can already be seen as airlines paint their aircraft in their alliance livery, rather than their own brand. Taking a lesson from the evolution of regional codesharing in the US, the planes will likely end up with a small legend at the door saying, for instance, “Star Alliance, operated by Continental Airlines.”
“I doubt other mergers will work as well [as Delta/Northwest], but if you have global alliances that could work just as well,” he said. “I see the consolidation of revenues streams which are easier to merge than the corporate entity or mess with the labor brain damage you get.”
These Global Network Carriers (GNC), as Boyd calls them, will take over for individual international carriers which are skewing for the high-value, international traveler. Boyd said that 25% of the capacity of these GNCs will be driven by international traffic. Boyd praised the Delta/Northwest merger but added in October that airlines were resisting mergers largely for the same reason Southwest bowed out of its Frontier bid – pilots. Indeed, despite early labor approval at the Atlanta and Minneapolis-based carriers, a single seniority list remains the biggest nut on Delta’s to-do list. US Airways has yet to resolve the same issue some years after it merged with America West.
Boyd Group International President, Mike Boyd, indicated that airline/alliance changes will also mean fleet and route network changes. He focused on the narrowbody segment of 101- to 180-seat aircraft as the one to watch. Right now Boeing and Airbus are studying whether they can achieve what they need by re-engining their current narrowbodies. Airlines are eyeing their prediction that a completely new narrowbody won’t come for more than a decade. That said, Boyd indicated he thought the Bombardier CSeries has the potential to be the next 737.
Airports have the most to fear from these virtual airlines, said Boyd. “Airline alliances are morphing into the next dimension in cooperation,” he said. “The alliance will, in many ways, be the airline. In a very real sense, the airline members will become lift-providers much like Comair or Mesaba are non-brand lift providers to Delta. That means that the objective should be to align your community with access to all three global airline alliances which is easier said than done. Alliances are going to be the next big step. People don’t realize how important international enplanements are. Alliances are going to replace the airline. LCCs are great but if they aren’t in an alliance they will be in a world of trouble. The future belongs to alliances.”
Anderson seemed to echo Boyd’s sentiments when he said earlier this week: “The Air France-KLM alliance will be metal agnostic and is, in essence, a cross border consolidation. It will allow us to operate as a single entity on pricing, distribution and capacity.” But, he quickly added that the Obama Administration may not be as welcoming as the Bush Administration was to such deals. "If a transaction were to occur, economics should prevail," Anderson said. "I think the case can be made ultimately, but it remains to be seen what this administration's take will be."
The administration is not the only one concerned. House Transportation and Infrastructure Chair James Oberstar, (D-MN) whose constituents at Northwest were most affected by the Delta/Northwest merger, is up in arms over alliances. He has already asked the General Accountability office to study not only the competitive but the employment aspects of such alliances, saying flat out he would have alliances expire after only three years as the Departments of Justice and Transportation re-examine their impact on competition.
The Washington factor, and the Democrat’s reliance on unions for support could be seen with both the Delta/Northwest merger application and the American/BA immunity application. Principals wanted them done before the administration changed from Republican to Democratic. The AA/BA deal is long past the deadline set for October for Department of Transportation approval.
One thing is for sure, should any merger between the remaining six US mainline carriers be accomplished they will likely pave the way for some interesting growth opportunities for low-cost carriers as hubs are rationalized. LCCs continue to benefit from this with new opportunities opened up at such former hubs as Pittsburgh and Raleigh/Durham. Most recently, American’s abandonment of St. Louis as a hub has given rise to new services from AirTran and Southwest. It has even attracted United, so we could see a reprise of the battles it has already had at Denver.
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