BARRON'S EDITORIAL COMMENTARY
Shrinking the Skies There are too many domestic airlines,
but a merger is not the answer
By THOMAS G. DONLAN
EVERY AMERICAN DID NOT TRAVEL by air last week -- it just
seemed that way. Flights were full, ground services,
including the Transportation Security Administration, were
overwhelmed. Passengers may be forgiven for wondering how
the U.S. aviation industry can make so little money
providing a service that everyone wants.
Two of the biggest air carriers, Delta Air Lines and
Northwest Airlines, are in bankruptcy. Some of the others,
including United Airlines and US Airways, have recently
emerged, or like American Airlines, barely avoided that fate
with a reorganization that mirrored what would have been
done in bankruptcy court.
Every major airline except American and Southwest has been
there at least once in the past 20 years, not to mention all
the once-famous and never-famous names that no longer exist.
Domestic airline investors have been hammered repeatedly,
although speculators have had chances to do very well.
Anyone with a suspicion that American Airlines' parent
corporation AMR would avoid bankruptcy at its moment of
crisis in 2004 could have ridden a one-dollar stock all the
way to a recent level around 30.
Don't call that easy money -- it would have taken real
courage to make the bet, especially to leverage the bet. But
fortunes have been made as well as lost on airline stocks,
even though the industry has made no net profit since the
Wright Brothers.
Cheap at Twice the Price?
As Andrew Bary outlined in Barron's Oct. 2 cover story, most
airline stocks are still cheap. The exceptions are those in
bankruptcy, where the bondholders will get new stock and the
old stockholders are likely to get nothing.
The solvent carriers mostly sell for less than 10 times
projected 2007 earnings. That would be a warranted multiple
if jet-fuel prices hold steady and the economy tumbles. Any
improvement in fuel prices would be a positive and mere
avoidance of disaster should push airlines further into
friendly skies.
But friendly skies for airlines are full of clouds for
passengers. The past few years of financial woes have
constrained growth, and that's been the real source of
domestic aviation's recent return to modest prosperity.
Even in October, not a wildly popular month for air travel,
the 11 carriers with independent national route systems
filled more than 70% of their available seats. For the third
quarter, indeed for the year through September, most of them
filled more than 80% of their seats. Official results aren't
in, but we suspect Thanksgiving-week travelers rarely saw an
empty seat.
We may be at a turning point in the domestic aviation
market. Unprofitable airlines keep flying the equipment they
have, and even ground those that cost a lot to fly. Capacity
shrinks, middle seats fill up. Competition among 11 carriers
keeps prices in check. There's nothing left to give, except
comfort.
U.S. airlines have only 140 airplanes scheduled for delivery
next year, and most will replace aircraft in the domestic
fleet, which numbers 5,000.
That will change in a couple of years. Profitable airlines
purchase new aircraft, almost by reflex. If past results are
indicative of future returns, U.S. airlines will order
hundreds of planes while they are prospering, and receive
them during the next economic downturn. Then the cycle will
begin again.
On the Wings of a Deal
"Those who cannot learn from the past are condemned to
repeat it." US Airways provided a sign of that earlier this
month, when it offered to buy Delta Air Lines out of
bankruptcy for nearly $9 billion, half cash and half stock.
Set aside the question of where a recently bankrupt airline
-- US Airways -- plans to get more than $4 billion in cash:
Borrow it, of course, in an era when lenders believe there
is no such thing as a risky loan, because all risk can be
traded away with derivatives. Just ask why US Airways would
want Delta, a currently bankrupt airline that failed the
last time it tried to fly its way to prosperity.
One answer is that Delta flies about 25% international
routes. Long hauls and international routes are more
profitable than U.S. domestic routes. Another answer is that
the U.S. doesn't need 11 carriers and reducing competition
would be an act of statesmanship, possibly a profitable act.
A third answer is that every airline manager wants to run
the world's biggest airline. A merger would put the new
airline ahead of American and United. The fourth answer is
the official US Airways claim that the combined airlines
would have "synergy" worth $1.65 billion.
But history suggests that use of the word "synergy" is a
tip-off to future disaster, and that airline mergers, in
particular, rarely work well. Union contracts don't shuffle
together easily; operations vary widely from airline to
airline, even if passengers don't perceive much difference
in the cabin.
US Airways recently merged with America West, so recently
that only about half the America West planes have been
repainted in US Airways colors. Other pending issues are
more difficult: Pilots are picketing, though not striking
yet, over contract adjustments and seniority rights in the
to-be-unified workforce.
Flight attendants and mechanics have similar concerns. They
also know that if merged airlines achieve the efficiencies
they claim to expect, no worker's job will be safe. And that
goes double in a merger with Delta, since Delta's workforce
is non-union, except for the pilots.
A merger would add to operating problems that US Airways and
Delta already have. Juan O'Callahan, an independent
consultant with 45 years in the aviation industry, notes
that the combined fleet would be dauntingly complex.
(O'Callahan has served on the boards of five U.S. aviation
companies, including America West. He was chairman of the
executive committee during the first year of America West's
bankruptcy.)
At the end of 2005, America West had a fleet of 145 aircraft
of five types, using four engine models. The pre-merger US
Airways had 268 aircraft of nine types and six engine
models. Each aircraft type and each engine type has to be
flown and maintained "by the book," and each book is
different. Scheduling qualified crews is more difficult than
it would be at an airline (Southwest is the only example)
with just one aircraft type and one engine manufacturer.
Even when the planes are the same, they may be different. US
Airways' Airbus 319 and 320s have different manufacturers'
engines depending on whether they were delivered to the old
US Airways or the old America West. The new US Airways flies
10 airplane types, only two of which are compatible with
Delta's 13 types.
Pilot Error
It's not impossible to manage such a mish-mash, it's just
difficult and costly. Call it a dis-synergy, or a dysergy.
Or adopt the language of airline-safety investigators and
call it "controlled flight into terrain."
O'Callahan's warning:
"A premature US Airways-Delta merger would result in a 900-
airplane fleet with 20 different aircraft/engine types,
creating a potential economic nightmare for pilot crew
scheduling and training and a vast new department to deal
with various maintenance bases, technical personnel,
overhauls and outsourcing contracts.
The extra crew and related costs associated with a 20-type,
mixed-bag fleet of 900 aircraft (and different training,
scheduling and seniority regimens) could amount to over $500
million a year."
It would be an act of statesmanship to do something to
reduce the number of U.S. domestic airlines to the point
where the survivors can be reliably profitable if run well.
For example, a bankruptcy judge with imagination might order
Delta liquidated by a trustee, rather than resurrected by
management and banks.
But cramming incompatible airlines together isn't
statesmanship; it's foolishness
Though JO appreciated being a the pawn of this diabolical rumot.