Date: January 10, 2008
Source: Wall Street Journal
Authors: Susan Carey, Dennis Berman And Paulo Prada

Delta Air Lines Inc. directors on Friday will be asked to permit the airline's new chief executive, Richard Anderson, to begin formal merger discussions with both Northwest Airlines Corp. and UAL Corp., parent of United Airlines, with the idea that Delta ultimately will choose between the two, according to people familiar with the matter.

That process, if it gets the green light, would follow exploratory conversations Delta had in December with both of those airlines as well as Continental Airlines Inc., according to another person with knowledge of the situation.

Of course, Delta's board may decline the request, or send Delta executives back to do more work, or only approve talks with one carrier. And if formal merger talks do commence, they may not wind up with a deal, given the challenges of combining carriers.

If Delta does embark on a two-track evaluation process with United and Northwest, that could force Continental onto the merger dance floor to avoid being left behind, according to several people familiar with the situation. Continental has repeatedly rebuffed earlier efforts by United to form a combination.

Delta's management and a special board committee, formed a few months ago to explore strategic opportunities, haven't decided whether United or Northwest would be the more attractive potential partner, said one person close to the situation.

After Delta successfully rebuffed a $9.5 billion hostile takeover attempt by U.S. Airways Group Inc. early last year, the creditors who hand-picked Delta's post-bankruptcy board urged the airline's new directors to remain open to future opportunities for consolidation. That's why the board, after hiring Mr. Anderson, an industry veteran with experience at Northwest and Continental, established the committee to explore strategic options, including mergers and acquisitions.

The board, however, "is not necessarily of one mind about it," said one person familiar with Delta directors. "It is their fiduciary responsibility to consider the possibility as they promote and protect shareholder value. But there is not necessarily a predilection toward consolidation."

Betsy Talton, a Delta spokeswoman, repeated that "a special committee of Delta's board" is working to "review and analyze strategic options ... including potential consolidation transactions." The company, however, "will not be providing updates on the process," she added.

Mr. Anderson could not be reached for comment.

A Northwest spokeswoman declined to comment. A United spokeswoman said her company's "position on the need for consolidation in the industry is well known," but declined to comment on rumors or speculation. Continental officials were not immediately available to comment.

Delta stock early today was trading at about $14 per share, giving the airline a market value of about $3.6 billion, based on shares that are currently trading. The airline's total value, however, is calculated to be more than $5 billion at current prices, considering some Delta shares, equal to about a quarter of the company's total stock, must still be distributed once some remaining bankruptcy claims get settled.

A Delta deal would be a stock-for-stock share swap at around "at-market" prices, says one person familiar with the matter.

Renewed efforts to consolidate the fragmented U.S. airline industry come at a time when high fuel prices are sapping carriers' newfound prosperity, the economy is slowing and competition from European airlines is increasing as a result of a new "open skies" treaty set to take effect in late March between the U.S. and the European Union. U.S. airlines' stocks have slumped to their 52-week lows and hedge funds that bought airline stocks on the hopes that mergers or asset spinoffs would lift those investments are frustrated and increasingly vocal.

Consolidation has taken on new urgency because carriers believe the chances of getting one or two big deals approved by antitrust authorities are better under the current Republican administration. Thus airline executives and investors feel deals must be forged in the next 30 to 45 days to allow enough time to let the transactions undergo scrutiny this year before the government changes.

Proponents think airline mergers would take excess capacity out of the industry, particularly domestically, and allow the players to further boost fares. Combinations also are seen as a way of further reducing costs by rationalizing duplicative information technology systems, headquarters and closing some hubs. They also can help broaden the combining airlines' network coverage, enabling them to better compete for corporate accounts.

Despite those economic arguments, however, any combinations of the major U.S. airlines are sure to draw heavy regulatory scrutiny because of the impact on fares and competition. United and Delta are the second- and third-largest carriers by traffic. Northwest is No. 5 and Continental fourth.

But the big airlines argue that discounters such as Southwest Airlines Co. and JetBlue Airways Corp. ensure hearty competition in the domestic market. International competition also is growing, not just from Europe but due to the growth of mega-airlines in the Middle East and Asia.