New era of industry consolidation? June 2000
Does United’s $4.3bn bid for US Airways really herald a new era of industry consolidation, or will the competition authorities refuse to permit a repeat of the merger mania of ten years ago?
Certainly, the stock–markets have been implying for some time that rationalisation is required to improve shareholder value in the major airlines. As the tables below indicate, the largest airlines in the US had been trading around book value before merger speculation hit the markets (early May). At the prevailing prices it would have been possible in theory to fund the purchase of these airlines out of 1–2 years of their cashflow. In Europe there are deep discounts to book value for carriers like KLM, SAir and SAS.
M&A activity is generally a good way of boosting share prices for the target airlines. US Airways' shares soared 72% after United’s offer (though it should have doubled if investors were fully confident that the deal would go through). Northwest shares jumped 22% on preliminary reports of a bid from American.
Conversely, United and American stock both fell by 13%.
The first issue is: will UA/US get past the regulatory authorities?
There is a formidable list of investigating bodies including:
- The DoT which has authority over transfer of international route rights;
- The DoJ to look at anti–competitive effects;
- The European Commission because it says it needs to;
- At least two congressional committees; and
- The Attorneys General of at least Pennsylvania, New York, Massachusetts who will examine the effect on their states' consumers.
The key authority is, however, the DoJ which will have to answer the question: what is the optimal number of airline to ensure competition exists? In this case United and US Airways will point to the lack of overlap between the two networks, domestically and internationally.
But it is not quite that simple. Nonstop competition would go on routes between the two airlines' hubs, e.g. Chicago- Pittsburgh, and there are specific airports at which United and US Airways have competed fiercely, n o t a b l y Washington Dulles.
United has attempted to deflect antitrust concerns through the curious sponsorship of a start–up — DC Air — which will operate from Reagan National in Washington using 222 slots sold by US Airways for a total of $141m. United will also lease aircraft and "lend" personnel to the start–up, which will be led by Robert Johnson, a US Airways board member and founder of a television network. This has naturally aroused suspicions about the independence of DC Air. Some cynics see this as a crude attempt to pre–empt American moving into this market.
Still, US stock–market analysts are giving the deal a slightly better than 50:50 change of getting past the regulatory authorities, if various other concessions are made. Then United has to make the merger work. Far from enhancing shareholder value many of mergers in the last major phase of US consolidation in the late 80s/early 90s managed to destroy shareholder value. The three original components of US Airways — USAir, Piedmont and PSA — were much more profitable airlines and better brands than the merged entity.
Convincing United’s labour force, in particular the pilots who own a quarter of UAL’s (recently devalued) stock, of the wisdom of the take–over is going to be the most difficult task. Indeed, the timing of the announcement of the offer for US Airways came at a very sensitive time, in the middle of the post- ESOP pay negotiations (see Briefing, pages 12–16). Moreover, United’s management has already made some startling concessions to heavily unionised and highly paid US Airways pilots who will apparently be able to assert their seniority over United employees. Also, a no–furlough pledge made by United seems to make no sense if the merger if to achieve genuine cost savings.
Then there is the question of hub rationalisation. One of US Airways' weaknesses was having too many hubs too close together in the east (Pittsburgh, Charlotte, Philadelphia, Washington National, and Baltimore). As these are now joined by United’s hub at Washington Dulles, de–hubbing would be necessary.
Finally, there are the threats from competitive reaction if a United/US Airways deal lowers to barriers to consolidation. American had to respond vigorously to United by approaching Northwest as it stands to lose its marketing agreement with US Airways, having recently lost Canadian to United- and Lufthansa–backed Air Canada. American plus Northwest would attack United/USAirways domestically, on the Pacific and on the Atlantic (possibly in combination with BA/KLM). The next move would then probably be a link–up between Continental and Delta (bringing in Air France).
The only airlines which will definitely not be in play in this game are the two most highly rated airlines in the US and Europe — Southwest and Ryanair. A US consolidation process could have some unexpected consequences for the global alliance game. The resources needed to make such mega–mergers work will inevitably divert management attention away from the more nebulous benefits of harmonising the products of disparate carriers throughout the world. And the potential benefits in the long–term of a US mega–merger will be much greater than those from global alliances. So expect a de–emphasis on global alliances from the US majors.
The implication for the US competition authorities of a series of US mega–mergers is also intriguing. Will the Commission adopt a more $1 or even promotional policy to intra–European mergers in the same way as it did in the aerospace sector following Boeing/ MDC?
|Source: Goldman Sachs|