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United and Continental announce merger details; to create world's largest airline

4-May-2010 8:51 AM

Continental Airlines and United Airlines (both Star Alliance carriers) entered (03-May-2010) a definitive merger agreement, creating "the world’s leading airline" with "expanded access to an unparalleled global network", "enhanced long-term career prospects" for employees, and a "platform for improved profitability and sustainable long-term value for shareholders". [more - Continental/United Press Release] [more - Merger website link] [more - Presentation] [more - Fact Sheet] [more - Full Merger Document] [more - Conference Call Transcript/Press Conference Transcripts/Letters to stakeholders] Details include:

  • Company name/branding: The holding company for the new entity will be named United Continental Holdings Inc and the name of the airline will be United Airlines. The marketing brand will be a combination of the brands of both companies. Aircraft will have the Continental livery, logo and colours with the United name, and the announcement campaign slogan will be “Let’s Fly Together”;
  • Shares: In the merger, Continental shareholders will receive 1.05 shares of United common stock for each Continental common share they own. United shareholders would own approximately 55% of the equity of the combined company and Continental shareholders would own approximately 45%, including in-the-money convertible securities on an as-converted basis. The stock swap is valued at more than USD3 billion (Bloomberg, 03-May-2010);
  • Executive news: Glenn Tilton, Chairman, President and CEO of UAL Corp, will serve as Non-Executive Chairman of the combined company’s Board of Directors through 31-Dec-2012 or the second anniversary of closing, whichever is later. Jeff Smisek, Continental’s Chairman, President and CEO will be CEO and a member of the Board of Directors. He will also become Executive Chairman of the Board upon Mr Tilton’s ceasing to be Non-Executive Chairman. The carriers added that key management positions will be determined prior to the transaction’s closing. The combined company’s management team is expected to include a balanced selection of executives from each company. In addition to Mr Smisek and Mr Tilton, the 16-member Board of Directors will include six independent directors from each of the two companies and two union directors required by United’s charter;
  • Revenues: On a pro-forma basis, the combined company would have annual revenues of approximately USD29 billion based on 2009 financial results, and an unrestricted cash balance of approximately USD7.4 billion as of the end of 1Q2010, including United’s recently closed financing transaction;
  • Synergies: The merger is expected to deliver USD1.0-1.2 billion in net annual synergies by 2013, including USD800-900 million of incremental annual revenues, in large part from expanded customer options resulting from the greater scope and scale of the network, and additional international service enabled by the broader network of the combined carrier. The combined company is also expected to realise USD200-300 million in net cost synergies on a run-rate basis by 2013;
  • Merger costs: One-time costs related to the transaction are expected to total approximately USD1.2 billion spread over a three-year period;
  • Ratings:
    • Fitch Ratings - Continental:  Affirmed the Issuer Default Rating (IDR) at 'B-' and the senior unsecured rating at 'CC/RR6' following the announcement. The rating outlook is "stable"; [more - Fitch Ratings for Continental]
    • Fitch Ratings - UAL Corporation and United Airlines: Placed the ratings on "Rating Watch Positive" following the announcement. Fitch placed the following ratings - Issuer Default Rating (IDR) for both UAL and United 'CCC', United's secured bank credit facility 'B+/RR1' and United's senior unsecured rating 'C/RR6' - on the 'Ratings Watch Positive'. Fitch added that UAL will likely be in a position to continue de-levering its balance sheet, albeit at a modest pace, over the next several quarters; [more - Fitch Ratings for United Airlines]
    • Fitch Ratings - commentary on merger:  Fitch expressed its view that a merger between CAL and UAL, if closed under terms similar to those outlined, will "eventually support sustainable improvements in margins, positive free cash flow (FCF) generation and stronger liquidity in a post-merger scenario". Fitch added that "significant execution risk exists, however, and the terms of new labor contracts could have a substantial impact on the economics of the merger". Fitch also believes that a combined network would offer "clear opportunities" for the post-merger carrier to deliver a sustainable RASM premium to the industry, adding that the two stand-alone networks are "very complementary", with United's strength in trans-Pacific routes with CAL having a strong market position in New York and into Latin America via the Houston hub. Fitch added that it believes the post-merger balance sheet debt for the new airline will likely exceed USD14 billion, in addition to approximately USD10 billion in capitalised aircraft leases. Combined unrestricted liquidity will likely approach USD7 billion (over 20% of pro forma post-merger annual revenue), according to Fitch, which added that it expects the transaction to be closed by early 2011;
    • Standard & Poor's Ratings Services - UAL Corp and United Airlines: Placed the B- corporate credit rating on watch with positive implications (MarketWatch, 03-May-2010). S&P’s commented, “we could most likely raise our corporate credit ratings on UAL and United to B if the merger is completed and we feel that the combined credit profile, including Continental, is materially superior to the current one". However, it warned that it may lower Continental's rating from “B” to “to B-“, commenting, “in our view, the combination has significant revenue and cost synergy opportunities, but also significant potential risks. The risks primarily relate to potential added labour costs and labour integration problems”;
    • Moody’s Investors Services: Stated it may change its ratings on UAL Corp (Reuters, 03-May-2010). Moody's currently rates UAL “Caa1”, seven steps below investment grade, with a “B2” rating on Continental.  While it affirmed Continental's rating, Moody’s commented that the outlook is negative due to the industry's weak track record in successfully executing large business combinations. Moody’s commented, "the success of the merger will also be dependent on the companies successfully meeting certain hurdles, including attaining labor's buy-in at a reasonable price, limited divestitures or other restrictions required by regulators and approval by shareholders of both companies”;
  • Fleet: The carriers stated the combined airline will have the financial strength to invest in globally competitive products, upgrade technology, refurbish and replace older aircraft, and implement the best-in-class practices of both airlines. United Airlines currently operates a mainline fleet of 360 aircraft, with Continental having an operating fleet of 333 aircraft. Meanwhile, Continental has an all-Boeing order book and United has a mixed order book, totalling almost USD22 billion at list prices (Reuters/Bloomberg, 03-May-2010).
    • Continental Airlines: 22 B737-700s, 13 B737-800s, six B737-900ERs, three B777-200ERs, 11 B787s and 14 B787-9s on order, valued at a list price of USD7,958 million;
    • United Airlines: 23 A319s, 19 A320s and 25 A350-900s (list price value of USD9,621 million) and 25 B787-8s (valuled at USD4,156 million). United recently split a USD10 billion widebody order between Airbus and Boeing, and had been expected to renew its single-aisle fleet during 2010;
  • Combined network: The combination brings together the "two most complementary networks of any US carriers", according to the airlines, with minimal domestic and no international route overlaps. The combined company will offer enhanced service to Asia, Europe, Latin America, Africa and the Middle East from hubs on the East Coast, West Coast, and Southern and Midwestern regions of the US. The combined company will have ten hubs, including hubs in the four largest cities in the US and will provide "enhanced service" to underserved small- and medium-sized communities. The combined carrier will continue to serve all the communities each carrier currently serves. Together, Continental and United serve more than 144 million passengers p/a as they fly to 370 destinations in 59 countries;
  • Headquarters: The new company’s corporate and operational headquarters will be in Chicago and it will maintain a significant presence in Houston, which will be the combined company’s largest hub. Additionally, the CEO will maintain offices in both Chicago and Houston; 
  • Necessary approvals: The merger has been approved unanimously by the Boards of Directors of both companies. However, it is conditional on approval by the shareholders of both companies, receipt of regulatory clearance, and customary closing conditions. The companies expect to complete the transaction in 4Q2010. During the period between signing and closing of the merger, the CEOs of both companies will lead a transition team, which will develop a specific integration plan. Meanwhile, the US Justice Department is “looking at the proposed transaction between these two airlines” (Associated Press, 03-May-2010). The Justice Department and Federal Trade Commission share jurisdiction over antitrust and competition matters although the Justice Department typically handles airline deals (Reuters, 03-May-2010);
  • Industrial relations: The carrier's stated employees will benefit from "improved long-term career opportunities" and "enhanced job stability". The companies believe the effect of the merger on front-line employees will be "minimal", with reductions coming principally from retirements, attrition and voluntary programmes. The company will provide employees with performance-based incentive compensation programmes focused on achieving common goals adding that the combined company will be "focused on creating cooperative labor relations, including negotiating contracts with collective bargaining units that are fair to the company and fair to the employee". United currently has 46,602 employees, while Continental has a workforce of 40,927;
  • Union responses:
  • The International Association of Machinists and Aerospace Workers' (IAM) stated it would work closely with members of Congress and the Departments of Transportation and Justice to ensure that if a merger is approved, it will "not be at the expense of workers at either carrier". The union stated its concerns include the impact of such a merger on the pensions, benefits, seniority and job security of employees at both carriers, with the union also expressing concern about the survivability of the combined airline and the merger's effects on passengers and the cities the airlines serve. [more - IAM]
  • Association of Flight Attendants-CWA, AFL-CIO (AFA-CWA) stated (03-May-2010) a new contract with pay, benefit and work rule improvements must be concluded before they can consider support for the announced merger. The union added that it would "vigourously defend the rights of AFA-CWA United flight attendants in the fight for a fair contract and during and after the merger process"; [more - AFA-CWA]
  • The Teamsters Union stated (03-May-2010) it is assembling an experienced team of experts to ensure its members' jobs and interests are protected should the proposed merger be approved. [more - Teamsters Union]
  • United Master Executive Council and Continental Master Executive Council commented (03-May-2010) that it is "important to remember that history has demonstrated that the integration of two airlines is always a difficult challenge", adding, "the support of the pilots is pivotal in determining whether a merger is successful or not, as will be the case with this merger of Continental and United"; [more - United/Continental Master Executive Council]
  • Effect on airfares: Mr Smisek commented, "there is no carrier in the world that can set air fares” adding “we couldn't set air fares before this. We can't set air fares after this" (Associated Press/Bloomberg, 03-May-2010). Separately, Airfarewatchdog commented, “at least in the short term, fares are likely to rise, especially on routes with less competition”, while Air Travelers Association stated the merger will “probably be neutral in terms of the effect on domestic fares”, due to LCC competition within the domestic market; 
  • Advisors: JP Morgan Securities Inc and Goldman, Sachs & Co acted as financial advisors and provided fairness opinions to United, and Lazard and Morgan Stanley acted as financial advisors and provided fairness opinions to Continental. Jones Day, Vinson & Elkins LLP and Freshfields Bruckhaus Deringer LLP acted as legal advisors to Continental, and Cravath, Swaine & Moore LLP acted as legal advisor to United;
  • Frequent flyer programmes: Miles accumulated in each airline’s frequent-flier programme will be combined into one account when the merger closes. Until then, each programme continues and points can be used under existing rules;
  • Effect on other carriers: If United acquires Continental, the new United will surpass Delta Air Lines in size (Associated Press/Reuters, 03-May-2010). The new carrier would also form the world's largest carrier;
  • Consolidation outlook: The recent announcement has caused speculation that American Airlines will also seek a partner, with codeshare partner, JetBlue, and US Airways Group, identified as possibilities (Bloomberg/Reuters, 03-May-2010). There has been speculation that Alaska Airlines could be seen as a takeover target (the carrier’s share price gained 10.3% yesterday, to its highest point since 1999). S&P stated investors are "asking who's next" in line for consolidation after the United-Continental agreement, adding that Alaska Air Group "is relatively complementary to American"; 
  • Response by ExpressJet: Stated it was "excited" to hear of the merger, adding that it does not anticipate that the terms of its aircraft leasing arrangements with Continental or its capacity purchase agreements with Continental and United to materially change due to the merger announcement. ExpressJet's capacity purchase agreement with Continental covers a minimum of 190 aircraft through 30-Jun-2015 and its agreement with United covers 11 aircraft for a minimum of three years, 11 aircraft for a minimum of two years – both effective 01-Dec-2009 – as well as ten additional aircraft from May-2010 to Dec-2010. ExpressJet currently operates 244 aircraft, including 206 aircraft for Continental as Continental Express and 32 aircraft for United as United Express. Based on May-2010 flight estimates, ExpressJet's market share in the combined entity would represent approximately 30%; [more - ExpressJet]
  • Senator responses: US Senator, Kay Bailey Hutchison, stated she plans to "thoroughly review and monitor both the short and long term effects of this merger on both the Houston economy as well as on the competitiveness of the US aviation industry as a whole". She added, “the proposed merger with United raises understandable concerns about the impact on the Houston area economy as well as broader issues with competition and choice". [more - Senator Kay Bailey Hutchison]

UAL Corp: “Today is a great day for our customers, our employees, our shareholders and our communities as we bring together our two companies in a merger of equals to create a world-class and truly global airline with an unparalleled network serving communities worldwide with outstanding customer service. 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. Knowing and respecting our colleagues at Continental as we do, we are confident that together we can compete successfully in what is now, clearly, a global marketplace,” Glenn Tilton, Chairman, President and CEO. Source: Company Statement, 03-May-2010.

Continental Airlines: “This combination brings together the best of both organizations and cultures to create a world-class airline with tremendous and enduring strengths. Together, we will have the financial strength necessary to make critical investments to continue to improve our products and services and to achieve and sustain profitability. We have forged a highly collaborative partnership with United over the past two years as we prepared for and executed a seamless transition to Star Alliance, an important achievement that gave us valuable experience in working together and built mutual respect between our two companies. I look forward to working with the employees of both companies around the world, so our airline can become an even stronger global competitor, deliver sustainable profitability, achieve best-in-class customer service under our unified brand, create long-term career opportunities and deliver increased value for shareholders,” Jeff Smisek, Chairman, President and CEO. Company Statement, 03-May-2010.

Continental Airlines: "I recognised that United is the best possible partner for Continental. I didn't want him (United's Tilton) to marry the ugly girl; I wanted him to marry the pretty one, and I'm much prettier," Jeff Smisek, Chairman, President and CEO. Source: Associated Press, 03-May-2010