American Airlines demonstrate legacy airlines can survive
AA will likely define the shape of the remaining legacy carriers
Several people have tiptoed around the board recently suggesting which legacy airlines will survive. I believe there are several key elements at play:
Profitable operation – You gotta make money, something none of the legacies have done consistently for a number of years.
Strengthened balance sheet – all of the legacies balance sheets are badly damaged and will only be repaired by massive earnings, or more likely an increase in equity (possible if a company starts making money consistently) or selling off assets.
Reasonably amicable employee relations – This is the airline industry which isn’t known for great labor relations but it is also a service business where the employees truly have the ability to make or break the company.
Competitive Product – The product bar has been considerably raised over the past few years, primarily by JetBlue. The product has to be updated and revised which in itself is an expensive proposition. Each carrier will likely take different approaches but two themes are likely to be seen at every carrier: more space and greater access to technology both for entertainment and to do business. The product has to be considered high value when compared with other carriers.
Strong worldwide network – The legacy carrier advantage is that they can carry passengers to hundreds of points around the globe; the increased costs they bear as a result of operating a hub and spoke system should be offset by the brand loyalty they are able to generate as a “one size fits all†provider of transportation.
American has demonstrated that it has what it takes to be a long-term survivor. Costs are definitely coming down, cash is increasing and will grow as further cost cuts kick in, AA has made big steps in mending employee relations, AA’s More Room Throughout Coach is the best answer so far (but clearly not the final) that a legacy carrier has made to improve and differentiate the product, and AA has the network breadth to compete worldwide and will only build on it.
AMR’s cash is more than enough to acquire assets that become available, although they are not likely to be distracted by a merger or asset acquisition any earlier than they have to. AA will expand to Asia, displacing United as having the best and most comprehensive network. AA will have the money to invest in upgrading the legacy product once it determines where it wants to go and could generate even larger sums of cash if it chose to divest of American Eagle or its significant maintenance operations. AA and AE employees will rally around their company when they see that they have reasonable job and financial security ahead of them.
So how do the other carriers stack up? Here’s what I think.
Continental – With American, clearly is capable of running as profitable of an operation as legacy airlines can now. However, CO lacks the network breadth and financial resources to shape the consolidation that will come in the industry. I’m not sure CO truly believes the current legacy airline business model is broken since they do it better than most of their peers, who very well may raise the bar well past CO. CO employees are and will be particularly cooperative in helping the company reshape its destiny once the company determines how it will change. Because it is a publicly traded company, CO’s future will be determined by the market; if it continues to separate itself from the competition, it could well set itself to be acquired by Delta or Northwest.
Delta – Although DL is viewed as the Titanic ready to happen du jour, it will very likely complete the financial restructuring needed to make itself a survivor. Delta has a long history of rising well above its place in the industry and will likely do the same through this downturn. Every stakeholder will work to ensure Delta’s survival because the cost of a Delta failure is far higher than what is being asked as part of a restructuring. I see Delta as an acquirer, particularly since Delta has significant wealth tied up in its regional carrier ownership and maintenance operations which could be unlocked to shore up the balance sheet.. Delta will be the primary beneficiary as US becomes less of a hub and spoke carrier. I believe DL could acquire either UA (or significant pieces of it) or CO. If US fails within the next six months and Delta restructures itself in the same amount of time, Delta could be shopping within a year.
Northwest – NWA has done a fabulous job of rescuing itself from near-failure and succeeding within a very difficult industry. Although NW has been very well managed financially, it does not have the network breadth to be a competitor if consolidation is initiated by one or more other carriers. NW could be acquired but will likely have the resources to be an acquirer. CO and US both would expand NW’s presence sufficiently for it to be a standalone player.
United – I know this is where people get testy but I do not see United as being able to survive long-term. Although it may be capable of becoming a profitable airline, it will undoubtedly have to cut deeply in order to emerge from bankruptcy, moves that will alienate a fragile peace that has existed at UA for the past year and will allow competitors to “pile on†even more than they have already. Longer term, UA will not have the wealth AMR and DAL have imbedded in their operations simply because the greatest asset UAL does have, its maintenance operations, may have to be spun off in order to get out of bankruptcy. If UA is able to emerge from bankruptcy, it will be in the same position CO is in today – operationally profitable but highly leveraged and incapable of controlling its own destiny. Although foreign airlines would love to have a piece, if not all, of United, I believe the US government will hold off on a widespread sell-off of the US airline industry until other US airlines are given a chance to buy what they want. Given that AA and NW significantly overlap with UA, DL is in the best position to acquire UAL if it wants to.
USAirways – Although US is doing what it needs to do to restructure its network, it has so alienated its employees that its survival is in doubt. I simply don’t think it will be possible for US to make the changes that it is apparently trying to make without the support of its employees, many of whom would rather see the company fold than survive and who have no incentive to make the company work. US’ future will probably be known within months and it will be written by its employees. It is doubtful that any other carrier will spend much to acquire US’ route system. AA is very capable of reactivating RDU and acquiring some slots and be more than capable of gaining all of the benefit it would obtain by a US acquisition. NW is more likely to acquire US to round out its network but CO is stronger in both the transatlantic and Latin markets where NW most needs to grow; NW holds a significant slot portfolio at DCA which it could reactivate to shore up its east coast position.
The following are issues which I see as applying to any consolidation in the industry.
Government approval – The US government will be much more tolerable of airline industry consolidation at this point as long as a carrier does not try to merge with a carrier that has a significant presence in the same cities or regions as the acquirer; this is much more the standard that is used in other industries. LCCs have reached the threshold where they dictate the pricing in the industry. LCC access to restricted airports has been greatly improved over the last several years.
Fleet – Some potential airline combinations may require that the surviving carriers swap equipment in order to achieve the fleet commonality needed. For instance, a combination of CO and NW makes a lot more sense if NW is able to trade CO’s Boeing equipment with Delta, for example, who likely would not want UA’s A320s.
Hubs - Only the strongest will survive; the US probably only needs 10-12 large hubs operated by 2-3 airlines to serve the needs of the hundreds of small cities that are dependent on hub and spoke systems for air transportation.
Alliances – Alliances, esp. in the domestic arena, are a low cost way to achieve some of the benefits of a merger without the integration costs. Unfortunately, alliances do not allow duplicated costs to be removed so there will be an incentive for legacy airlines to grow and acquire in order to operate the largest network possible under one corporate umbrella. I believe AA will be one of the carriers that survives and thrives.
I know this is a lengthy treatise but I cannot answer those of who have asked for my thoughts on consolidation without giving some justification for what I believe. I welcome your feedback and discussion.
