GAO: no seasonal cheer for UAL/US January 2001

As the Justice Department’s antitrust review of the proposed UAL/US Airways merger looked like entering the home stretch, on December 20 US General Accounting Office (GAO) released a mostly negative report on the competitive merits of the deal. What are GAO’s views on the matter and how is the DoJ likely to rule?

The GAO report, titled "Issues related to the proposed United Airlines- US Airways merger", was requested by two members of Congress, James Oberstar and Louise Slaughter, and carries political weight. However, its focus was naturally much narrower than that of the DoJ investigation, which is currently anticipated to be concluded in January.

The report did not examine in detail the impact of the proposed merger on airline concentration at particular cities or effects on new market entry — subjects that the DoJ is interested in. Nor did it evaluate US Airways' long term financial viability — something that United and US Airways hope that the DoJ will give some weight to.

The GAO report, first, looked at how the merger would alter the US domestic industry using common measures of market strength. Second, it assessed effects on consumers by analysing data in specific markets. Third, it compared DC Air’s plans with the service scheduled by competitors by analysing frequencies and types of aircraft operated.

GAO agreed with the view held by analysts and industry observers that the proposed merger, even with the divestiture of assets to DC Air, "would create an airline so large and with dominance in so many markets" that it would "spur further industry consolidation". That has been a major concern for politicians and federal regulators.

The deal would "significantly alter the current state of competition in the domestic airline industry". The "new United" would account for 25.6% of domestic passenger enplanements, compared to Delta’s 19.3%, American’s 13.5% and Southwest’s 13.4%. It would take in almost $9bn more in total annual revenue than the next largest carrier — $26.6bn compared to American’s $17.7bn.

GAO also pointed out that the combine would have far more impact than the previous industry deal in the works, namely Northwest acquiring control of Continental. New United would increase dominance in five times as many markets and affect nearly three times as many passengers. That was a cheeky reminder that the DoJ was determined to press on with an antitrust lawsuit over a much lesser deal, effectively forcing Northwest to sharply reduce its stake in Continental in an out–of–court settlement. GAO concluded that the proposed merger could reduce competition in 290 of the top 5,000 US markets, in which 16m (5% of the total) passengers travelled in 1999. In 43 of those, affecting 4.1m people and including important markets like Washington to Boston and Tampa, competition would be eliminated.

In another 102 markets, affecting 5.7m passengers, the number of competitors would be reduced from three to two. The largest of those are Baltimore–Chicago, Chicago- Washington, Washington–Orlando, Baltimore–Los Angeles and Miami–Washington.

While United and US Airways already individually dominate 1,030 of the top 5,000 domestic markets, the combine would dominate another 126 of those markets, bringing the total affected passengers to 61.1m. GAO pointed out that the domination in terms of the number of markets would be 35% higher than Delta’s or, in terms of affected passengers, 25% higher than Southwest’s.

In 1999 the US major carriers in aggregate dominated about two–thirds of the top 5,000 domestic markets, affecting 200m passengers. Delta’s domination in terms of markets was the largest (849), but the 289 markets that Southwest dominated carried more passengers (48.8m).

The merger would allow the combine to dominate nonstop travel in all hub markets. At present, the two individually already dominate 26 of 28 hub markets. The merger would lead to domination of markets connecting US Airways' Philadelphia hub with United’s at Chicago and San Francisco.

Meagre benefits

GAO also warned that, in combination with the increase in the number of dominated markets, various operating and marketing barriers resulting from the merger would "make potential entry by new airlines in key markets more difficult". The benefits listed seem rather meagre in comparison. By combining operations in markets where the two had a relatively limited presence, an effective competitor could be created in 65 markets, affecting just 2.9m passengers. Also, competition could increase in another 256 relatively small markets that accounted for less than 1m passengers. The public would gain from more nonstop and direct service and expansion of available FFP destinations.

GAO’s analysis of DC Air’s planned markets and service basically implied that the new entrant may not make an effective competitor, because it proposes operating fewer flights and smaller aircraft than other airlines in competitive markets. It would face direct competition in nine of the 43 planned nonstop markets out of Reagan National and indirect competition (from service at other Washington area airports) in 28 of its markets.

GAO noted DC Air’s plans to emerge as a low cost carrier offering low fares, which it considered a critical factor for enabling the new entrant to compete successfully in the markets that it hopes to inherit from US Airways. However, "because DC Air would not share its proprietary business information with us, we cannot evaluate the airline’s potential to offer lower prices".

The release of the report and an accompanying statement by Congressman Oberstar provoked an angry response from US Airways. The carrier alleged that Oberstar, who represents Northwest’s home base in Minneapolis, "stretched the GAO report to serve his own agenda". The company also pointed out that the report, on its own terms, failed to take into account US Airways' financial position.

DoJ’s demands

In his testimony to GAO, US Airways chairman Stephen Wolf characterised the company as "the last of the mature–cost mid–sized carriers", most of which (Braniff, Pan Am, Eastern) have gone bankrupt and two of which (Continental and TWA) have reduced their costs through bankruptcy. High unit costs "make it increasingly difficult to achieve profitability". The percentage of routes profitable on a fully allocated basis has declined steadily since 1998, while market share in the East Coast is falling. In line with expectations, the DoJ, in its private meetings with United and US Airways, has already asked for far more divestitures than what the airlines offered. Those are believed to involve a wider sale of assets but possibly not any of the eight hubs. If so, the key question is: will the lucrative US Airways Shuttle be involved? Sam Buttrick, analyst with UBS Warburg, believes that the focus is on market positions (gates and slots) in Boston, New York LaGuardia and Philadelphia.

Whether or not a settlement is possible will depend on the extent that the required divestitures and associated loss of revenue synergies reduce the worth of doing the deal. Buttrick suggests that prospects for the original $60 per share deal are increasingly remote, but that US Airways' management is unlikely to go below $45-$50.