United Airlines parent UAL and Continental Airlines are in preliminary talks about a merger that would create the largest airline in the world, sources familiar with the situation said on Wednesday.
The talks come amid heightened merger activity in the fragmented and highly competitive airline sector, which is emerging from a prolonged slump following the September 11, 2001, attacks in the United States.
US Airways last month made an unsolicited bid for larger, bankrupt rival Delta Air Lines; AirTran on Wednesday offered to buy Midwest Air; and bankrupt Northwest Airlines is evaluating strategic alternatives, including a merger.
"Everyone talks to everyone all the time, but (United and Continental) renewed contact after the USAir and Delta situation emerged," said one source, who declined to be identified. "It's far from certain. At the moment, it's just talks."
Despite potential hurdles, the combined company, which would surpass American Airlines as the world's number 1 carrier in passenger traffic, would have many interesting components.
United brings its strength on the West Coast, coveted gates at London's Heathrow Airport and its strong presence in the important Chinese market. Continental offers its key Newark, New Jersey, hub, Trans-Atlantic access and a strong presence in Latin America.
"It makes a lot of sense," said Roger King, an analyst with CreditSights. "It would be a good aggressive strategy by United and a good defensive strategy by Continental."
A deal is still far from certain and not imminent.
"The biggest hurdle is the antitrust and golden share issues. Those are the focus of any discussions," said a second source, who declined to be named.
"You need to resolve those points -- and face some union contract issues -- before you can even get to issues like price, leadership and timing," the second source said.
It is not the first time the two carriers have talked. United held discussions with Continental and Delta before exiting bankruptcy in February, said Fruman Jacobson, a lawyer at Sonnenschein Nath & Rosenthal, which represented United's unsecured creditors.
A deal between United and Continental would have to contend with integrating work forces and combining fleets and route networks. But the carriers would face an even more difficult road than other potential airline deals.
First and foremost may be convincing Continental's management to do a deal, said airline consultant Mike Boyd.
"There's probably more smoke than fire at this point," he said.
While United has been a vocal proponent of consolidation, Continental has repeatedly said it would prefer to remain independent, but recently softened its stance. Shortly after US Airways announced its bid for Delta, Chief Executive Larry Kellner said the company would consider a deal, if necessary, to stay competitive.
Continental and United declined to comment.
A deal, which would create an airline with more than 26 percent market share, is certain to face close scrutiny from antitrust authorities, which in the past have frowned on big airline mergers.
But given the industry's troubles and the rise of low-cost carriers, airline executives have said they believe the US Department of Justice may be more amenable to big deals now.
A Continental-United deal also faces a unique problem. Northwest Airlines holds a 'golden share' in Continental that gives it the right to block mergers involving the Houston-based carrier in a shareholder vote.
The airlines could offer Northwest some assets or other incentives in exchange for its support. A deal, if it is structured as a Continental takeover, could also circumvent the golden share by avoiding a vote by Continental shareholders.
But that may not suit United Chief Executive Glenn Tilton.
"He wanted to be the guy who ends up on top," said creditor lawyer Jacobson.
