Aug 142013
 
American's merger with US Airways has run into unexpected DoJ opposition.

American’s merger with US Airways has run into unexpected DoJ opposition.

It is fair to say that the US Department of Justice astonished the aviation industry by announcing, yesterday, its objection to the merger between American Airlines and US Airways.

The general expectation, and the very confident predictions of both airlines, was that the DoJ would passively roll over and obediently approve the merger, albeit probably with a bit of ‘for show’ trivial concessions demanded from the airlines, just to affirm the DoJ’s relevance to the proceeding.  This would be an outcome similar/identical to its past responses to the many dozens of airline mergers in the past, most recently the two mergers that created the mega-carriers Delta (merged with Northwest) and United (merged with Continental).

But on Monday the DoJ announced it was filing an anti-trust lawsuit challenging the proposed airline merger, and added that it was being joined in the suit by the attorneys general of Texas (where AA is headquartered), Arizona (where US is headquartered), Florida, Pennsylvania, Tennessee, Virginia and DC.

The reasons for their objection would seem to be equally applicable to many of the recent past mergers too, making their proud puffery sound slightly out-of-place.

Attorney General Eric Holder thundered

Airline travel is vital to millions of American consumers who fly regularly for either business or pleasure.  By challenging this merger, the Department of Justice is saying that the American people deserve better.  This transaction would result in consumers paying the price – in higher airfares, higher fees and fewer choices.  Today’s action proves our determination to fight for the best interests of consumers by ensuring robust competition in the marketplace.

I have to be careful – it sounds almost as if I’m complaining about the DoJ action now.  That’s of course not so, but it does beg the question ‘If now, why not before?’.  Why has the DoJ waited until now to take assertive action?  There is nothing unique in this merger that wasn’t also a factor in the other two recent mega-mergers, or to lesser extent in all the smaller mergers dating back to de-regulation in 1979 and even the mergers prior to that time, too.

One almost wonders if the triggering event this time was the concentration of airline market share at the politician’s and bureaucrat’s own airport – Washington’s Reagan National?  It is one thing when you see airports that are remote and ‘irrelevant’ to the DC commuting crowd either become uncompetitively dominated by the merged airline or else massively downgraded from a hub to a spoke, but when a merger would place 69% of all flights to/from DCA in the hands of one airline, that finally gets the politicians and their bureaucrats to sit up and take note.

True, not all mergers have been anti-competitive, but the most recent ones, passively approved by the DoJ (and DoT and state attorneys general) have been egregiously obvious in their anti-competitive implications.

Mergers are Sometimes Good

In case you wonder, we definitely concede that a merger may be ‘good’ when it is between two small airlines with largely non-overlapping route systems, creating a new larger sized carrier with a better route system, resulting in a new ‘major’ airline – for example, let’s look all the way back to the merger between North Central Airlines and Southern Airlines in 1979, becoming Republic Airlines.  That took two smaller regional players and created a new national airline.

As an interesting postscript to that merger, Republic in turn merged with and into Northwest in 1986, and it could be argued that the merger took two successful airlines and created one predestined for subsequent weakness and failure.  A bad merger followed a good merger.  Here’s an interesting history of that merger, and of course, today Northwest too is no more, now being subsumed into Delta.

A merger may also be acceptable when the alternative is the closure of the failing (failed) airline – for example AA’s buyout of the ailing TWA.  And if a buyer could have been found for Braniff or Eastern (among many other airlines that just closed completely) that may have been preferable to seeing the airline disappear.

But when a merger occurs between two already large full service airlines that both posted way above average profits in the last quarter, what is the underlying rationale and who will benefit?

The Airlines Make a Noose then Stick Their Heads In It

The most delightful thing about the DoJ objection was the information they relied upon to support their objection.  Sure, they could have quoted from our many past columns on the issue!  But they found an even more credible source to confirm their assertion that this merger would be anti-competitive and would harm travelers, who would suffer some unholy combination of higher fares, higher fees, and fewer flights.

The DoJ pointed to American’s own future plans to profitably trade as a standalone airline, with such plans developed as recently as January this year.  If AA can be profitable as a standalone airline, why does it need to merge?  They offered up quotes from American Airlines such as

  • An internal analysis at American in October 2012, concluded, “The [Advantage Fares – deeply discounted fares] program would have to be eliminated in a merger
  • Another American executive said that same month, “The industry will force alignment to a single approach–one that aligns with the large legacy carriers as it is revenue maximizing”

The DoJ also pointed to statements from US Airways’ President Scott Kirby and CEO Doug Parker over the last year or so, with quotes such as :

  • President Scott Kirby said, “Three successful fare increases – [we are] able to pass along to customers because of consolidation.”
  • At an industry conference in 2012, Kirby said, “Consolidation has also…allowed the industry to do things like ancillary revenues…. That is a structural permanent change to the industry and one that’s impossible to overstate the benefit from it.”
  • As US Airways CEO Parker stated in February 2013, combining US Airways and American would be “ the last major piece needed to fully rationalize the industry.”
  • A US Airways document said that capacity reductions have “enabled” fare increases.

With such damning comments as these, from the executives of the two airlines, there’s really very little more that needs to be said (other than ‘I told you so’!).

Here’s the full text of the DoJ press release.  The complete court filing spans some 56 pages of material.

The Industry Responds

All of a sudden, industry commentators woke as if from a deep trance, and discovered that the airline merger would be a bad thing.

Columns opining that point appeared in leading trade and general publications, such as the Wall St Journal, the New York Times and London’s Financial Times.

One has to ask where were the howls out outrage at the earlier stream of news about the progress of the merger.  Instead, the primary response was to obediently parrot the press releases from the airlines.

There was another significant response to the announcement as well.  AA shares lost half their value, and US Airways’ shares dropped 13%.  Bloomberg’s ten carrier US Airlines index dropped 6% on the news.  Clearly, investors anticipated increased profits from all airlines if the merger proceeded, and now is worried that the airlines will have to lift their game and lower their record level profits, with a bit more competition rattling around.

If common sense and basic economic theory is insufficient, and the airline executives own words weren’t strong enough a confirmation of the anti-competitive effects of this merger, the ultimate bottom line has to be the stock market negative response.

The Airlines Respond

Did the airlines say ‘Fair enough, you caught us’?  Did they concede that, well, yes, their statements did indeed rather overrule their standard series of empty claims that the merger was essential and would boost consumer choice and competition?

No, of course not.  Quite the opposite.  They doubled down and renewed their empty claims.  Astonishingly, and showing no shame, they restated their claim that this would be a pro-competitive merger that would create a broader airline network and more choices – see this article quoting US Airways’ CEO Doug Parker, and headed ‘We Will Fight Them’.

Yes, merging two carriers into one is supposed to give you more choices.  Go look at flights between most cities in the US, and note how currently you can fly on either AA or US between the two cities, usually with a change of plane somewhere in the middle.  Now imagine the situation with only one merged carrier rather than two.  Does that look like ‘more choices’ to you?

While the two airlines claim the merger will only impact on 12 routes, these are only the point to point non-stop routes where they directly compete.  It ignores all the routes that most of us would fly on normally, where either or both airline choices take you through a hub.  Because, for example, to get from Los Angeles to Miami, AA might fly you through DFW or ORD and US might fly you through PHX or CLT, the two carriers pretend they don’t compete on that route.

The DoJ points out there are some 1100 such city pairs where the two airlines in fact do compete, via their respective hubs, and suggests that losing the competition on those 1100 city pairs would not be a good thing for us.

The DoJ also came close to expressing regret at not having opposed earlier airline mergers, pointing out that the observed benefits of past mergers had failed to live up to the airline promises.  That is hardly a revelation to many of us, and it is great the DoJ is now catching up with the marketplace.

What Can We Expect to Eventually Result

It is hard to know what the final outcome may be.  There have been rare cases in the past where the DoJ has successfully opposed a merger, causing it to be discontinued – for example, the proposed US Airways and United merger in 2001.  United decided, the same day as the DoJ announced its opposition to that merger, to abandon its plans to merge.  Of course, with the benefit of hindsight, twelve years later, one might wonder exactly what that DoJ ploy actually achieved – United subsequently merged with (much larger than US Airways) Continental, and US Airways subsequently merged with America West.

More common has been a conditional approval that requires the airlines to give up some of their slots at key airports, a condition that after some negotiating, is subsequently complied with by the airlines, and final approval given.

Although the DoJ has specifically highlighted its concern about the impact on its own ‘hometown’ airport, Reagan National Airport in DC, it hasn’t said ‘If you release xx number of slots, we’ll withdraw our opposition’.

One also has to guess that the DoJ’s public statement and filing of a formal suit opposing the merger did not burst into life without prior warning.  It seems very likely that the DoJ had preliminary discussions with the airlines, indicating their concerns, and seeking compromise points that would give the airlines a merger with some constraints, and clearly, any such negotiations failed, and the bellicose responses by the two airlines in public now seems to make it unlikely for a quick ‘kiss and make up’.  Certainly, the near instantaneous collapse of the earlier UA/US merger after the DoJ’s opposition is not being repeated here.

On the other hand, what we see in public does not necessarily accurately reflect the backroom negotiations and subsequent lobbying efforts, even though the attorneys general of the airlines’ home states have joined in the suit as well.

So get ready for massive public posturing and misinformation by the airlines.  It also seems likely the airlines will have a surprise partner on their side – their unions, who have agreed to the merger.

Let’s welcome the DoJ decision, and hope the merger is abandoned.

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