Regulatory, Houston, labour, slots issues complicate United-Continental deal. AA likes it

Regulatory approvals may go beyond 2010

United and Continental want to close their merger deal by year's end, but Delta CEO Richard Anderson has observed that the regulatory environment has changed since the Delta merger, citing the fact that its proposed slot swap deal with US Airways (involving New York's LaGuardia and Washington National) has already taken far longer than it did to gain approval to merge two airlines.

The slot waivers were again, finally, granted by the Department of Transportation yesterday after a nine-month process which initially forced Delta and US Airways to give up slots. While they ultimately chose who would receive the slots, yesterday's waiver called for a blind auction of the slots. Enter Southwest. See related report: Delta-US Airways slot swap approved, but FAA calls for blind sale

So, however much Continental CEO Jeff Smisek and United CEO Glenn Tilton may protest that their merger was built to close, Washington seems to be back to its excruciating snail's pace. The chances of gaining approval this year are questionable at best.

Houston HQ issue won't help

In addition, Congressional delegations are already flexing muscles, with Texas Senator Kay Bailey Hutchison, who is the ranking minority member of the Senate Commerce Committee, expressing concerns about Houston losing Continental's headquarters in favour of Chicago. Having gone on record during the DL-NW merger as wanting more rather than fewer airlines because it was in the best interests of the consumer, she added she would follow the regulatory review closely. Clearly she was not persuaded by Mr Smisek's off-the-cuff remark on Monday that Houston would be a growth market for the combined carrier.

"Houston is going to be the largest hub of the world's largest airline," he said. "We will continue with a significant presence and will grow service not only with frequencies but with destinations and all that equals net job growth. We will be delivering more to Houston than Continental could have delivered on its own."

Smisek addresses employee concerns

In Mr Smisek's letter to employees, he said the merger would break the cycle of losses. "Ever since September 11, 2001, our future has been unstable and uncertain," he wrote. "We've lost more than USD1 billion since then, and every time we've made progress, something bad has come along to set us back. This merger will help us break this cycle."

He went on to explain many aspects of the merger. "Many complex factors went into our decision to merge," Smisek told employees. "The biggest factor is that the combined airline has a much greater chance of succeeding and thriving in the changing airline environment than either carrier has independently. For one thing, we have seen major changes in the competitive dynamics of our industry. Not only have Delta and Northwest merged here in the U.S., but many of our foreign competitors have merged, such as Air France and KLM, British Airways' recent merger with Iberia, and Lufthansa's acquisition of Austrian, Swiss, Brussels and British Midland. These carriers are now better positioned to compete against us. We've worked hard over the past 15 years to become a global airline, and we need to be prepared to compete globally with larger, stronger competitors who are attracting valuable corporate customers. We do not want to be left behind, and we need to merge while our best partner, United, is still available."

Smisek also cited the initiatives launched by both Delta and American in New York which threatened to supplant Continental as New York's airline of choice. In addition, he said switching to Star Alliance, while valuable, was not enough. "It has become clear that it is just a piece of what we need to be successful over the long term," he said. "We've seen over the past few years that alliances, while helpful, aren't always enough to secure our future. Delta is trying to swap slots with US Airways so Delta can grow its presence significantly at LaGuardia. Low-cost competitors have continued their growth, particularly on high traffic routes, from New York and other important markets. Other competitor initiatives, such as American's new alliance with JetBlue, Delta's attempt to lure Japan Airlines away from oneworld, and the recent decision of China Eastern and Shanghai Airlines to join SkyTeam, highlight the many changes in the industry driving our decision to merge with United now.

Smisek's culture more important to retain than HQ

In response to a question about moving headquarters, Smisek said it was necessary to locate the headquarters in Chicago to get the transaction accomplished, but didn't explain why driving the conclusion it was a deal-breaker for United. In Monday's call he indicated it was important to retain the carrier as Chicago's home-town airline to better compete with American, which he said is a definite target on the Chicago competitive scheme. He also indicated that, although Greater Houston Partnership had offered incentives to stay, Continental would have been required to undertake a number of financial commitments it was not in a position to make.

It seems Continental's board valued getting Mr Smisek to run the company more than it did retaining a particular location. "Our board of directors believes that the most important 'social' issue in a merger of equals is who runs the company and thus most influences its culture and its future," he explained. "Our board also believes it is important to merge the brands, as Continental is known for great service and a great culture, while United is the more globally recognized name.

He also said the fact that US Airways pulled out of talks with United didn't make a difference. "It doesn't make our future as a stand-alone carrier any more secure," he said. "Put another way, given the changing economic and competitive environment, we would have had to consider reengaging with United whether or not US Airways had been talking with them, as we need to secure our future."

Mr Smisek went on to explain the merger steps: "The first step is accomplishing the legal merger," he wrote. "A lot of regulators, including the Department of Justice and the Department of Transportation, will review the merger. That review will probably last through a good part of this year, and we expect to complete the legal merger by the end of 2010. The second step is the operational merger. It will take us until the first half of 2012 to operationally merge the two carriers. This is when we will obtain a single operating certificate and run as a single carrier. This process will take at least a year after the legal merger occurs but we should conclude sometime in the first half of 2012."

.. and he stresses Continental's culture will be preserved

He also promised to retain the company's Working Together culture, since he will be leading the organisation and carrying on its emphasis on customer service and pride. "Open, honest and direct communication won't change as a result of the merger, nor will our Working Together culture," he told employees. "You know how important I believe our culture is, and as CEO of the merged company, I will do everything I can to make sure that our Working Together culture becomes a fundamental part of the combined airline.

"One of the most important assets Continental brings is its culture," he continued. "Our culture is integral to success. The combined company will continue our focus on direct, open and honest communication and treating each other, and customers, with dignity and respect."

Labour reactions: not so hopeful

The most glaring difference from the DL-NW deal is the reaction of organised labour. Here again Delta set the bar, inking a deal with labour before it even announced the merger.

On Monday, after the United announcement - and despite being preceded by constant rumours - labour acted as one, immediately casting a jaundiced eye on the proposal. All labour groups want new contracts before they even begin to discuss seniority issues and they see this as their chance.

Far from the endorsement Delta and Northwest got for their plans, United and Continental labour were cautious and threatening. Unons flat out said that they are expecting to get what they are asking for if management wants any cooperation on the merger front. For United, this will mean parity with Continental's higher pilot rates. But the two groups said that the target Continental CEO Jeff Smisek discussed - the Delta contract - was not good enough.

Continental Master Executive Council Chair Jay Pierce called the USD700 million in salary increases and USD500 million in equity Delta and Northwest pilots received a good place to start. The problem is this would mean raises for wide-body crews at the cost of declining wages for B737 crews. United's Master Executive Council Chair Wendy Morse agreed: the Delta contract was not good enough, except as a starting point.

On Monday, Mr Smisek indicated that the combination will help Continental its scope clause, which limits Express operations to 50-seat jets (turboprops have a higher cap, over 70) while United's caps out at 70-seat jets. Not so fast, said pilots.

Of particular interest to Ms Morse was the stronger protections enjoyed by Continental pilots against outsourcing, especially given United's recent controversial launch of Washington-Madrid service using Aer Lingus to fly the route. But she specifically mentioned regional airlines. See related story US airline pilots flex muscles: Aer Lingus-United JV; Continental and pattern bargaining centreforaviation.com/news/2010/03/19/us-airline-labor-notes/page1

United's flight attendants joined the pilots' chorus in demanding a new contract as the price of considering whether or not to support the merger deal. They repeated the threat of calling on Washington to oppose the deal. just as the International Association of Machinists and Aerospace Workers' (IAM) had done on Monday.

"Management needs to pay attention to the extraordinary hurdles associated with any merger transaction," said AFA-CWA President at United Greg Davidowitch. "They cannot move forward without various approvals by the government, other constituencies and agreement with labor. Integration of in-flight operations could take years to complete and it will not occur at all unless we can support the deal with the protection of our jobs and improvement of our careers upfront."

American says consolidation is "positive"; oneworld alliance a vital asset

American Airlines Chair and CEO Gerard Arpey weighed in on the proposed merger saying, as he has always, consolidation is a positive direction - but not necessarily for American. While indicating no merger plans, in a letter to employees Mr Arpey stood fast in his conviction American could weather the merger mania sweeping the industry, something analysts clearly don't buy.

"While only time will tell - and of course the future is what we make of it - it's fair to say that a combined United/Continental has the potential to change the industry landscape in a number of ways, some positive and some negative," he told American employees.

He again reiterated the cost headwinds facing American, resulting from its refusal to enter bankruptcy as its peers did in the post-9/11 period. But, he added, that the resulting wage scales once United and Continental merged would be good for American since they would address the dislocation between American and industry pay rates. But, he said that would be offset by the combined carrier's size and the breadth of its network.

"A combined United/Continental would mean one fewer choice and may result in a better balance between industry supply and demand, potentially resulting in a more rational competitive environment," he said. "But the history of airline mergers suggests that in the process of merging, their labor costs will rise and move towards ours. If that is the case, the more we are able to control our own costs moving forward, the more this convergence will strengthen our competitiveness.

"That said, there is no denying that network depth and breadth is a key element of airline competition today, and, if approved by regulators, the new United/Continental will surpass us in size," he continued. "The partnerships we are crafting and will soon implement across the Atlantic and Pacific are extending our global reach like never before. The immunity we expect for those partnerships will finally level the playing field between oneworld and the other major global alliances. The oneworld carriers - including American, British Airways, Cathay Pacific, Iberia, Japan Airlines, LAN, Mexicana, Qantas and others - collectively represent the strongest airline brands in the most important markets around the world."

Mr Arpey concluded on a fighting note: "We have every intention of competing vigorously and, of course, are continuing to evaluate a range of alternatives to make American and oneworld even stronger."

Anyway, are mergers really effective?

Mergers rarely achieve all of their cited goals - rationalising capacity, strengthening airlines, job stability for labour. The DL-NW merger bears the signs of a success so far, but still has to prove its long term sustainability. Andt previous mergers have achieved none of those things, even during the last big cycle during the 1980s; now it remains to be seen whether the current generation of combinations will produce better results. No matter how much airline CEOs say they will cling to capacity discipline, their good intentions have always in the past dissolved into a fight for market share.

Regardless, it is highly doubtful, given the many cycles through which the industry has been, including merger cycles, that airline fortunes will change significantly for the better.

The industry continues to have chronic, year-in and year-out losses, punctuated by a few bright years when airlines actually managed to make money. Those few bright spots were always followed by more losses which were far more than the momentary profits the airlines were able to gather. This time around there has been a lot of talk about a new attitude, notably from Mr Tilton - and there are some signs of a greater discipline emerging. But, without being unduly cynical, once the good times return, the party atmosphere revives and so the cycle continues....