Secret Squirrel
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I found this on another website and didn't see it on here.
Top ten false claims about the need for U.S. airline mergers
By Hubert Horan
April 2008
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 U.S.—(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 realize 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. There is no objective, quantitative analysis showing competitive or efficiency gains, or long-term improvements in corporate value. These same three groups generated huge publicity for the “pro- merger†case in early 2006. Nothing happened then, and no one else has taken up the cause since. The Big 6 Legacy carriers have been intensively studying merger/consolidatio n scenarios for ten years, but the only carriers that could justify merging (America West-US Airways) were bankrupt and on the verge of liquidation.
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. These mergers would protect and entrench weak airlines such as United and Delta that haven’t generated returns for shareholders for over a decade and would enrich many of the same managers that drove them into bankruptcy. A true shakeout might consolidate smaller airlines with limited scale or network scope, but does anyone actually believe that United and Delta are too small to compete? Does anyone believe that aviation is a declining, shrinking industry? A true shakeout would allow more efficient carriers such as Southwest and AirTran to grow faster by dramati cally shrinking unprofitable Legacy capacity. The misrepresentations about “natural shakeouts†can also be seen in Europe where very large airlines with high costs and traditional business models (Air France and KLM in Europe) are using mergers to make it harder for airlines with lower costs and lower fares (such as Ryanair and Easyjet) to compete.
3. “Airline mergers would be a necessary response to $100/bbl 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. The argument that mergers are needed now assumes that airline mangers had already been doing a fantastic job optimizing fleet, network structure, information technology, employee relations, operational efficiency, customer service, brand marketing, supplier relationships, capital structure, and things like that, and therefore, the only option left as conditions worsen is to change the number of airlines. Wall Street analysts and airline executives are pushing the same merger PR arguments that they did when fuel was $50/bbl and when demand and prices were extremely robust, and the money to finance deals was practically falling off of trees.
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 big 6 US Legacy carriers would cost something on 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. There have been mergers between large airlines where strong potential synergies were wiped out by terrible implementation (Northwest-Republic , Continental- People Express) and mergers with careful, expensive implementation that generated no long-term financial benefits (Delta-Western) and mergers that were across the board failures (American-TWA) , and all past cases involved smaller operations than cases like Delta-Northwest or United-Continental would today. The slightest hiccups while integrating complex computer systems, aircraft maintenance programs, employee operating practices and seniority lists and the like could cause huge disruptions that would alienate customers for years. More importantly, the financial structure these mergers would follow appears designed to ensure the worst possible implementation. All of the big financial gains (stock price bump triggered by the merger announcements, management change-in-control bonuses, fees to investment bankers, lawyers and consultants) would be realized prior to implementation, and none of these people would have any financial incentive to manage the operational and customer service risks.
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 realize. Legacy carriers have very little potential for further scale economies, unless you believe that Aeroflot under the USSR was a model of efficiency. If you merge airlines in bankruptcy (as with last year’s proposed Delta-US Airways merger) you can maximize cost synergies by restructuring hubs, fleets, and union/vendor contracts as part of the reorganization proce ss (although you’d still face significant implementation challenges and risks). The cost of merging Delta and Northwest outside of bankruptcy protection is much higher because they have much less ability to shed the assets and staff that would become redundant after a merger.
6. “Mergers are required to rationalize excess industry capacity.†Once again, this is the exact opposite of the truth. The industry does have “excess†(structurally unprofitable) capacity, and higher fuel prices mean that even more capacity is unsustainable. But nobody needs expensive, risky mergers to cut this capacity, and consolidation will actually make it more difficult to bring supply and demand back into line. Mergers give disadvantaged employees, lessors, local airports and politicians greater leverage to block or disrupt capacity cuts, all of whom can point to select insiders (hedge funds, senior executives) making big short-term gains at their expense.
Top ten false claims about the need for U.S. airline mergers
By Hubert Horan
April 2008
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 U.S.—(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 realize 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. There is no objective, quantitative analysis showing competitive or efficiency gains, or long-term improvements in corporate value. These same three groups generated huge publicity for the “pro- merger†case in early 2006. Nothing happened then, and no one else has taken up the cause since. The Big 6 Legacy carriers have been intensively studying merger/consolidatio n scenarios for ten years, but the only carriers that could justify merging (America West-US Airways) were bankrupt and on the verge of liquidation.
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. These mergers would protect and entrench weak airlines such as United and Delta that haven’t generated returns for shareholders for over a decade and would enrich many of the same managers that drove them into bankruptcy. A true shakeout might consolidate smaller airlines with limited scale or network scope, but does anyone actually believe that United and Delta are too small to compete? Does anyone believe that aviation is a declining, shrinking industry? A true shakeout would allow more efficient carriers such as Southwest and AirTran to grow faster by dramati cally shrinking unprofitable Legacy capacity. The misrepresentations about “natural shakeouts†can also be seen in Europe where very large airlines with high costs and traditional business models (Air France and KLM in Europe) are using mergers to make it harder for airlines with lower costs and lower fares (such as Ryanair and Easyjet) to compete.
3. “Airline mergers would be a necessary response to $100/bbl 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. The argument that mergers are needed now assumes that airline mangers had already been doing a fantastic job optimizing fleet, network structure, information technology, employee relations, operational efficiency, customer service, brand marketing, supplier relationships, capital structure, and things like that, and therefore, the only option left as conditions worsen is to change the number of airlines. Wall Street analysts and airline executives are pushing the same merger PR arguments that they did when fuel was $50/bbl and when demand and prices were extremely robust, and the money to finance deals was practically falling off of trees.
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 big 6 US Legacy carriers would cost something on 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. There have been mergers between large airlines where strong potential synergies were wiped out by terrible implementation (Northwest-Republic , Continental- People Express) and mergers with careful, expensive implementation that generated no long-term financial benefits (Delta-Western) and mergers that were across the board failures (American-TWA) , and all past cases involved smaller operations than cases like Delta-Northwest or United-Continental would today. The slightest hiccups while integrating complex computer systems, aircraft maintenance programs, employee operating practices and seniority lists and the like could cause huge disruptions that would alienate customers for years. More importantly, the financial structure these mergers would follow appears designed to ensure the worst possible implementation. All of the big financial gains (stock price bump triggered by the merger announcements, management change-in-control bonuses, fees to investment bankers, lawyers and consultants) would be realized prior to implementation, and none of these people would have any financial incentive to manage the operational and customer service risks.
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 realize. Legacy carriers have very little potential for further scale economies, unless you believe that Aeroflot under the USSR was a model of efficiency. If you merge airlines in bankruptcy (as with last year’s proposed Delta-US Airways merger) you can maximize cost synergies by restructuring hubs, fleets, and union/vendor contracts as part of the reorganization proce ss (although you’d still face significant implementation challenges and risks). The cost of merging Delta and Northwest outside of bankruptcy protection is much higher because they have much less ability to shed the assets and staff that would become redundant after a merger.
6. “Mergers are required to rationalize excess industry capacity.†Once again, this is the exact opposite of the truth. The industry does have “excess†(structurally unprofitable) capacity, and higher fuel prices mean that even more capacity is unsustainable. But nobody needs expensive, risky mergers to cut this capacity, and consolidation will actually make it more difficult to bring supply and demand back into line. Mergers give disadvantaged employees, lessors, local airports and politicians greater leverage to block or disrupt capacity cuts, all of whom can point to select insiders (hedge funds, senior executives) making big short-term gains at their expense.