ANALYSIS: DOJ challenge of US-AMR merger shocks industry

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The US Department of Justice (DOJ) has challenged the proposed merger of American Airlines and US Airways on antitrust grounds in court, in a move that took many airline industry followers by surprise.

"We did not expect this," says Jamie Baker, an airline analyst at JP Morgan who covers the US industry, in a research note today. A sentiment echoed by many of his peers.

The DOJ and district attorneys from Arizona, Florida, Pennsylvania, Tennessee, Texas, Virginia and Washington DC filed the 56-page lawsuit challenging the merger with the US District Court for the District of Columbia today.

While the suit alleges the usual decreased competition, fare increases and negative impact to consumers that are common in such challenges, it goes further to cite industry trends towards fare and fee increases, and capacity discipline that would be compounded by an American-US Airways combination.

Bill Baer, assistant attorney general in charge of the DOJ's antitrust division, says that the US mainline carriers participate in "tacit coordination" where they do not talk directly but watch each other closely and match fare and fee increases, during a media call today. He adds that the American-US Airways merger would significantly increase the industry's ability to function as a de facto oligopoly.

"As we look at the markets today, it's not functioning as competitively as it ought to be," he says.

One example cited in the lawsuit is an alleged desire by US Airways to charge fees on checked bags across the Atlantic. Alone the carrier is viewed as too small to be a "price leader", prompting others to add the bag fees too, but combined with American it would have "sufficient size to lead industry fee and price increases across the board".

In addition, comments by executives at both carriers regarding the viability of each carrier on a standalone basis appear to have come back and bitten them. The agency cited American's long adherence to a standalone bankruptcy reorganisation plan, which involved significant expansion both domestically and internationally, prior to the merger announcement and comments by US Airways chief executive Doug Parker that US Airways did not "need" American in order to survive or continue to report profits in its suit to block the merger.

"We have no problems with airlines being profitable," says Baer. "What drives this challenge is the reduction in competition."

NEW MOVES?

The DOJ appears to be treading new ground in terms of its review of airline mergers with the American-US Airways deal. Previous reviews have focused on nonstop market overlaps and concentrations at individual airports, while here the agency appears focused more on larger industry capacity and pricing trends.

Baker says that the addition of "connecting markets and baggage fees into its calculus" is a "significant" departure from its typical analysis of airliner mergers, in his research note.

"It's so bogus," says Michael Boyd, chairman of aviation consulting firm Boyd Group International, on the merits of the DOJ's challenge. Many of the issues cited by the agency, including fare matching and capacity discipline, are a result of changing industry economics as a result of high fuel prices and the removal of inefficient 50-seat regional jets - not industry consolidation, he says.

The agency's focus on blocking the merger without the possibility for concessions is also unusual. Concerns regarding concentration at Newark Liberty International from the merger of United Airlines and Continental Airlines resulted in the carriers' agreeing to divest 18 slot pairs at the airport to Southwest Airlines in exchange for antitrust approval of their deal in 2010.

"We think the right solution here is a full-stop injunction," says Baer, adding that the DOJ is still willing to hear proposals from the carriers.

This position came as a surprise. "[They] had an air of finality to them that wasn't constructive in my view," says Robert Mann, a New York-based airline industry analyst with RW Mann & Company.

He says that the DOJ laid the foundation for the American-US Airways deal by allowing both the United-Continental and the Delta Air Lines-Northwest Airlines mergers to move forward.

"You have two horses out of the barn, you can close the door on the third one if you want but that's not going to solve the issue for the consumer," says Mann.

FIGHTING CHANCE

American and US Airways plan to fight the challenge raised by the DOJ. The suit is expected to add months - not to mention additional cost - to the timeline of their proposed merger, which they had hoped to close by the end of September.

"We will fight them," says Doug Parker, chairman and chief executive of US Airways and future chief executive of the combined carrier, in a letter to employees today. "We are confident that by combining American and US Airways we are enhancing competition, providing better service to our customers and improving the industry as a whole."

The airlines cite the facts that combined they will connect more destinations worldwide than either can alone, provide long-term opportunities to employees and create increased choice and enhanced travel products to customers in many markets.

To block the deal, the DOJ must prove its analysis of the merger to the court in order to win an injunction. The judge will have to weigh this against American and US Airways' own analysis for why the deal should go through.

"In recent years, the agencies have developed a fair amount of experience litigating merger challenges successfully, so expect that they would put their case on effectively though we have only heard DOJ's side of the story at this point," says David Meyer, a partner in Morrison and Foerster's antitrust group who previously worked in the DOJ's antitrust division.

While the burden of proof may lie on American and US Airways in such a case, bets are not off yet.

"I think the chance of the merger going through is more than 50%," says Savanthi Syth, an airline analyst with Raymond James who covers US Airways. "[But] it's not a slam dunk anymore. I think they can challenge this."

The merger agreement expires on 14 October but can be extended by either carrier to 13 December. It can be extended further at the consent of both airlines.

Additional reporting by Jon Hemmerdinger.