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AIRLINE WEEKLY – April 16, 2012

ìSOMETHING EVEN MORE SPECIAL?î
What to expect if US Airways does merge with American

AIRLINE WEEKLY, April 16, 2012

Itís not inevitable. But a US Airways-American combination has become likely enough, and possibly imminent enough, that itís time to start wondering not just whether something will happen butómore interestinglyó what a hypothetical ìAmerican Airwaysî would look like. How well positioned would it be to compete against United and Deltaóand to compete
against and cooperate with other global giants?

First and least importantly, the merged airline would likely be called American Airlinesóthe far more famous global brandóeven if it essentially results from a hostile takeover by US Airways. Donít forget: the current US Airways management team is quite familiar with taking over a larger airline and adopting its brand. Yes, some people view US Airways as an airline thatís been frustratingly left out of recent transactions. But in fact, not only is it the airline that caused those transactions ñ Delta merged with Northwest after US Airways tried to buy Delta, and United merged with Continental after US Airways tried to merge with United. Itís also the airline that started the current round of consolidation with a merger that it did successfully execute: the one between America West (which current US Airways executives an) and the old US Airways.

A major difference between that merger and this would-be merger is that the 2005 deal saved two airlines that probably wouldnít otherwise exist today: the old US Airways was in ìChapter 22î (a slur for company thatís gone bankrupt not once but twice) and close to liquidation, while American West would have alter succumbed to the fuel spike, recession and brutal pricing environment in the western U.S. ñ the American West part of the combined airlineís network has b y all appearances been unprofitable for several years now. (An important lesson: no, bigger isnít always better. But it often is ñ not just being bigger per se, with the related economics of scale, negotiating leverage, pricing power and so forth, but also the diversified geographical exposure.)

A US Airways-American merger, on the other hand, would unite one airline (US Airways) that is already solidly albeit not spectacularly profitable with another that, after whacking its costs in bankruptcy, would almost certainly be a profitable standalone airline. US Airwaysí case for a merger would thus be not that itís necessary for survivalóitís clearly notóbut that the two airlines would be stronger together than apart.

For perspective, a combined American-US Airways would (by ASM capacity this week) be the No. 2 airline in the U.S. and in the world, just behind United and ahead of Delta. That assumes no major post-merger capacity cuts, which is a reasonable assumption based on United and Deltaóboth cut almost nothing post merger. By revenue, the combined company would be No. 3 in the world behind Lufthansa (with its ample non-airline revenue) and United, based on 2011 figures.

A merger would combine one carrier (US Airways) that has grown through consolidation over the decades and another (American) that has grown mostly organically. If they do merge, they would be doing so not because decision makers think there wouldnít be any challengesó but because they recognize there would be enormous challenges but think the benefits are worth the risks and headaches. Those challenges fall into four broad categories: technology, fleet, labor and network.

No merger is complete without some technological snafus. Just ask United, whose customers are still frustrated by lingering issues from when it integrated its reservations systems more than a month ago. A post-merger American would likewise have big decisions to make about which systems to adopt followed by big challenges associated with migrating systems and retraining people. But technological challenges are at least usually limited in duration: they rarely have a long-term broad strategic impact on an airline (with Southwestís inability to execute technologically perhaps being an exception in terms of the harm it has caused). The good news for the airline is that suppliers would fall all over themselves to be the surviving post-merger provider in every key area, whichóas in other operational areasówould mean nice negotiating leverage for American.

The fleet negotiations have already happened, and American already committedómonths before it filed for Chapter 11 protectionóto a massive 460-narrowbody order (260 from Airbus, 200 from Boeing). In this regard, the merger would be quite different from those at Delta and United, which brought together airlines with relatively light order books and thus a clean decision-making slate for a post-merger management team. But those also created merged carriers that werenít exactly a paragon of fleet harmony. In each case, as would be the case here, a primarily ìBoeing airlineî merged with a primarily ìAirbus airline.î But while fleet simplicity matters, it matters less at huge legacy airlines where each of several fleet types has enough scale to efficiently support an infrastructure of mechanics, parts, pilots, flight simulators and so on. Having five A320s and B737s would be tremendously inefficient; having 250 of each isnít such a big problem. Some people think American over-ordered, even if it got great per-unit pricesóDelta, which has an old fleet too and whose management team gets some benefit of the doubt for having turned it into the most profitable U.S. legacy airline, much more cautiously ordered not just from one manufacturer but also just one variant: 100 B737-900ERs. But even if American did get too ambitiousóa question whose answer depends partly on unknowns like future fuel-price trendsóthe order would proportionally be a lighter load for a larger merged airline.

American and US Airways also have incompatible widebody fleets and incompatible outstanding widebody orders (a mix of A330s, A350s, B777s and B787s). But again, Delta manages its consistent profitability despite being a flying museum (you can even still fly on an old Northwest DC-9) of every aircraft type imaginable. United too succeeds despite a rather messy combined United/Continental fleet.

Remember that statement about how if this happens, it wonít be because anyone thinks itíll be easy? In no area is that more true than labor integration. US Airways still hasnít integrated the pilots and flights attendants from its last merger nearly seven years ago. Combine its famously intransigent unions with Americanís, and itís easy to imagine the mother of all labor nightmares. On the other hand, though, precisely the fact that Americanís rank and file donít love its executives might make them open to outside overturesóand with three seats on the nine member creditor committee (essentially the airlineís board for now), unions will have a lot to say about what happens. Within a few months, if a judge imposes what management says is necessary, Americanís workers might find themselves working for far lower compensation. US Airways workers are likewise still working at bankruptcy-era wages, having turned down better offers from management that union leaders think arenít good enough. US Airways management makes it clear that the airline canít afford to pay what its competitors pay because its mostly second-tier network doesnít provide the revenue they get: US Airwaysí unit revenue is roughly 15% less on a stage length-adjusted basis, by its estimates, and it sustains itself by in turn paying roughly 15% less. A combination with American would vastly change the revenue picture for the better (more on that in a moment). While labor shouldnít expect a blank check, itís easy to imagine US Airways being able to offer employees from both airlines more than they would get without a merger. US Airways management is keenly aware that lack of labor buy-in was a major reason why its 2006 bid for Delta failed.

Mergers in other industries often generate a mix of cost and revenue synergies. But when airline mergers succeed, in most cases they do so far more because of revenue synergies than because of cost synergies. In fact a highly successful merger might have no net cost synergies: imagine the ìcost creepî if a combined US Airways-American ends up having to give raises to more than 100,000 employees to get them to get their buy-in for a deal. And what drives those all important revenue synergies? The combined network, along with related pricing power that results from less competition. First, start by conceding what a combined US Airways-American network would not be: a dream route map. It would not be ìcheckmate,î as former Continental CEO Gordon Bethune described a combined United-Continental network. Maybe not even ìcheck.î American likes to talk about its ìcornerstoneî cities, but almost nowhere in the world does an airline profit in a hub city where itís not the top carrieróand itís not No. 1 in New York, Chicago or Los Angeles. (It is No. 1 in Dallas and Miami, which are almost certainly its most profitable hubs.) US Airways, on the other hand, is No. 1 at all four of its hubs (in order of apparent profitability, they are Washington Reagan, Charlotte, Philadelphia and Phoenix). But it canít do much more than itís doing at any of them, either for regulatory (Reagan) or market-demand reasons. Its smallish hubs do outpunch their weight in many ways, but theyíre still smallish hubs. Finite local demand means more of a dependence on lower-yield connecting traffic than in bigger cities, which helps explain the unit-revenue disparity.

A merged network wouldnít solve all those problems, but it would at least make some of them less important. Take Chicago OíHare, the hub thatóperhaps more than any otheró American canít live with and canít live without. A quick look at any map makes its importance to Americanís system obvious: American is lucky enough to have a hub in the premier Midwestern city, perfect for east-west traffic flows across the northern U.S. while generating far more local demand than, say, Detroit. The difference is that Delta dominates Detroit, whereas American is a distant second in Chicagoóby ASM capacity, United is now nearly 40% bigger. American is thus left to pick up the corporate contracting scraps there. Ditto to varying degrees in New York and Los Angeles. Now, itís true enough that Americanís profitability everywhere will improve once new labor contracts are in placeópay rates will drop, and more flexible work rules will provide new revenue opportunities too (remember when American had to abandon plans to fly from Dallas to Beijing because its pilots said no?) But the fact wonít change that itís hard to profit in a hub where youíre not No. 1. What would change after a merger with US Airways is that those hubs where American is not the top airline will simply comprise a smaller percentage of its overall flyingódropping from 43% of its seats today touching those hubs, according to an Airline Weekly analysis using OAG MAX Online, to 28%. Every legacy airline flies some routes that donít profit in a narrow sense but are important for other reasons, such as securing lucrative corporate contracts that are overall moneymakers. But currently, American subsidizes too much of that unprofitable flying.

One lesson from recent mergersóAir France/KLM was the first to prove this on a large scaleóis that redundant post-merger hubs are not a bad thing. They are at worst slightly positive (because the combined airline at least controls capacity and pricing at both hubs) and at best highly positive, because capacity can be optimized among hubs. Sure, Newark and Washington Dulles handle a lot of the same international traffic flows for United, but thatís fine: now the two hubs cooperate rather than compete, plus United can tactically shift some capacity, as it did when it recently moved its Buenos Aires flights from Dulles to Newark. Similarly, the proximity of Philadelphia to Washington and New York can only be either a somewhat good thing or a very good thing. American and US Airways together with Americanís joint venture partners would control the largest share of transatlantic capacity from northeastern seaboard airports (starting at Washington Dulles and going north), a title currently held by United and its partners. Given Americanís key position in one world compared to US Airwaysí place on Starís periphery, a merged airline would almost certainly remain in one world and within Americanís existing joint ventures across the Atlantic and Pacific and to Australia. Those too could enable some interesting flying: Philadelphiaóor maybe even Charlotteómight be able to support flights to Tokyo, for example, but US Airways doesnít have aircraft with the range for that. A350s would change that a few years from now, but Americanís B777sóor Japan Airlinesí B787s, for that matterócould change it a lot sooner.

Again, Americanís network still wouldnít match Unitedís for revenue generation. But thatís okay: Deltaís doesnít either, but it matches Unitedís profitability by having lower costs. Of course, all this would still need to pass regulatory muster. Thereís no guarantee antitrust officials would look kindly upon the creation of yet another giant airline. But not much logic would support saying no, considering this airline wouldnít even be as big as the merged United that they allowed not long ago. And it wouldnít monopolize any sphere in the way that a merged Delta/US Airways could have used Atlanta and Charlotte to dominate many southeastern U.S. traffic flows. Regulators might require certain divestitures: considering they werenít thrilled about letting US Airwaysí seat share at capacity-constrained Washington Reagan rise to (soon) 44% after its slot swap with Delta, itís hard to imagine they would let the combined airline control 57% of the airport after adding Americanís slots.\

But thatís an exception. Generally, the merged airline would be incrementally more powerful, and the industry as a whole would againóas after other recent mergersólikely become incrementally less competitive and incrementally more profitable. No, regulators arenít likely to say no. But of all the other stakeholders who do hold the cards, just one groupóUS Airways managementóis clearly in favor of a deal for now. They would have to convince not just their shareholders (probably not a tough sell) but also, more ominously, labor groups at both airlines. Americanís creditors and perhaps management. The pitch: that while a standalone American might be okay, a bulked-up airline could really beóas American used to sayósomething special in the air.

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M-F: 9:00AM - 5:00PM (CT)
Phone: (817) 540-0108

Call APFA

Contract & Scheduling Desk
M-F: 7:00AM - 7:00PM (CT)
Phone: (817) 540-0108

Chat APFA

After-Hours Live Chat
M-F: 3:00PM - 11:00 PM (CT)
Sat-Sun: 9:00AM - 5:00PM (CT)

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APFA Headquarters
1004 West Euless Boulevard
Euless, Texas 76040

M-F: 9:00AM - 5:00PM (CT)
Phone: (817) 540-0108

Call APFA

Contract & Scheduling Desk
M-F: 7:00AM - 7:00PM (CT)
Phone: (817) 540-0108

Chat APFA

After-Hours Live Chat
M-F: 3:00PM - 11:00 PM (CT)
Sat-Sun: 9:00AM - 5:00PM (CT)

APFA Events

Currently, no scheduled events...

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