Shrek
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http://news.medill.northwestern.edu/chicago/news.aspx?id=158923
Merger buzz swirls around UAL
by Daniel Platt
March 02, 2010
UAL_MKT1
Daniel Platt/MEDILL
Delta Airlines holds a market capitalization twice that of United and Continental combined.
UAL Corp., parent of Chicago-based United Airlines, would be well advised to ramp up merger talks with Houston-based Continental Airlines.
At least, that’s what some experts are saying.
They believe that United, struggling in an era of depressed industry revenues, could invigorate its market value and its competitiveness in a crowded market by joining with another domestic carrier.
They say the increased efficiency generated by combining routes, hubs and fleets, would generate a positive impact on a combined company’s market value.
“It makes business sense,” said Vaughn Cordle, chief analyst at AirlineForecasts LLC, an equity research firm. “By merging, both companies can consolidate and eliminate overlapping functions to generate cost synergies. The opportunity cost is too high not to consider.”
As time goes on, consolidation is looking even more attractive. The recent merger between Delta Airlines Inc. and Northwest Airlines—creating the largest airline group by traffic—threatens both United’s and Continental’s market share, specifically on the East Coast.
“The union of Continental’s Newark hub and United’s presence at Washington-Dulles would be a powerful combination,” said Jay Sorensen, airline consultant and president of Wisconsin-based IdeaWorks. “Currently, Delta is attempting to dominate New York at John F. Kennedy and LaGuardia Airports.”
Like many other airlines, United is losing money, though less than before. It’s coming off a 2009 fourth quarter loss of $240 million, an improvement from a $1.3 billion loss in the same quarter last year. For the full year, United recorded a loss of $651 million compared with a $5.4 billion loss in 2008.
Before February, UAL’s stock was trading between $12 and $14. It’s a far cry from last summer when shares were trading near $3, but even farther off from the summer of 2008 when the price was hovering around $40.
The possible solution: “UAL has been supportive of consolidation for a long time,” Chief Financial Officer Kathryn Mikells said last week at the Reuters Travel and Leisure Summit. “It is something we will continue to look at.”
United’s stock has responded to the rising talk of consolidation. Since Mikells made the statement on Feb. 23, United’s shares have climbed nearly 15 percent to $17.87 from $15.58. Continental’s stock has risen 3 percent since last Tuesday.
According to a Bloomberg LP survey of 10 analysts, the consensus 12-month target price is $23 with eight buy ratings. However, individual estimates vary widely, perhaps because of consolidation uncertainty. In early February, Helane Becker of Jesup & Lemont Securities Corp., who maintains an 18-month target price of $15.66, downgraded the stock to hold. Daniel McKenzie of Hudson Securities Inc. recently raised his 12-month target price to $26 from $20 and rates the shares as a buy.
In his February note, McKenzie said that his report did not include a valuation premium to account for a potential merger with Continental, but added it's “a merger we believe is inevitable."
The Bloomberg survey of analysts is projecting 2010 earnings per diluted share of $1.04, up from a loss of $4.32 per diluted share in 2009.
“The objective of being in business is to maximize firm value,” Cordle said. “Big airlines are coming up short in covering their average capital costs.”
He points to the Delta-Northwest merger's creation of a combined market capitalization of nearly $10 billion, close to double the current market capitalizations of United and Continental put together, a statistic United CEO Glenn Tilton quoted last week in an interview with the Financial Times.
“The investor seems to have spoken,” he said. “The market seems to have suggested that scope and scale in global business are important.”
According to Cordle’s valuations, a combination of Continental and United could generate enough in synergies to create additional $5 billion in value, moving the combined company into alignment with the new Delta.
“That is the only reason they should merge,” Cordle said. “I would argue that the opportunity cost of not merging is $5 billion.”
He contends that consolidation is attractive because airline profits are inadequate to fix company balance sheets, satisfy labor, reinvest in aircraft and still provide a normal return for shareholders.
United has been stockpiling cash since the end of 2008, going from a negative free cash flow of $1.7 billion to a positive free cash flow of nearly $650 million in 2009. United sits with the most free cash flow among its industry peers.
Sorensen says airline management teams have to consider all possibilities for consolidation in order to avoid elimination.
“It’s a cut-throat business with assets that are very movable,” he said. “If they don’t keep open minds, they can end up like Pan-Am or Eastern Airlines that no longer exist.”
As competition from low-cost carriers like Air Tran and Southwest continues to eat away market share, Sorensen says being a large company is one of United’s most important attributes.
“They can’t beat them in operating cost, but they can try to beat them in size and mass.”
However, not all industry experts agree on the wisdom of consolidation.
“Ninety percent of all airline mergers in the last 30 years have been dismal and utter failures,” said Hubert Horan, an independent airline consultant in Phoenix.
An example he points to is American Airlines’ acquisition of Trans World Airlines in 2001 for more than $600 million in cash and $3 billion in assumed debt. The deal, combined with the shock to the airline industry of Sept. 11, nearly brought the carrier to bankruptcy.
Horan said that while the idea of a United-Continental marriage has been talked about for five years, it remains a long shot because contracts, labor negotiations and management power struggles can get in the way.
“If United and Continental agreed to merge, unions would threaten to disrupt operations if they weren’t taken care of and lessors of planes would still want to get paid for overlapping planes taken out of service,” he said. “In the real world, you have to deal with these things.”
He says that the idea of consolidation keeps getting floated by United management because while United is not near the verge of liquidation as it was several years ago when it filed for bankruptcy protection, it is still stumbling along and not successful at providing a return on investment.
“It’s a lot easier to make money from an M&A deal than to be profitable,” he said.
Where other experts see a potential merger as a way to create billions of value, Horan said not only will the result be minimal cost savings, but the customer will not benefit from the combined airline.
“It’s decimal place stuff, saving money on paper clips and having one frequent flier program instead of two,” he said. “For the consumer, a flight from Chicago to Los Angeles will be no more competitive under a bigger company than it is today.”
Sorensen of IdeaWorks points to more personal issues that keep mergers from being completed.
“In a new airline, they have to agree on things like which management team will stay and where the headquarters will be,” he said.
According to SCordleAB of AirlineForecasts, the longer that large legacy carriers like United wait to consolidate, the worse their position in the market will be moving forward. The large domestic carriers have lost more than $60 billion over the last decade and have continued to lose market share to low-cost carriers. With less market share comes less pricing power.
“Only way to maintain profitability is to control supply of seats where you get high enough price to break even on average capital costs,” he said. “If they continue in the status quo, it will destroy their economic value.”
Merger buzz swirls around UAL
by Daniel Platt
March 02, 2010
UAL_MKT1
Daniel Platt/MEDILL
Delta Airlines holds a market capitalization twice that of United and Continental combined.
UAL Corp., parent of Chicago-based United Airlines, would be well advised to ramp up merger talks with Houston-based Continental Airlines.
At least, that’s what some experts are saying.
They believe that United, struggling in an era of depressed industry revenues, could invigorate its market value and its competitiveness in a crowded market by joining with another domestic carrier.
They say the increased efficiency generated by combining routes, hubs and fleets, would generate a positive impact on a combined company’s market value.
“It makes business sense,” said Vaughn Cordle, chief analyst at AirlineForecasts LLC, an equity research firm. “By merging, both companies can consolidate and eliminate overlapping functions to generate cost synergies. The opportunity cost is too high not to consider.”
As time goes on, consolidation is looking even more attractive. The recent merger between Delta Airlines Inc. and Northwest Airlines—creating the largest airline group by traffic—threatens both United’s and Continental’s market share, specifically on the East Coast.
“The union of Continental’s Newark hub and United’s presence at Washington-Dulles would be a powerful combination,” said Jay Sorensen, airline consultant and president of Wisconsin-based IdeaWorks. “Currently, Delta is attempting to dominate New York at John F. Kennedy and LaGuardia Airports.”
Like many other airlines, United is losing money, though less than before. It’s coming off a 2009 fourth quarter loss of $240 million, an improvement from a $1.3 billion loss in the same quarter last year. For the full year, United recorded a loss of $651 million compared with a $5.4 billion loss in 2008.
Before February, UAL’s stock was trading between $12 and $14. It’s a far cry from last summer when shares were trading near $3, but even farther off from the summer of 2008 when the price was hovering around $40.
The possible solution: “UAL has been supportive of consolidation for a long time,” Chief Financial Officer Kathryn Mikells said last week at the Reuters Travel and Leisure Summit. “It is something we will continue to look at.”
United’s stock has responded to the rising talk of consolidation. Since Mikells made the statement on Feb. 23, United’s shares have climbed nearly 15 percent to $17.87 from $15.58. Continental’s stock has risen 3 percent since last Tuesday.
According to a Bloomberg LP survey of 10 analysts, the consensus 12-month target price is $23 with eight buy ratings. However, individual estimates vary widely, perhaps because of consolidation uncertainty. In early February, Helane Becker of Jesup & Lemont Securities Corp., who maintains an 18-month target price of $15.66, downgraded the stock to hold. Daniel McKenzie of Hudson Securities Inc. recently raised his 12-month target price to $26 from $20 and rates the shares as a buy.
In his February note, McKenzie said that his report did not include a valuation premium to account for a potential merger with Continental, but added it's “a merger we believe is inevitable."
The Bloomberg survey of analysts is projecting 2010 earnings per diluted share of $1.04, up from a loss of $4.32 per diluted share in 2009.
“The objective of being in business is to maximize firm value,” Cordle said. “Big airlines are coming up short in covering their average capital costs.”
He points to the Delta-Northwest merger's creation of a combined market capitalization of nearly $10 billion, close to double the current market capitalizations of United and Continental put together, a statistic United CEO Glenn Tilton quoted last week in an interview with the Financial Times.
“The investor seems to have spoken,” he said. “The market seems to have suggested that scope and scale in global business are important.”
According to Cordle’s valuations, a combination of Continental and United could generate enough in synergies to create additional $5 billion in value, moving the combined company into alignment with the new Delta.
“That is the only reason they should merge,” Cordle said. “I would argue that the opportunity cost of not merging is $5 billion.”
He contends that consolidation is attractive because airline profits are inadequate to fix company balance sheets, satisfy labor, reinvest in aircraft and still provide a normal return for shareholders.
United has been stockpiling cash since the end of 2008, going from a negative free cash flow of $1.7 billion to a positive free cash flow of nearly $650 million in 2009. United sits with the most free cash flow among its industry peers.
Sorensen says airline management teams have to consider all possibilities for consolidation in order to avoid elimination.
“It’s a cut-throat business with assets that are very movable,” he said. “If they don’t keep open minds, they can end up like Pan-Am or Eastern Airlines that no longer exist.”
As competition from low-cost carriers like Air Tran and Southwest continues to eat away market share, Sorensen says being a large company is one of United’s most important attributes.
“They can’t beat them in operating cost, but they can try to beat them in size and mass.”
However, not all industry experts agree on the wisdom of consolidation.
“Ninety percent of all airline mergers in the last 30 years have been dismal and utter failures,” said Hubert Horan, an independent airline consultant in Phoenix.
An example he points to is American Airlines’ acquisition of Trans World Airlines in 2001 for more than $600 million in cash and $3 billion in assumed debt. The deal, combined with the shock to the airline industry of Sept. 11, nearly brought the carrier to bankruptcy.
Horan said that while the idea of a United-Continental marriage has been talked about for five years, it remains a long shot because contracts, labor negotiations and management power struggles can get in the way.
“If United and Continental agreed to merge, unions would threaten to disrupt operations if they weren’t taken care of and lessors of planes would still want to get paid for overlapping planes taken out of service,” he said. “In the real world, you have to deal with these things.”
He says that the idea of consolidation keeps getting floated by United management because while United is not near the verge of liquidation as it was several years ago when it filed for bankruptcy protection, it is still stumbling along and not successful at providing a return on investment.
“It’s a lot easier to make money from an M&A deal than to be profitable,” he said.
Where other experts see a potential merger as a way to create billions of value, Horan said not only will the result be minimal cost savings, but the customer will not benefit from the combined airline.
“It’s decimal place stuff, saving money on paper clips and having one frequent flier program instead of two,” he said. “For the consumer, a flight from Chicago to Los Angeles will be no more competitive under a bigger company than it is today.”
Sorensen of IdeaWorks points to more personal issues that keep mergers from being completed.
“In a new airline, they have to agree on things like which management team will stay and where the headquarters will be,” he said.
According to SCordleAB of AirlineForecasts, the longer that large legacy carriers like United wait to consolidate, the worse their position in the market will be moving forward. The large domestic carriers have lost more than $60 billion over the last decade and have continued to lose market share to low-cost carriers. With less market share comes less pricing power.
“Only way to maintain profitability is to control supply of seats where you get high enough price to break even on average capital costs,” he said. “If they continue in the status quo, it will destroy their economic value.”
Who knows, I may slang gear for you again someday. The route network would be one of the best in the world and I think that will be needed to offset many battles in the future (MPL and cabotage being some of them)
