Analysis: Three Regionals at Risk in Merger Talks

Pinnacle, SkyWest and Comair may be at grave risk in any Delta/Northwest or Delta/United merger. Should the Northwest merger take place the likelihood that Cincinnati and Memphis will be “de-hubbed” is very strong. Salt Lake City could also fall victim. Indeed, some suggest that since Comair is...

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Pinnacle, SkyWest and Comair may be at grave risk in any Delta/Northwest or Delta/United merger. Should the Northwest merger take place the likelihood that Cincinnati and Memphis will be “de-hubbed” is very strong. Salt Lake City could also fall victim. Indeed, some suggest that since Comair is wholly owned by Delta and has mostly 50-seaters, it could just go away.
Delta hopes to reach an agreement to merge with either Northwest or United within the next two weeks but industry insiders suggest that the United angle is a smokescreen to make a combination with Northwest look better. The Memphis Commercial Appeal reported that it a DL/NW combination could be a done deal given the fact that Northwest hired a merger consultant before it emerged from bankruptcy last May. The newspaper said that insiders believe that major issues have already been resolved.
A merger hasn’t even been announced yet and Representative Steve Cohen, D-Tenn., wants the House Transportation and Judiciary committees to convene a joint hearing and has already made a formal request in letters to Transportation Committee Chairman James Oberstar, D-Minn., and Judiciary Committee Chairman John Conyers, D-Mich, who represent districts including Northwest’s two largest hubs. Cohen rounds out the triumvirate by representing the district with its third largest domestic hub.
"Northwest has 66 percent of the business at Minneapolis, 60 percent at Detroit, and half of all flights at Memphis," Cohen wrote. "Such a merger would lead to the loss of countless jobs at these locations. Also, Delta's Cincinnati and Atlanta hubs would overlap with Northwest's in Detroit and Memphis, leading to the likely closure of the smaller of the two hubs."
While the loss of such a major carrier would be devastating to Memphis, any de-hubbed city is likely to attract the attention of low-fare carriers as happened at Pittsburgh when US Airways de-hubbed it after the American West merger, leading to lower fares in the market. Southwest went into PIT after LCC left. However, that is unlikely to make up for the loss of a major carrier. Analysts reported that over 60 percent of passengers at Memphis connect which could just as easily be done over Atlanta.
Delta’s board gave CEO Richard Anderson the green light to pursue industry consolidation on January 12. A proposed merger will be presented to the board at its next meeting in early February with an announcement coming shortly thereafter. Despite industry predictions that airline profits will continue, the newspaper suggested most airlines will post losses for the fourth quarter. AMR and Continental have already announced year-end profitability. Related Story
Anderson, who previously headed Northwest, knows it as an insider, possibly making it easier to approach unions. OAGAviation Analyst Tulinda Larsen suggested that a DL/NW merger would pair down SkyTeam – Air France/KLM and DL/NW – to one on either side of the Atlantic. Indeed, insiders suggested that a DL/NW deal began with the merger of Air France and KLM in 2004 since the two European airlines had both Delta and Northwest as code-sharing partners. A combination would allow SkyTeam to control more parts of the world. In addition, it won’t be long before U.S. carriers will be able to fly anywhere across the Atlantic, given the European Union’s Open Skies, and a DL/NW deal could put them ahead of the pack, especially for high-end traffic.
Although, hearings have been sought, Larsen said the combination would be much easier to sell on the hill, at Justice and Transportation as they are ranked three and five in the industry. There is also less route overlap domestically, offering a relatively simpler route to capacity reduction by simply parking or parting out Northwest’s DC-9s.
A Delta/United deal would give the combined carrier 29 percent market share, according to the Atlanta Journal Constitution, while Delta/Northwest would be 23 percent, again making the merger easier to play in Washington. Combined revenue for DL/UA would be $37.7 billion vs $29.9 billion for DL/NW. The Wall Street Journal reported that Delta is valued at $4.1 billion to United’s $3.8 billion and Northwest’s $3.7 billion.
Delta is strong in the trans-Atlantic, East Coast and Southeastern markets and both United and Northwest are strong in Asia and the Midwest. United also brings its strong West Coast market to the mix. Both United and Northwest are more heavily unionized than Delta. The DL/United fleet match better than DL/NW. Either deal means the Delta would surpass AMR as the largest airline in the world.

Will Merger Help?
While merger talks sparked a lot of excitement, there are some analysts who doubt it will bring the desired goals. Indeed, studies indicated that more than half of mergers in other industries failed to create value.
Even so, Northwest CEO Doug Steenland told employees that doing nothing would be a disaster but skeptics indicate the pain of a merger outweighs the cost cutting aspects. The Wall Street Journal pointed out that any reduction in service will lead to higher fares which would have a positive impact on all carriers – not just the merged pair. It also noted that planes are already flying full, leaving little room for consolidation.
Some analysts pointed out that much of the benefits from a merger could be done without a combination. Carriers are already paring domestic capacity with little or not growth expected this year. They are already raising fares although any ability gained from a merger to do more may run head long into a softening economy. Finally, carriers could park aircraft as they have often done in the past. Clearly more rationalization remains to be done without mergers, which would be a much more difficult way to achieve rationalization.
They also pointed out that higher wages are needed to win union approval and any route consolidation would yield more congestion and delays, especially if the loss of Memphis leaves only one Southern hub. Then there is the general pain of trying to merge two companies, something still going on at the combined US Airways/America West.
Finally, any improved profitability short-term would be lost, especially if one merger cascades into many. Indeed, a Continental/United combination could result if Delta taps Northwest, eliminating any advantage to larger market share.
The bottom line, say analysts, is the only winners will be the investment bankers and lawyers, thus the reason for the long-term pressure Wall Street has been putting on the airline industry to consolidate and/or to provide an increased value for them.
Observations of the industry over the last two years, reveals that, despite all the rhetoric that airlines plan for long-term profitability, they seem to jump when Wall Street says to jump. Once Wall Street suggested that growing cash coffers at regionals be used to increase value for investors, many regionals quickly developed stock buy-back programs. Wall Street began pushing for consolidation last year – in fact earlier than the ill-fated US Airways/DL proposal in 2006 – and lo and behold the industry is approaching merger mania.
To be sure, the industry remains fragmented with competition preventing true rationalization, making mergers seem the answer, but one has to wonder who is wagging the dog and what will really be accomplished.