Delta-Northwest deal expected to trigger other discussions

Monday, February 11, 2008
Delta Air Lines jets line up on the tarmac at Hartsfield Jackson Atlanta International Airport in Atlanta, Ga., in this Nov. 22, 2006 file photo. Executives at the nation's oldest airlines believe that size matters; that unless you have lots of planes flying at convenient times to many different cities, travelers won't remember you the next time they book a flight. Because of that fixation on size, consolidation in the airline business isn't likely to stop at one deal. (AP Photo/Ric Feld, file)

DALLAS -- The Delta-Northwest combination inching toward completion would create a new world leader, leapfrogging American Airlines and the Air France-KLM tandem in passenger traffic, but would also likely trigger a chain reaction of other deals, with unknown consequences for travelers.

The next potential deal in line -- United and Continental -- would be even bigger, and other pairings are likely, too, as carriers bulk up to compete in the new, more competitive global airline industry.

Executives at the big airlines believe that unless you have lots of planes flying at convenient times to many cities, valued corporate travelers won't remember you the next time they book a flight.

The economics of the airline industry also are driving carriers into each others' arms.

High fuel prices are causing many airlines to lose money, and the threat of recession makes the outlook even more grim. Airlines have raised fares, but not enough to offset fuel. Conventional wisdom holds that in mergers, airlines could reduce overlapping routes and raise prices.

Delta Air Lines jets queued up on the tarmac Nov. 22, 2006, at Hartsfield Jackson Atlanta International Airport in Atlanta. Delta and Northwest are in talks to merge, and the buzz has stirred speculation that United and Continental will follow suit with their own combination. (Ric Feld ~ Associated Press)

Of the so-called legacy U.S. airlines -- those that existed before deregulation and operate hub-and-spoke route networks -- Continental Airlines Inc. has been the most profitable since the industry downturn that began in 2001.

Continental's chief executive, Lawrence Kellner, said he would prefer to remain a stand-alone company but doesn't want to fall behind if others start merging.

"We do pay attention to relative size, and I think we would have some concern" if rivals merge, Kellner recently told analysts. He said he'll watch what competitors do, and "if we see something or hear something, we won't hesitate to act aggressively."

Northwest and Delta Air Lines Inc. have been talking about joining the two carriers, and people close to the talks say a deal could be announced as soon as next week.

In a memo to his employees Wednesday, Northwest Airlines Corp. chief executive officer Doug Steenland said "consolidation is highly likely at some point," and doing nothing "could be our worst alternative."

"I do believe that consolidation is highly likely at some point -- particularly with the high cost of fuel and the other challenges that the industry faces," he said.

If Delta Air Lines Inc., the nation's third-largest airline, combines with No. 5 Northwest Airlines Corp., it would create the largest U.S. airline, passing United and the current leader, American Airlines.

But United, the second-largest, and No. 4 Continental could trump Delta by joining forces.

The history of airline mergers is mixed at best. It's a challenge to combine different aircraft fleets, labor unions and cultures.

"Mergers are always a problem, and that's why Continental is not in favor of one," says Raymond Neidl, an analyst for Calyon Securities. "They have always been expensive and sloppy."

Neidl said network carriers believe they need bulk to compete with each other and with growing European and Asian airlines, especially when limits on U.S.-Europe service are eased at the end of March.

Continental and United operate complementary route networks, making a combination attractive. Continental has a strong presence in Latin America and, from its hub in Newark, N.J., flying to Europe. United has strong routes across the Pacific, including in the growing Chinese market.

A Continental-United partnership wouldn't have as much global reach as Delta and Northwest -- an important consideration for business travelers -- "but it would certainly surpass either carrier by themselves and also American. It's not a bad second choice," said Robert Mann, an airline industry consultant.

Other potential partners for Continental and United "aren't in the same ballpark," he said. Many analysts believe antitrust concerns could prevent American from buying another big carrier.

Potential roadblocks to a deal could include the new company's name, whether it would be based at Continental's home in Houston or United's base in Chicago, and who would run it. Leadership issues reportedly have been a sticking point in the Delta-Northwest talks.

Roger King, an airline analyst for CreditSights, said United's name might survive, and there might be dual headquarters, but Wall Street prefers Continental's management team.

"One of the problems with United is that their (profit) margins aren't that good; they just can't seem to run an airline as well as Continental can," he said.

There are also parochial issues, such as a tax-abatement deal that requires Continental to keep at least 2,400 employees at its headquarters through the end of this year. And labor issues.

Jay Pierce, the new chairman of the pilots' union at Continental, said he worries a merger could cost jobs, and so pilots want stock in any new combined company as a condition for supporting the deal.

"The pilot group would be assuming risk" in a merger, he said. "Risk deserves reward."

United's unions say they won't block a deal if employees benefit -- they see consolidation as a chance to raise their pay, which was reduced when United parent UAL Corp. went through bankruptcy. The president of the United pilots' union, Steve Wallach, vows his group "will not rubber-stamp any merger unless and until our interests are addressed."

Continental is reported to be talking with United, but nobody expects it to announce anything before Northwest makes a deal. That's because Northwest holds a so-called golden share of Continental, allowing it to block a change in ownership at Continental.

Northwest once owned 6.7 million shares of Continental stock. The Justice Department sued Northwest, claiming that its controlling interest in another airline was anticompetitive. As part of a settlement in 2000, Northwest sold its Continental stock but got the golden share.

However, if control of Northwest itself changes -- as it would if it is acquired by Delta -- Continental can buy the share for $100.

The airlines declined to comment on possible deals. Executives' public remarks have been vague -- Continental's Kellner and United CEO Glenn Tilton have acknowledged only that their companies have examined how potential deals could affect them.

Tilton told employees this week, "The work we have done puts us in a strong position to participate in consolidation when the opportunity and the time is right for all of our stakeholders. No one will be making our decisions for us."

And what if Continental or United decide not to play musical chairs? What if, even in the face of a Delta-Northwest deal, they did nothing?

They might become takeover bait.

"Continental thinks they can survive on their own because of their strong hubs in the New York area and Houston and their international routes, but other airlines might be interested," said Neidl, the longtime industry analyst.

Even a Delta-Northwest curtain-raiser could draw competing offers -- some analysts think American's parent, AMR Corp., might bid for Northwest. There is speculation that US Airways Group Inc. could bid for Continental or United, although it might need a partner who can bring cash to the table.

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