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A Failed US Air-American Merger Would Hit International

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The US government's effort to prevent US Airways and American Airlines from merging could hurt the carriers' ability to compete on increasingly tough international routes, and that would probably mean fewer options for business travel.

In an antitrust lawsuit filed last month, the Department of Justice focused on competition in the United States, arguing the USD$11 billion combination of US Airways and American's parent AMR would harm consumers by leading to higher domestic fares.

While the suit mentioned international routes that US Air, American and competitors United and Delta fly, it cited no international service on more than 1,000 routes that it said would be "presumptively illegal" if the merger went ahead.

By leaving international routes out, the lawsuit overlooked the fiercest arena of airline competition these days: long-haul international flights that are vital to airlines' financial success.

Overseas routes are the most lucrative because airlines can charge higher fares and typically carry more customers willing to pay extra for business or first class seats. United, which has the largest international route among US carriers, gets half of its revenue from international service. For American the figure is 40 percent and for US Airways 25 percent.

Not surprisingly, airlines have been adding flights and amenities in a race for market share on these routes.

Carriers in Asia, Europe and the Middle East in particular have increased flights to US cities and plan to add more. They have added lie-flat beds, spacious first-class cabins, cocktail lounges, even showers. US carriers are rushing to catch up.

Industry experts say that by preventing the merger, the Justice Department would handicap US Airways and American in that race - a move that would eventually doom them.

Business customers would lose out because instead of getting four US competitors on international flights, or three under the merger, the market for international flights would collapse to a United-Delta "duopoly." Companies often negotiate preferred fares in exchange for giving an airline most of their travel business, and would prefer a third big player, analysts say.

"A stalled merger would harm the two potential partners on their international routes by robbing them of capital to spend on cabin and service upgrades in their international markets," said David Fitzpatrick, a managing director at AlixPartners.

Fitzpatrick said he recently returned from Asia on a flight operated by a US carrier with an old and tatty plane, a sharp contrast to the flight out on Singapore Airlines.

"They needed to fix that airplane, nothing worked," Fitzpatrick said at the Reuters Aerospace and Defense Summit. "It's no fun to fly on a bankrupt airline, or one that's on the verge."

US Airways and American are still large domestic carriers and presumably would have the ability to borrow money, buy jets and compete. But they won't draw the best-paying customers.

"They're not counted out, but they're clearly not as large as Delta or United," said Kristopher Kelley, an analyst at Janus Capital.

"If you're a New York investment banker, or a pharmacy company out of New Jersey, perhaps there's no reason to use American," he said, because those aren't American hub regions.

And if the airlines have trouble earning money on domestic routes, they won't have the money to invest in the lucrative overseas routes. And "the profits that they might experience with New York to Heathrow won't fund the whole airline," Fitzpatrick said.

WEAKNESS IN PROFIT

From a distance it may appear that US Airways and American could compete as separate airlines, including internationally. The Department of Justice used the airlines' own statements about their profitability to argue that they are strong enough to compete as independent entities.

"We certainly don't need to merge with another airline," the lawsuit quotes US Airways chief executive Doug Parker as saying in mid-2012, as the airline posted record second-quarter financial results.

Both airlines have relatively strong profit margins. In the second quarter, US Airways posted an operating margin of 8.4 percent, just below Delta's 8.7 percent, which led the industry, according to Robert Herbst, a founder of AirlineFinancials, an analytic service. American's margin was 5.5 percent, better than United's figure of 5.2 percent.

And American had USD$5 billion in cash and had just ordered 460 new aircraft when it entered bankruptcy in 2011. Through bankruptcy, it cut staff costs sharply and posted record profits in August.

But those strengths overlook the size and scope of United and Delta, which also have lowered costs through bankruptcy and merged with other airlines in the last five years, giving them more time to integrate and build their routes and customers.

United and Delta also have a time advantage. If the merger is stopped, American would need to renegotiate its labor contracts, which were worked out in anticipation of a merger. Similarly, US Airways had planned to join its two pilot groups, themselves a product of a merger, in a single contract through the merger process.

Herbst said that Delta and United have become so dominant on international routes and the domestic routes that feed travelers to international travel that US Airways and American will struggle to attract business passengers who want to stay with one airline for the whole trip.

Eventually, he said, the two erstwhile partners "will have to pull out of international markets."

(Reuters)