Date: January 31, 2008
Source: Financial Times
Author: Claudia Montoto

Delta undecided between United and Northwest as talks continue; American viewed as realistic threat to Delta/Northwest tie-up

Delta Airlines is understood to still be in talks with United Airlines about a potential tie-up, despite market reports that have spotlighted a Northwest/Delta combination. It was said that although Delta has not yet chosen a partner, the company finds both potential partners attractive.

Delta continues to view United as a high-yield investment opportunity following some cost cutting and restructuring. It also sees an added value in United's strong Pacific network and its slots at London's Heathrow airport. The labor issues of both airlines, in particular United's under par union relations, are considered by Delta to be equally complicated and will require considerable time and attention no matter which combination is chosen, if any.

Still, an industry banker monitoring the potential wave of consolidation said he wondered whether the semi-official word that Delta was holding conversations with two parties was a strategic move to make a Northwest tie-up appear more attractive. "I think it was just a tactical head fake," he said, noting that he had not heard talk of a Delta/United tie-up.

Acknowledging discussions with both legacy carriers could have been a means to discipline its negotiations with Northwest, the industry banker speculated. Moreover, he said that because Delta pilots had made it clear they would not merge with United, announcing discussions with Northwest in conjunction with United could have been a way of making a deal with the former appear more attractive to the unions.

Meanwhile, American Airlines, the world's largest airline by total passengers transported, could be a threat to a Delta deal, particularly if it tied-up with Northwest, the banker said. Having taken a hard look at Northwest "years ago", the banker speculated that American could attempt to bust the deal by making a competing offer if and when the deal is announced. Further, a second industry banker said Northwest did not agree to the merger with American in 2000 as the offer did not reflect the full market premium to Northwest's share price at that time.

Moreover, the first banker noted that American has more practical experience with mergers than any other airline, which could make the top carrier "more courageous" under the right circumstances.

The banker characterized Northwest as American's logical merger partner, and speculated that it could make a play to cement its position as a ubiquitous business-class carrier and ensure it is not short-changed during consolidation. Other potential combinations could attract the attention of antitrust regulators and are less likely, the banker said. He explained that an American/Delta merger would have significant overlaps in the Southeast; while an American and Continental tie-up could be problematic because of their Texas hubs in Dallas and Houston. Lastly, he noted that United and American would have a roughly 60% market share in the Chicago market because they are number one and two, respectively, making a tie-up unlikely.

To keep its options open to consolidation, American could proactively disrupt a Delta and Northwest combination to safeguard its position as an industry leader. Should Delta choose Northwest as a merger partner, United would likely respond by pursuing Continental, in which case the only legacy carriers not hitched would be American and US Airways - an unlikely pairing because the latter is a low cost, low-fare carrier.

American is likely thinking ahead on the probable tie-ups, the banker suggested. If United merges with Delta or Continental, American will be faced with a "very, very serious problem;" namely that its hegemony with the business traveler will be threatened, the banker said. He added that a United and Continental tie up would put American in hot water, not just because the aggregate market share of the combined entity would be bigger, but because the new entity would be an enterprise that would practically have a hub in the major population centers around the perimeter of the US. This, he said, would be a very effective kind of competitor for American.

Still, the banker said a Delta/Northwest deal is high on the inevitability scale because both airlines are members of the SkyTeam alliance. However, he said that deal would not catapult other carriers to merge because the formed entity would not be "such a world beater". One of the shortcomings of a Delta/Northwest deal would be that the combination would fail to reach several key markets, such as the West and Southwest regions, the banker said.

According to the industry banker, a tie-up of American and Northwest would be very beneficial because American's enormous US network and transatlantic operation would act as a feeder to Northwest's Pacific operations. This combination would likely lend a hand to American's number-two position in Chicago, by providing hubs in Minneapolis and Detroit, he said. Yet despite the obvious sense that such a tie-up would make, the banker said he does not believe an American/Northwest deal would make more sense than a Delta/Northwest combination. Still, the banker noted that although American does not have much leverage in its stock, the company has "a ton of cash" which it could use to realize a deal.

According to AMR Corporation's most recent quarterly filing issues in October, the company has roughly USD 5.4bn in cash.