Merger mania: US Airways and Delta

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The bold approach by US Airways to merge with Delta Air Lines throws the spotlight on the latest consolidation plays in an industry that has often promised much but delivered less in terms of merger success. The key to success also lies in a merger delivering a real growth opportunity

Doug Parker is a persistent man. And, if he had his way, he would be a serial consolidator. The US Airways chief executive wrote to Gerald Grinstein, his counterpart at Delta Air Lines, on 29 September proposing an $8 billion merger between his carrier and Atlanta-based Delta. The news of Parker's approach broke in mid-November.

Parker is keen on mergers. His letter to Grinstein came almost exactly a year after Parker's America West completed its merger with US Airways. In terms of subsequent performance, the new US Airways is a relative success so far. It has posted three consecutive profitable quarters excluding special items like hedging and post-merger charges. Perhaps Parker has the magic touch to make mergers work?

This is the second time Parker has sought a merger with Delta, which is now 14 months into bankruptcy reorganisation. He telephoned Grinstein for the first time earlier this year with his merger idea. Then, as now, Grinstein and Delta are reluctant to be wooed. They will review Parker's offer but prefer to fight their own way out of an agonising bankruptcy process, hoping to emerge in the first half of next year.

Parker is, of course, not alone in advocating consolidation. Airline chiefs from around the industry, each with self-interest in mind, have urged mergers. His approach leads many observers to foresee it launching a wave of consolidation. There is not a wave, but recent deals show at least a few ripples appearing. One of the most significant this year is in Asia where Cathay Pacific has acquired Hong Kong rival Dragonair. On the other hand, any combination between Air New Zealand and Qantas, who had proposed a full equity alliance in late 2002, appears quashed. They have just received the regulatory thumbs down for a less ambitious codeshare plan.

In Europe three smaller acquisitions look set to tidy up domestic market situations. Belgium's SN Brussels and Virgin Express are finally merging, creating a single carrier - Brussels Airlines - in the process. In the UK, British Airways is "selling" its loss-making regional airline business BA Connect to low-fares player flybe. In Portugal TAP is buying rival Portugalia. Of more seismic proportions in Europe is Ryanair's audacious bid for fellow Irish carrier Aer Lingus.

The hostile bids by both Ryanair and US Airways for market rivals could be doomed to fail. Regardless of success or failure, these bold attempts set merger mania going. The previously unthinkable gets thought.

The theory of mergers sounds fine, but the risks are many, and anyone treading the merger path in the airline industry should be cautious about promising too much, too soon. As one analyst notes, most airline mergers have "destroyed far more wealth than they have created".

In addition, with the industry at or around the top of the cycle there is the risk of paying top dollar for the intended target. Then the onus on stripping costs out of the merged entity becomes even more acute as the cycle wanes and traffic and revenue slows.

Mergers can be a defensive play, such as Lufthansa's acquisition of Swiss nearly two years ago. However, the bigger win comes if the deal gives the acquirer access to real structural growth and access to new markets. The Cathay Pacific/Dragonair combination fits this criterion nicely. The US Airways bid for Delta talks more about synergy value - put at $1.5 billion - than opportunities to expand.

Parker set out his merger motivations in a videotaped message to employees: "We're looking to control our own destiny and ensure that we have an airline that can compete in any scenario that may emerge. We want to get to where we never have to worry ever again."

The worries need to be put away early in the merger process by being conservative in the cost promises and diligent in seeking the path to growth. Answer these questions honestly and then there's the next hurdle to tackle: persuading the regulators.

This is the second approach US Airways has made to Delta Air Lines

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