Delta/Northwest: the birth of a world super carrier

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Delta Air Lines and Northwest Airlines will go ahead with their planned merger - which, if approved, will create the world's second-largest carrier after Air France-KLM in terms of revenue and the world's largest in terms of global traffic - despite the admittedly high barriers, which range from labour to their very different fleets. A combined Delta/Northwest would bring in annual revenues of $31.7 billion, almost a third higher than that of what would be the world's third largest carrier by revenue, American Airlines (see table).

Under serious consideration since December 2007, the merger of Delta and Northwest - both of which exited Chapter 11 bankruptcy protection last year - will produce a combined cash balance of $7 billion upon consummation, the best cost structure and debt-to income ratio in the industry, and access to financial markets, says Richard Anderson, the Delta chief executive who would lead the combined entity.

The two hopefuls hastened their way towards the altar despite the fact that a key player - the Northwest pilot group - is not on board, even though the two carriers promised no hub closures and no involuntary furloughs of front-line workers. Delta and Northwest have attempted to reassure investors and others that the combination was not a short-term response to rising fuel costs. As Anderson puts it: "The strategic basis is a sound strategy, whether fuel is at $60 or $100. Fuel wasn't forcing our hand, but surely it was an important factor."

World top 10 airlines by revenue  
Revenue ($bn)
Air France-KLM Group 32.8
Delta and Northwest 31.7
AMR Corporation 22.9
British Airways 20.4
United Airlines 20.1
Lufthansa Group 19.4
Japan Airlines Corp 17.1
Continental Airlines 14.2
ANA Group 13.3
US Airways Group 11.7
Source: ATI
The combined carrier will have two different fleets, but this, says Anderson, "is a bit of a misnomer. With the exception of the [Boeing] 757-200, we have different fleets, but it works quite well. For instance, the [Northwest] Airbus A319 out of [Delta hub] Cincinnati westbound is a perfect example." Delta president Ed Bastian adds: "The Northwest 747 at New York JFK allows for 'gauge plays'." Doug Steenland, the Northwest chief executive who will have a seat on the board but step aside from day-to-day management, says that will "put us back into the non-stop JFK-Tokyo market."

Air France-KLM, which had previously offered to inject $750 million into a merged Delta/Northwest to facilitate the merger of its SkyTeam partners, has since decided that "the principles governing the merger no longer require additional funding through an exclusive capital increase from Air France-KLM". The Franco-Dutch carrier says it is "confident we can quickly build a global partnership between Delta, Northwest, KLM and Northwest in the form of a joint venture offering a network with extremely attractive multiple hubs".

USA-world marketshare   

   USA-world  ASK
 1  Delta and Northwest 14.0%
 2  American Airlines 9.9%
 3  United Airlines 9.4%
 4  Continental Airlines 7.8%
 5  British Airways 5.1%
 6  Lufthansa 4.7%
 7  US Airways 2.9%
 8  Air France 2.9%
 9  Virgin Atlantic 2.7%
 10  Korean Air Lines 2.6%
   Other 38.0%
 SOURCE: Innovata   
Bastian says it is "not the right time to raise more capital", adding that the combined carrier will be profitable in 2009. But ABN Amro analyst Andrew Lobbenberg believes the decision for Air France-KLM not to invest has more to do with political reasons than financial ones, and says in a research note: "In our view it is unusual for airlines to turn down the offer of cash. We think the Delta-Northwest transaction is controversial in the US and as such it will need as much political support as necessary. Having a major French industrial partner on board would not have increased the political appeal of this deal."

Anderson is keen to point out the benefits that the transatlantic joint venture between the four SkyTeam carriers will bring. "This really is the first time that we have a carrier in the US that has a complete route network. When you think about what deregulation did, this is really the culmination of that," he says. "All four together [Air France plus Delta, KLM plus Northwest] have 27% of the transatlantic market. All 6,000 city pairs won antitrust immunity [in early April], and that is really good." Of the 1,000 city pairs in the combined networks of Delta and Northwest, only 12 have any overlap, and "there is virtually no overlap on overseas routes," says Steenland.

World traffic top 10 by RPK

     RPK (bn)
1  Delta and Northwest  284
2  American Airlines  223
3  Air France-KLM Group  206
4  United Airlines  189
5  Continental Airlines  136
6  Lufthansa  118
7  Southwest Airlines  116
8  British Airways  113
9  Qantas  101
10  Japan Airlines 87 
SOURCE: ATI
But the plan faces obstacles from the US Congress, from investors and from other airlines. Jim Oberstar, the Minnesota Democrat who chairs the US House Transportation Committee, has called the proposed merger "probably the worst development in aviation history in the aftermath of deregulation in 1978. If this merger goes forward, other carriers will follow".

And JP Morgan's Jamie Baker points out that fuel prices are likely to outpace any revenue generation from the merger. "Unfortunately, by the time Delta and Northwest consummate their marriage - if at all - and potentially revisit their aversion to hub closures, industry losses are expected to have escalated and value destruction is likely to have continued unabated," he says.

USA-domestic marketshare

  ASK
1  Delta and Northwest 19.9%
2  American Airlines 16.1%
3  Southwest 14.6%
4  United Airlines 12.4%
5  US Airways 10.0%
6  Continental 9.2%
7  JetBlue 4.0%
8  AirTran Airways 3.5%
9  Alaska Airlines 3.4%
10  Frontier 1.8%
   Others 5.1%
SOURCE: Innovata
Northwest's decision to merge with Delta meant that its "golden share" in Continental - which gave Northwest the right of first refusal on any potential sale of Continental - could be redeemed by the Houston-based carrier, clearing the way for other responsive mergers in the US airline industry. Continental chief executive Larry Kellner said the carrier will reconsider its often-repeated belief that it should stand alone "to make sure we remain a strong long-term competitor". While United Airlines was less than committed in its response, the pilots of both United and Continental said in a joint statement: "We will not stand idly by while the CEOs and their executives attempt to merge our airlines without regards to the long-term feasibility of the final entity."

And American Antitrust Institute vice-president and senior fellow Diana Moss has called for a new level of scrutiny at the US Department of Justice, saying that it should "account for possible adverse changes that would be compounded by a United/Continental merger or other mergers, if one or more were to occur".