U.S. Airlines Look for Soft Landing in Bumpy Field
November 20, 2006
by Irwin Stelzer
The alchemists that run America's airlines are at it again, attempting to turn base metal into gold. US Airways' hostile bid of almost $9 billion for bankrupt Delta, if successful, would create the industry's largest carrier and might be followed by the long-rumoured merger of United with Continental, and American with bankrupt Northwest. Such consolidation would be the latest in a long line of proposed solutions to the industry's perpetual losses - cartel-type regulation, deregulation, bankruptcy court protection, and government bail-outs.
America West, before absorbing US Airways, but keeping its name, filed for bankruptcy protection after the first Gulf war, and avoided a second such filing after September 11 only by arranging a government bail-out. US Airways twice filed for bankruptcy reorganisation, in 2002 and 2004.
Alfred Kahn, the former airline-industry regulator who is considered the godfather of airline deregulation, said: "It is ironic ... that what has always been considered the financially weakest of the major carriers (US Airways) is proposing to take over what was once widely believed to be the strongest (Delta).
"If the proposed deal does survive congressional and anti-trust scrutiny, and win the backing of Delta's creditors, the merged airline will retain the Delta name in the belief that Delta is a better brand than US Airways, which tops its rivals in passenger complaints and lost baggage.
It is Delta's condition as a bankrupt that makes it attractive to US Airways. Doug Parker, chairman and chief executive of US Airways, says that half of the $1.6billion savings resulting from the merger would come from using the bankruptcy court to void onerous labour contracts and aircraft leases.
Delta responds that it would emerge from bankruptcy in far better shape as an independent than it would burdened with the problems created by a merger. Gerald Grinstein, Delta's chief executive, is, to put it mildly, unsympathetic to Parker and his proposal. He plans to use Delta's Atlanta hub and a cost structure that he reckons will be 25% below those of Lufthansa, Air France-KLM, and other international carriers to become a big force in international markets.
Meanwhile, the markets are on Parker's side, with buyers bidding up US Airways' stock to a 40% premium over the value of the creditors' claims on Delta. The big question is whether US Airways can overcome four hurdles.
The first is Delta boss Grinstein, who plans to step down in a few years, and wants to hand a healthy, independent carrier over to his successors, rather than exit the company under pressure, and while it is still bankrupt. "The history of mergers in the airline industry is almost always one of failure," he wrote in an e-mail sent to all employees.
The antitrust authorities will have to be convinced that consumers will not be harmed by the reduction of competition, especially on East Coast routes. They prevented United Airlines from acquiring US Airways in 2000, and shot down a proposed merger between American Airlines and Northwest.
They did approve the merger of America West and US Airways, but only because the routes of these carriers did not overlap -50% of the routes of Delta and US Airways do overlap. But the rise of the low-cost carriers, which provide potential and actual competition on the routes served by the proposed enlarged Delta, is now seen as protection against monopoly exploitation, even though Parker has a record of cutting capacity to drive up fares.
Then there are the unions, who know that a good portion of the savings that Parker is talking about will come out of their pockets. They face a similar fate at the hands of the bankruptcy court, but would rather deal with the devil they know. So they will lobby Jim Oberstar, the Minnesota Democrat who will become chairman of the House Transportation Committee when his party takes control of Congress in the new year, to hold hearings on the impact of the proposed merger. Oberstar opposed the United-US Airways merger in 2000, and told the press: "Mergers reduce opportunity for competition and thereby increase costs to travellers." So his should be a union-friendly forum.
Finally, Parker will have to convince half of Delta's unsecured creditors, representing at least two-thirds of the value of outstanding claims, that his offer of cash and stock is better value than sticking with Grinstein and ending up with shares in an independent Delta when it comes out of bankruptcy. These creditors, including Boeing, US Bancorp and General Electric, are a hard-nosed bunch, and will follow the money. If Parker has got his arithmetic right, he should clear this hurdle.
If the merger is approved, look for at least temporary upheaval. The glitches in the US Airways-America West merger have yet to be worked out. Throw in the need to co- ordinate pay scales and frequent-flyer programmes with Delta, and Parker's management team will be tested to the limit.One way or another, the problems of the industry will remain largely unchanged.
Badly managed carriers will still be able to keep flying under the protection of the bankruptcy courts; airlines will be able to control only a portion of the travel experience, the rest being at the mercy of monopoly operators of airports and security-obsessed bureaucrats; America will still protect its carriers from the foreign competition that might improve service on domestic routes; and airline managements will continue to cut costs and quality, attempting to discover, in the words of one executive, just how much cheese you can take off the pizza before customers stay away.
This article originally appeared in the November 19, 2006, Sunday Times. (London)
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.