Feedback: Why mergers don't add up

Industry veteran and consultant Hubert Horan details his top 10 false claims about the need for US airline mergers, drawing on his experiences with multiple mergers and restructurings at Northwest and America West Airlines, Swissair and Sabena

1. "There's a strong, growing groundswell of support for airline mergers." This is ­complete nonsense. Only three very narrow groups are arguing for legacy airline mergers in the US - (a) individual hedge funds who don't understand industry fundamentals but have made big speculative gambles on consolidation, (b) a handful of very senior airline executives who are finding it very ­difficult to generate sustainable profits but would realise multi-million ­personal payouts in most merger scenarios, and (c) Wall Street firms, lawyers and consultants lusting after big fees. No one with any long-term stake in these airlines is advocating mergers.

2. "Airline mergers would be part of a natural industry shakeout process." A wholly dishonest claim. "Natural" industry shakeouts involve wiping out the managements and investors of small, weak, inefficient competitors in a declining industry, and the displacement of companies using obsolete technologies and business models.

3. "Airline mergers would be a necessary response to $100 barrel fuel and a downturn in the business cycle." This is the exact opposite of the truth. If no one could justify a legacy merger when revenue, cash flow and access to capital were extremely strong, then they certainly can't be justified now. Cash flow becomes incredibly critical to airlines during an economic downturn, and multi-billion dollar merger costs would rapidly drain needed reserves. The revenue risk of implementation problems becomes much greater when demand is weak.

4. "Airline mergers could be implemented with limited risk." It is hard to believe that anyone could make this general claim with a straight face. A merger between two of the big six US legacy carriers would cost something of the order of $5 billion to implement, and there has never been a merger between large airlines that was both an ­operational and financial success.

5. "Airline mergers would generate significant operating synergies and strengthen efficiency." None of the merger advocates have presented an iota of evidence supporting this claim. Any merger could generate some savings, but no airline merger has ever been justified primarily by cost synergies, and these savings could never cover the multi-billion dollar implementation costs and disruption risks. All of the costs are 100% certain, and need to be paid for up front while the synergies are much less certain and might take years to realise. Legacy carriers have very little potential for further scale economies, unless you believe that Aeroflot under the USSR was a model of efficiency.

6. "Mergers are required to rationalise excess industry capacity." Once again, this is the exact opposite of the truth. The industry does have "excess" (structurally unprofitable) capacity, and more costly fuel means even more capacity is unsustainable. But nobody needs expensive, risky mergers to cut this capacity, and consolidation will actually make it harder to bring supply and demand back into line.

7. "US airlines need to merge in order to compete with foreign airlines that are better financed and offer better service." The claim that US carriers have a distinct competitive disadvantage against foreign airlines contradicts all recent evidence - legacy hubs provide a highly efficient means of serving many international markets, international routes are highly profitable and US carriers are shifting capacity to them as fast as possible.

8. "Airline managers have an obligation to pursue mergers in order to boost their falling stock prices." The people arguing this do not seem to understand the difference between sustainable growth in shareholder value and short-term stock price manipulation. This is not a plan to strengthen airline finances, but a scheme to enrich one narrow group of investors at the expense of every other group of investors.

9. "Consolidation would strengthen the entire industry." Widespread ­consolidation is actually the biggest threat to consumers, employees and investors. It hasn't happened yet, but hypothetically one could design an isolated legacy merger that actually created long-term corporate value based on improved efficiency or ­competitiveness.

10. "Airline mergers would increase long-term corporate value without harming consumers." Legacy mega mergers won't increase the level of service operated, won't improve the quality of customer service, could ­easily increase costs and reduce ­efficiency, and would increase overall financial risk while ­seriously damaging ­certain portions of the capital structure.

Read what Airline Business and Flight bloggers think of the Delta-Northwest merger at flightglobal.com/blogs

Source: Airline Business