A Preview of the Next Airline Merger

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In 2008, Delta Air Lines merged with Northwest Airlines. In 2010, United Airlines merged with Continental Airlines to form United Continental Holdings (NYSE: UAL). And after over a year of on and off negotiations, two more legacy carriers appear set to merge.

The New American Airlines

After being the last legacy airline to file for bankruptcy, American Airlines (NASDAQOTH: AAMRQ.PK) finally threw in the towel in Nov. 2011 in an effort to restructure what it saw as an unprofitable cost structure. Seeing an opportunity to be part of airline consolidation, US Airways (NYSE: LCC) began to show interest in acquiring its far larger rival. However, American Airlines did not project the need to merge as much as US Airways did. Through a process of offers, counteroffers, and the consideration American may choose to emerge from bankruptcy on its own, a deal was eventually reached in early 2013 giving US Airways shareholders 28 percent of the new airline and American Airlines stakeholders the remaining 72 percent.

Under the merger plan, the new carrier will take the name American Airlines and repaint its planes as part of a larger effort to rebrand the airline. Over time, there could be a reduction in hubs since the new American Airlines could realize additional efficiencies by eliminating or reducing traffic to hubs in close proximity to each other. Already some analysts are fearing for the future of the Phoenix Sky Harbor Airport, a US Airways hub, due to its existence between American’s Dallas and Los Angeles operations.

The integration process

Integrating two multi-billion dollar companies is never easy, and airline mergers are no exception. While the Delta-Northwest merger is often cited as a well executed airline merger, the events at United Continental have shown that airline mergers can be turbulent affairs. Between the reservation system problems that delayed many frustrated airline passengers, United Continental was also forced to post a loss for 2012 due to merger related costs. These are mostly one-time costs and analysts expect a return to profitability for 2013 but the reservation system errors have soured many customers on the United Continental brand.

Looking at American Airlines and US Airways, the road ahead is filled with uncertainty. On the workforce side, US Airways still has not fully integrated its America West workers from the 2005 merger and could be forced to address this issue as American Airlines workers are added. Yet, on the reservations systems side, American Airlines has shown it doesn’t need a merger for a system error to anger passengers as an incident earlier this year exposed. Whether or not this has any bearing on how the reservation system will perform in a merger is not certain, but it will make some investors question how well the two airlines can merge their systems.

Beyond the costs

It is almost certain the new American Airlines will face some merger headwinds and a fair share of merger-related costs, but long term investors need to look beyond the costs of just the next few years. The AMR-US Airways merger is just the latest example of industry competition reduction and a realization of the economies of scale available to larger airlines. Fewer competitors gives carriers more room to raise fares and increase earnings. Already analysts are projecting strong earnings growth over the next few years for United Continental, a sign of a recovering industry and the completion of the airline’s merger. If the new American Airlines can do the same, the skies could be bright after some near-term turbulence.

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Alexander MacLennan owns shares of Air Canada and Delta Air Lines. He also owns the following options: long $22 Jan 15 Delta calls, long $25 Jan 15 Delta calls, long $30 Jan 15 Delta calls, long $17 Jan 15 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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