US Airways Watched American Flounder, Then Pounced
US Airways has spent years looking for a merger partner only to be turned away and labeled the "ugly girl" amid a wave of US airline industry consolidation.
It finally saw an opportunity late in 2011, when rumours swirled that American Airlines was in trouble.
Still, US Airways was caught off guard when American's parent AMR filed for bankruptcy in November that year. US Airways executives had estimated that American had enough cash to sustain operations at least until May of 2012, according to people familiar with the situation.
Chief executive Doug Parker quickly assembled a team to devise a strategy to move on American, a much larger rival. Within about a month, Jim Millstein, a restructuring executive formerly with the US Treasury and Barclays were brought in as financial advisers, and Latham & Watkins hired as legal counsel.
Parker wanted to act fast because he felt that American would try to exit bankruptcy quickly, the sources said. But after US Airways' hostile bid for Delta Air Lines had failed in early 2007, the last thing Parker wanted was to appear overly aggressive.
In the face of AMR chief executive Tom Horton's initial resistance, the US Airways team spent several months wooing American's creditors and unions, hoping to persuade them to put pressure on management to come to the table.
In April last year, American's three largest unions voiced support for a US Airways takeover. And in May, AMR's official unsecured creditors committee convinced Horton to explore a merger as an alternative to an independent restructuring plan.
Parker "recognised who effectively would be the arbiters of this deal and he put together a campaign to bring them over to his side," said Robert Mann, an airline consultant.
A person familiar with the discussions said Parker and US Airways President Scott Kirby decided early in the process that they would only proceed if they had the support of American employees. "That was a lesson learned from Delta. If we don't have them, it won't happen. And they led the way," the person said.
On Wednesday, the boards of AMR and US Airways approved the USD$11 billion merger, and an announcement is expected early on Thursday.
A big point in Parker's favour was the fact that American has had difficult labour relations for more than a decade. The pilots union rejected a new concessionary contract last August, in part due to fears that approval would be seen as a vote of confidence in AMR management and undermine the case for US Airways.
The pilots grudgingly approved the contract a few months later, but only after AMR's influential bondholders assured the union that they would not support any restructuring plan unless American remakes its board and management team.
"There's a toxic employee situation at AMR because frankly the employees don't trust their management," said Michael Boyd, an aviation consultant whose firm has worked with Parker.
"From that perspective, you've got labour unions on both sides of this who really would like to see Doug Parker run this larger airline."
Meanwhile, the mega airline mergers in 2008 and 2010 that created today's Delta Air Lines and United, were increasingly marginalising both American and US Airways.
Wall Street analysts and investors were almost unanimous in saying that a marriage was the best shot at reversing the fortunes of the two airlines, seen as too small to compete effectively against a Delta or United, and too large to be as nimble as the smaller carriers like JetBlue.
Reflecting investor enthusiasm about the prospects of a merger, shares of US Airways have risen 57 percent since the spring of 2012, when the airline reached agreement with American's main unions to support a potential merger.
While a combination would still need approval from US regulators, both US Airways and American believe that would not be a problem since Delta-Northwest and United-Continental mergers were approved.
According to some antitrust experts, US Airways and American would likely be allowed to combine if they agreed to divest assets in some cities to preserve competition.
FIVE-WAY TALKS IN DALLAS
While the support for a deal grew among American employees and creditors, it remained a tough sell to AMR management, which wanted to emerge out of bankruptcy as an independent company and consider any deals on its own terms.
Under an agreement with creditors, American entered into merger talks with US Airways last summer, but the American executives spent several months talking up the risk of integrating different unions, while talking down the benefits of combination, people familiar with the situation said.
It took five-party discussions in Dallas to change the tide. These talks took away much of the year-end holidays for the two airlines' executives, the pilots' unions on each side, and AMR's creditors committee.
They spent the month of December trying to negotiate a joint contract that would cover both unions in the event of a merger. A tipping point came shortly after Christmas, which resulted in a memorandum of understanding on December 28.
That deal provided a clear picture for how the unions would be integrated, and was instrumental in convincing the American board in January that revenue and cost benefits from a merger would outweigh a standalone restructuring, sources said.
"Getting that done, that was really a joint effort, and a good one of US Air and AMR working together," said a person familiar with the negotiations.
"That whole process, people could see more clearly the possibilities as opposed to obstacles to not to do a deal. That might have been the catalyst moment for the AMR board," the person said.
JURY IS OUT
Now comes the hard part. The combined carrier is to be branded American Airlines, based in Fort Worth, Texas, where American is currently based, and will be part of the oneworld global airline alliance, of which American is an anchor member.
It remains to be seen whether the new American will replicate the success of Delta, which has expanded its network and upgraded its facilities to attract new customers and improve earnings since its merger with Northwest. United, on the other hand, has struggled to overcome disruptive technology changes that alienated customers.
The new company will have to meld employee groups from the two carriers, and prove that USD$1 billion in merger synergies can be achieved.
The tie-up is a reversal of fortunes for Parker, 51. As the longest-serving chief executive of a major US airline, he kick-started the industry's consolidation wave when his America West bought US Airways out of bankruptcy in 2005.
But the mega-mergers that followed and fundamentally transformed the industry had eluded him until AMR.
In 2010, Continental CEO Jeff Smisek noted that United had first courted US Airways as a merger partner but then reversed course and ended up with Continental.
"I didn't want him to marry the ugly girl," Smisek said at the time, referring to US Airways. "I wanted him to marry the pretty one, and I'm much prettier."
Smisek later sent Parker an apology, saying that he was "carried away in the moment."
Parker could yet have his revenge - by joining forces with American, US Airways would surpass both United and Delta to become the world's largest airline by revenue and passenger traffic.