United/US Airways: start or end of the merger process? November 2000
The proposed $11.6bn United/US Airways merger, which was approved by US Airways' shareholders by an overwhelming 98.5% vote in mid–October, may face fresh complications because of an unexpected spanner thrown in the works by Continental. The Houston–based carrier has offered to pay 50% more than DC Air for US Airways' Washington Reagan National assets — an alternative that would value those assets more fairly and probably also be more acceptable to the regulators.
US Airways' shareholders had, of course, been expected to approve UAL’s $60–a share offer, because the price was almost double the low 30s that US Airways' shares had been trading. The deal envisages UAL paying $4.3bn in cash and assuming $7.3bn of debt and lease obligations.
The offer had to be generous in light of the high degree of risk of being eventually turned down by the regulators. But it is also clear that UAL was able to offer so much only because the deal would ensure that US Airways' valuable slots at National would not end up in the hands of strong competitors.
The DC Air deal
As part of the merger agreement, UAL would sell US Airways' 119 jet slots, 103 commuter slots, eight gates and related facilities at National for $141m to new entrant DC Air, owned by Robert Johnson, founder of Black Entertainment Television and a member of US Airways' board since 1998.
To ensure a quick transfer once the merger is completed, US Airways has set up a new wholly–owned subsidiary to operate the 44 routes in question (subject to DoT approval) from November 18.
The asset sale to DC Air was designed to avoid an inevitable antitrust challenge regarding overlapping service in the Washington area, were US Airways is the dominant carrier at National and United at Dulles. The move also hoped to address political issues such as adding a new entrant, providing minority ownership and ensuring continuation of service to small communities.
However, the DC Air deal has met with extensive criticism from all quarters, on grounds that the assets are sold too cheaply, that Johnson is not experienced enough, that he is not an independent buyer and that DC Air will not be a strong competitor. A late- September SEC filing by US Airways revealed that there were nine shareholder lawsuits challenging the DC Air proposal.
Consequently, Continental hit a nerve with its early–October offer to pay $215m for the assets that are due to go to DC Air. The carrier said that it is offering what it believes the assets are worth and contrasted its position as a strong and well–funded competitor with that of DC Air, which will at least initially be heavily dependent on United.
US Airways and United did not consider Continental’s proposal, citing their "binding" agreement that prohibits discussions with third parties regarding any alternatives. There have apparently been no other offers for any of US Airways' assets.
However, this is not likely to be the end of the matter. The DoJ, which will have a final say on the merger and which assets should be disposed of, may not look favourably at a plan that proposes addressing competition concerns by selling assets to an entity that will continue to have strong business connections with the seller. The regulators will like that even less now that there are alternatives. Of course, the DoJ may decide that more assets should be sold as a precondition to the merger.
Other airlines may put in their own bids for US Airways' assets, either following Continental’s example or, most likely, if and when the regulators have clearly indicated their intentions.
Access to Washington National, which is one of only four airports in the US with strict slot controls, is highly coveted by numerous airlines, including low–fare operators like AirTran. The other major carriers would probably also be interested in US Airways' Shuttle and leaseholds at Philadelphia. One way or another, it seems likely that United and US Airways will eventually have to consider other bids.
US Airways claims that the merger proposal has attracted support from more than 50 members of Congress, as well as obviously numerous community leaders and regional economic development boards. But the Senate Commerce Committee recently passed a nonbinding resolution opposing the merger, arguing that it would not be in the public interest. Many state attorneys also oppose the deal after conducting their own investigations.
The views of the legislators and politicians can influence the DoJ, which is conducting an antitrust review, and the DoT, which is providing input for the DoJ investigation. Of course, the merger proposal will also have to pass the scrutiny of the European Commission.
The DoJs focus
While the DoJ’s primary focus is to assess the case on its own merits, wider issues such as competitive consequences obviously influence the decision. Recent developments on that front have been positive for United and US Airways, as the cooling of the talks between American and Northwest have lessened fears that the United/US Airways deal would spark off a wave of industry consolidation.
However, in a shrewdly timed message clearly aimed at the regulators, in late October American released a statement to the effect that it continues to consider its strategic response to possible industry consolidation and that it remains open to merger possibilities.
One reason why merger talk has lessened in recent months is that the travel chaos and passenger dissatisfaction created this past summer by ATC delays, airline labour shortages and worsened customer service has turned political sentiment against airline consolidation. Ironically, the worst culprit was United, which had to cancel some 25,000 flights and delay thousands of others in the third quarter when its pilots refused to work overtime in protest at the lack of progress in contract talks.
The question asked by travellers and politicians alike was: If it is this bad with eight network providers, what would it be like with only three airline combines and one of them went on strike?
One rather ominous sign is that the DoJ is all set to go to court on November 1, two years after filing a lawsuit, to try to force Northwest to sell its controlling stake in Continental. The DoJ believes that the ownership stake substantially reduces the incentive for the two carriers to compete.
Some sort of last minute out–of–court settlement is possible, because the trial was postponed by a week at Northwest’s request and Continental has been keen to buy back the stake. But the mere fact that the DoJ is going to such lengths to oppose a lesser deal indicates that antitrust laws will be rigorously applied for the United/US Airways merger.
Is UAL up to it?
Even if the deal can survive regulatory scrutiny, is United is a position to take on the challenge of integrating the two carriers' workforces? The summer episode of labour strife ended when the United offered its pilots industry–leading pay (the contract was ratified in late October), but it still has to deal with unhappy flight attendant and machinists' unions. Because of a substantial hike in labour costs and a dented image, UAL could report a loss for 2001 for the first time since 1993.