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WSJ on "The State of the Industry"

KarmaPolice

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Business
More Stable Airlines Fly Out of Mergers; Fliers Poised to Benefit From Greater Investments, Stability
By Susan Carey, Jack Nicas And Mike Spector
1030 words
11 February 2013
19:23
The Wall Street Journal Online
WSJO
English
Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved.
The U.S. airline industry is starting to fly high again.

An expected merger agreement this week between AMR Corp.'s American Airlines and US Airways Group Inc. could end the latest chapter on consolidation that has helped to stabilize an industry troubled for decades.
The $10 billion-plus deal would follow three other industry megamergers since 2008, a period of consolidation that has produced a healthier industry with the prospects of sustainable profitability and investment-grade credit ratings.

Travelers would have fewer airline choices—an AMR-US Airways merger would leave four airlines controlling about 83% of domestic seats—but potentially the benefits of greater reliability and airline investments.

Few believe U.S. fares would rise dramatically as a result of the merger. Competition remains intense as discount carriers account for roughly 37% of domestic passenger air trips, keeping a lid on price increases. On an inflation-adjusted basis, domestic fares are about 15% lower than they were in 2000, according to government data.

And even though there are fewer airlines, passengers still have numerous choices. For instance, a person who wants to travel to Seattle from Savannah, Ga., can choose between flying Delta via Atlanta, American through Dallas, US Airways via Philadelphia or Charlotte, and United through three of its hubs.
People familiar with the matter said the AMR and US Airways boards are scheduled to meet separately on Wednesday to consider the merger plan, which could be announced later that day or on Thursday if the timing doesn't slip. US Airways Chief Executive Doug Parker would run the combined carrier as CEO, while AMR CEO Tom Horton would become nonexecutive chairman for a limited period. Current talks are focused on the length of Mr. Horton's term, the makeup of the new board and potential compensation for the airline's new management and other employees, these people said.

The U.S. airline industry has struggled to stay aloft since it was deregulated 35 years ago. The ensuing decades brought multiple bankruptcies, liquidations and billions of dollars of losses as carriers pursued what in hindsight were self-destructive strategies as they tried to cope with rising costs, inefficient labor contracts and the advent of low-fare competitors.

This year, analysts are predicting that all of the nation's 11 publicly traded passenger airlines will be profitable, and together earn roughly $6.8 billion, even though jet fuel— their biggest expense—currently costs about $3.24 a gallon. That would top one of the industry's most profitable years, 1997, when it earned $4.8 billion amid jet-fuel prices hovering around 60 cents a gallon. Only in 2006 and 2007 did the industry exceed the 2013 estimate, but those results were inflated by items related to bankruptcies.

Emboldened by both bankruptcies and mergers, U.S. airlines are reducing capacity on money-losing routes, cutting back at some of their hubs and taking a hard line on costs, said John Thomas, head of the global aviation practice at L.E.K. Consulting LLC. "Taking structural costs and inefficiencies out of the system is what excites people about consolidation," he said. "Large carriers can weather the storm so much better than small carriers."
 
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Instead of worrying about a bigger, fiercer competitor, rival executives have said they are pleased by the prospect of another merger. Jeff Smisek, CEO of United Continental Holdings Inc., said last year that losing United's partnership with US Airways through the Star Alliance would be "negative." But "if they left as a result of consolidation, I think that would be very good for the business and for the industry," he said.

Across the world, airlines are consolidating assets to form larger networks. In Europe, Air France and KLM formed Air France-KLM SA, and British Airways and Iberia joined to create International Consolidated Airlines Group SA. In addition to the three recent megamergers in the U.S.—United and Continental Airlines; Northwest and Delta Air Lines Inc.; and Southwest Airlines Co. and AirTran Airways—regional carriers, which fly on behalf of the majors, also hooked up. Pressed by their airline partners, some have cut unprofitable flights to small cities due to high fuel prices.

Air travel is the latest network industry, after railroads, telecom and utilities, to reinvent itself through consolidation, said Brookings Institution economist Clifford Winston. "Mergers have worked for all the network industries in helping those industries shed the least efficient carriers," he said.

Airlines have become more efficient in meeting demand for travel. In the year ended in October 2012, airlines carried 736 million passengers, 54% more than in 1992. They filled nearly 83% of their seats in the period, compared with 64% in 1992.

Analysts said several factors, including the wave of consolidation, have raised the barriers for newcomers. Hunter Keay of investment researchers Wolfe Trahan & Co. said the biggest barrier is that starting an airline requires so much capital, yet it is near impossible to convince lenders to invest in a company so tied to a commodity as volatile as fuel. David Swierenga, an airline economist with consultancy AeroEcon, said startup carriers still can enter the business, "but the bigger problem is: how do you compete with the networks of these very large airlines?"

One of the biggest hazards in an airline merger is worker unrest. But in the case of AMR and US Airways, American's three big unions and US Airways' pilots are on board with transitional labor agreements. Unions must still agree to single seniority lists, something that has proved difficult in past mergers.

Airline marriages can take years to implement and often lead to technology and service glitches. "The execution risk is high," said Bill Swelbar, an airline researcher at the Massachusetts Institute of Technology. Because Delta and United have begun melding cultures and operations, American would have "no room to stumble," he said.
 
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