The case for an American-US Air merger

http://www.dallasnews.com/business/columnists/mitchell-schnurman/20121217-mitchell-schnurman-the-case-for-an-american-us-air-merger.ece
Mitchell Schnurman: The case for an American-US Air merger
The Dallas Morning News 12.17.12

It’s early to celebrate a new year and a new era at American Airlines, but put a merger with US Airways atop the wish list. There may be no better gift for North Texas.

Thorny issues remain — setting a value for each airline, getting pilots to agree on seniority, deciding which management team will run things. Don’t let them be a buzz kill.

While they’re real threats, the upside of an American-US Air combination is too good to pass up, and doing it in bankruptcy brings more benefits. In revenue, network, leadership, labor and corporate culture, this is a chance to transform American, not just put a new paint job on the fleet.

Instead of harping on everything that could go wrong — here’s looking at you, Tom Horton — it’s almost time to focus on making a merger that works. Here are my top reasons for combining American and US Air, and sooner, rather than later.

Competing with the big dogs. American badly trails United and Delta in revenue, network reach and profit, in part because they expanded through mergers. Larger networks attract higher-paying corporate accounts and strengthen global alliances, which feed even more lucrative business. American needs a bigger take of that virtuous circle.

Adding US Air won’t solve American deficits in New York or the Pacific. But it would boost traffic on the East Coast, complement American’s hub in Miami and generate combined revenue on par with the Big Two.

American ranked No. 4 in domestic market share in the East, Midwest and West, wrote analyst Michael Linenberg of Deutsche Bank. With US Air, it would be No. 1 in two regions and third in the other. That’s critical, he said, to holding on to corporate business. The Oneworld alliance, another key piece, would get a big lift on valuable traffic from the East Coast to Europe.

Delta recently agreed to buy almost half of Virgin Atlantic, bolstering routes to London and reminding all that the leaders aren’t standing still. American would have to increase revenue by roughly 50 percent to catch up to United and Delta. That’s never going to happen as a stand-alone.

Seize the moment. Horton, American’s CEO, told pilots last week that the airline could emerge from Chapter 11 and then explore a merger. In theory, American could get a better price and maybe a partner like JetBlue.

But it’s also possible that American would analyze forever and end up with nothing. That was the story for the past decade, as rivals continually outmaneuvered American’s management team, including Horton. Outside events could also intervene, from terrorism to oil shocks. Right here, right now, American has the chance to make a move with the last big dance partner.

Maybe Horton is just playing hard to get. His job is to land the best deal for all stakeholders, including creditors seeking maximum recovery. Building a stronger stand-alone, as he’s done in the past year, gives American more options and more leverage.

An oft-heard complaint is that US Air needs a merger more than American. That shouldn’t disqualify the idea. Analysts believe US Air will get about 30 percent of the combination, despite generating a slightly higher share of revenue and cash flow. American’s dominance will be rewarded, but if the price is too high, the bid could turn hostile, and no one may win.

A leadership transfusion. A merger with US Air offers two for one: a new management team to go along with a bigger network. American needs both.

Bad blood between labor and management goes back for decades. While it didn’t start with Horton, he didn’t end it, either. American’s top-down, button-down culture needs a reset and transfusion. Union leaders have demanded a change at the top, and about 7,500 American pilots signed a petition declaring no confidence in management.

Horton supporters say this is simply an emotional response to tough times. Fact is, that’s reason enough to make a move. Here’s another: US Air’s Doug Parker and his team look like an upgrade, not just a dose of fresh air.

They championed the merger early on, while Horton was reluctant, at best. They won over American labor leaders in six weeks, after American had failed in six years of contract negotiations. They’ve shown an “ability to turn an unprofitable US Airways into an airline whose margins often lead the industry,” analyst Bob McAdoo of Imperial Capital wrote last week.

And they’ve done this before. In combining America West and US Air, Parker’s team found more ways to cut costs and increase revenue than others. Synergies totaled 7 percent of revenue, more than mergers involving United, Delta and Southwest, Linenberg said.

Don’t waste a crisis. Merging in Chapter 11 adds complexity and risk, but there’s a payoff. The fleet can be tailored to the combined network, rather than to two airlines, and more facilities and airport leases can be cut. That’s easier and cheaper inside bankruptcy.

The tough nut is labor. Unions have leverage, because mergers can’t proceed without them, so they can delay and raise the costs. In this case, unions have a motive to proceed in earnest. At American, they want the growth upside and Parker’s leadership. At US Air, where workers have long been underpaid, unions want new contracts with big pay bumps.

Pilots could drive merger momentum. Union leaders from both airlines are trying to hammer out the integration of work groups. This is tricky, because it can dictate which pilots fly the most lucrative routes. US Air and America West pilots have been fighting over seniority for most of the past decade, and it was a sore point for American and TWA in the early 2000s.

Horton and his team have repeatedly warned about this problem. Pay too much for labor peace, and the merger disappoints. Fail to get a deal, and unhappy workers can hurt the operation.

If the pilots can’t settle on a framework, they’ll validate Horton’s concerns. Make a deal, and another major obstacle fades away.