United/US Airways Merger Faces Headwinds

April 8, 2010

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Efforts to merge United Airlines and US Airways could run into strong headwinds from unhappy pilots and tougher antitrust enforcement.

The possibility of a deal to create the world's second biggest airline sent airline shares higher, although neither US Airways nor United would confirm discussions that sources said were advancing.

Sources with knowledge of the situation said the negotiations began more than a month ago, although much of the groundwork was laid in 2008 when the two held similar talks.

The sources said the parties are currently focused on general themes, and issues such as deal structure and management will be discussed in coming weeks.

The parties were said to be mindful of hurdles to a successful merger, including competition concerns and serious labour questions at both carriers involving pilots.

"Everybody is aware of the problems," said one source.

United's pilots said they were vehemently opposed to a merger, while US Airways' pilots said they were open to a merger and wanted to be part of the discussions.

Goldman Sachs and JPMorgan Chase are advising United, several people familiar with the matter said. Citigroup is advising US Airways, the sources said.

All three banks declined to comment.

Aviation experts generally agree that consolidation would help the airline industry, and a merger with US Airways would help United. But some said a deal with Continental Airlines would be better for United.

United and Continental held merger talks in 2008 and later opted for an alliance, which has been successful.

Airlines are recovering from a painful downturn that forced massive downsizing in the last two years. A merger could accelerate fleet reductions, helping improve balance sheets.

Philip Baggaley of rating agency Standard && Poor's said a merger with US Airways would improve United's route network but could lead to higher labour costs. The combined company would probably emerge with heavy debt, he said.

UAL shares closed up 6.8 percent at USD$20.23 on Nasdaq. US Airways shares gained 10.7 percent to finish at USD$7.55 on the New York Stock Exchange.


"Clearly these potential talks are a massive positive for US Airways and United, but I think it speaks volumes to the changing landscape in the airline industry," said Morningstar Equity analyst Basili Alukos.

He said a potential major airline merger, combined with the capacity cuts of 2008 and 2009 hint that the industry "could be en route to earning its cost of capital."

"History is not on the side of the airlines, but maybe the horrible losses encountered recently have scared newcomers enough to reconsider starting an airline," Alukos said.

US Airways and UAL have courted for a decade -- interrupted only by their turns in bankruptcy between 2002 and 2005. A proposed merger, when both carriers were much bigger, crumbled in 2001 over fears the deal would crimp competition.

Talks revived in 2008 but fizzled amid recession.

The chief executives at both companies, Doug Parker at US Airways and Glenn Tilton at United, were, and continue to be, vocal proponents of further consolidation in an industry that has long suffered from competitive pressures and overcapacity.

The last merger of two major US airlines was between Delta Air Lines and Northwest Airlines, which concluded in 2008 and analysts consider successful.


Alukos and other experts said the biggest challenge would be integrating unionised employees.

US Airways, formed in 2005 from a merger with America West Airlines, still has two pilot unions.

Airline labour groups - especially pilots - are notoriously hard to merge because pay and work rules are closely tied to seniority. A pilot could easily lose seniority in a merger and end up flying less desirable routes and planes.

James Ray, spokesman for the US Airline Pilots Association (USAPA), which represents pilots at US Airways said the union is open to a merger, but wants to be part of the discussions.

"Our union president has talked to (US Airways CEO) Doug Parker and said we are open-minded and look forward to being an active partner with US airways should they pursue a merger with anyone," Ray said.

The Air Line Pilots Association (ALPA), which represents pilots at United, said it was vehemently opposed to a merger with US Airways, that would not benefit either the airline nor its pilots.

""United CEO Glenn Tilton is well aware of our position regarding mergers and US Airways," said a statement by union official Captain Wendy Morse.

Bill Swelbar, an airline researcher at MIT, said union troubles could be a fatal impediment.

"It is my opinion that the labour issues will significantly undermine the synergies. I'm just not convinced there is an attraction. There is nothing about this that has me going 'this just seems like a great deal'," Swelbar said.

Delta and Northwest worked out their labour issues before announcing their deal.


Prospects of a US Airways-United marriage have for years raised questions about market concentration in the eastern portion of the United States, particularly at airports in the Washington DC area.

Any proposal would have to satisfy Justice Department antitrust officials under the Obama administration. They have already recommended steep concessions from carriers seeking waivers from antitrust law to strengthen their alliances.

The Delta-Northwest merger was approved by the Bush administration, which was considered more business friendly.

"Now you've got a more aggressive enforcement regime. It seems to me the antitrust hurdles are no lower than they were in 2001 and maybe higher," said John Briggs, an antitrust expert with Axinn Veltrop Harkrider.

US Airways is trying to beef up its already strong presence at Washington Reagan airport and held 11 percent of the regional Washington market overall in 2009. United is big at Dulles airport in Virginia and commanded 22 percent of Washington air travel last year, according to Transportation Department data.

US Airways biggest hub is Charlotte, North Carolina, followed by Phoenix and Philadelphia. United spreads out the rest of its operations at Chicago, Denver, San Francisco and Los Angeles.

"There are still some significant overlaps between United and US Airways, and I think the government would take a close look at that. I'm not necessarily saying to block it, but to decide what may need to be taken away in certain markets," said Edward Faberman, an aviation attorney with Wiley Rein.