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U.S. Airways Looks to Buy Delta for $8 Billion

November 15, 2006 at 2:50 PM EST
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JEFFREY BROWN: U.S. Airways is the nation’s sixth-largest airline. It came out of bankruptcy only last year and merged with America West. Delta is the nation’s third-largest airline and still in the midst of bankruptcy.

Today, the smaller U.S. Airways made an $8 billion bid for the larger Delta. And if it’s successful, the new combined airline will be one of the largest carriers in the world, providing the most flights on the East Coast and in transatlantic travel.

Here to tell us what’s going on is Richard Gritta, professor of finance and transport in the Pamplin School of Business at the University of Portland.

Professor Gritta, let’s start with, why is U.S. Air making this bid? What does it want?

RICHARD GRITTA, University of Portland: Well, it wants to survive, just like everybody else. And to survive, the key thing now is to abandon the short-haul markets, where the lower cost carriers are basically bleeding the major or legacy carries dry. And so this makes sense. This makes sense to merge with a carrier that has a lot of international routes and go where you can make money.

JEFFREY BROWN: Now, remember, not that long ago there seemed to be obituaries in the works for U.S. Airways. How is it able now, so soon after coming out bankruptcy, to make an $8 billion bid?

RICHARD GRITTA: Well, they’ve got the backing of Citicorp, and that’s a big thing. They’ve got financial backing. And if you’ve got money, you can always do a deal. But I think they feel to survive the long run, they’ve got to do something, and the something is merge. And Delta makes sense for them.

Delta Air Lines

Richard Gritta
The University of Portland
Well, basically, the entire airline industry has -- absent a couple of carriers, like Southwest -- been a mess because of operating strategies that were flawed -- hub and spoke -- and financial strategies that were too aggressively using debt.

JEFFREY BROWN: Now, what about Delta? Explain their situation. Here they are struggling still to get out of bankruptcy. Tell us what they're going through.

RICHARD GRITTA: Well, basically, the entire airline industry has -- absent a couple of carriers, like Southwest -- been a mess because of operating strategies that were flawed -- hub and spoke -- and financial strategies that were too aggressively using debt.

So Delta for a while -- at least in the 1980s -- was a very healthy carrier. And then they loaded up with debt when they expanded in the late 1990s. And, of course, all the confluence of events have conspired to hurt all the airlines, including the run-up in fuel prices. So now they're looking at the problems of the vast majority of the carriers being so illiquid that they can't make their debt obligations, and so you seek bankruptcy.

JEFFREY BROWN: And Delta, of course, has all along said that it wants to come out of bankruptcy as an independent airline, but now it says it will review this offer. So does that mean there is still a possible fight to come? And could there also be some competing bids to come?

RICHARD GRITTA: Well, there could be a fight, but the thing you have to realize is, in bankruptcy, that it's really the creditors that control the situation. Under the Bankruptcy Reform Act, it's the creditors that will agree to any deal that's done. So management may not have any choice in the matter.

Problems and possible implications

Richard Gritta
The University of Portland
Well, as a simple economic principle, that if you allow mergers, what happens is there's less competition. And when there's less competition, prices can go up.

JEFFREY BROWN: Now, you've said that, in the case of U.S. Airways, that a merger might make some sense. There's always considerations when these things are proposed, there are pros and cons out there that analysts see. Lay that out for us a bit. What are the possible problems, for example, in trying to bring together two airlines like this?

RICHARD GRITTA: Well, as a simple economic principle, that if you allow mergers, what happens is there's less competition. And when there's less competition, prices can go up. Airfares have been relatively high in the international market for that very reason, because there's less competition. So that's a con.

On the pro side, the merger candidates will tell passengers that, "Look, you'll have more seamless travel. You can travel around the world on our carrier, and you can, of course, merge your frequent flyer miles and get awards faster." So there's two sides to the coin.

JEFFREY BROWN: Now, I was going to ask you next about the implications for consumers. You just said one possible implication is higher airfares. Tell us what else.

RICHARD GRITTA: Well, I think basically that's the biggest one that I would be concerned with, or the Justice Department will be concerned with. What will the mergers do to service and to fares?

Right now service, especially domestically, has fallen apart because of the financial pressures on the airlines, and the only reason why airfares are low in the domestic market is because of the presence of low-cost carriers like AirTran, like JetBlue, and, of course, the original role model for the low-cost carrier, Southwest.

The airline industry

Richard Gritta
The University of Portland
The industry has been, continues to be, very, very fragile.

JEFFREY BROWN: You know, this industry, having watched it for a long time, seems to go through these cycles of "bigger is better" at one point and then, "No, the smaller low-cost approach is the way to go." Where are we now in that kind of thinking, especially in light of this new potential merger?

RICHARD GRITTA: Well, I think the thinking now revolves around the fact that you can't make money locally if you're a major or legacy carrier against the start-ups because they have very different cost structures. Some of them, like Southwest, fly point-to-point service, which is a key we found in studies to minimizing your costs per available seat mile. That's the key unit in the industry.

So they feel like they have to go internationally where there's less competition, and they can sustain enough of a yield to make money. So that's new, I think, within the last five or six years, the realization that maybe they should abandon the short haul where they can't win for the long haul where, at least under the current situation, they can.

JEFFREY BROWN: What does that suggest to you about the possibility of floodgates opening here and more consolidation to come?

RICHARD GRITTA: Well, I've always believed -- we design bankruptcy tracking models, mathematical models that look at this industry. And we've got data clear back to about 1970. The industry has been, continues to be, very, very fragile.

So I expected fully that we'd see another major carrier go down, one way or another, either liquidate or, more preferably, merge. And a statistic that to me is shocking is, if you look at the 16 carriers that did exist or exist now that are major carriers, more than 10 of them now have filed receivership one or more times, and some of the classic names in industry have gone away. I mean, Eastern Air Lines, the Wings of Man, Braniff, Pan Am, and, of course, TWA disappeared forever. That's really sad.

Other airline consolidations

Richard Gritta
The University of Portland
A lot depends, you understand, on what happens to the economy, what happens to the price of fuel, interest rates, and how the union problems get resolved in all of this. And then finally, and very importantly, what the Justice Department does.

JEFFREY BROWN: So more of the big names out there, we may be hearing more about them, either trying to consolidate or merge or are experiencing more problems?

RICHARD GRITTA: Well, you know, I fully suspect that Northwest may start looking to partner up in, and a possible merger candidate there would be Continental. And Continental has been doing better of late, relatively speaking.

So we could see the disappearances of another two major carriers, in my estimation. A lot depends, you understand, on what happens to the economy, what happens to the price of fuel, interest rates, and how the union problems get resolved in all of this. And then finally, and very importantly, what the Justice Department does.

JEFFREY BROWN: All right. We wait to see on the Justice Department. We wait to see, of course, on what Delta says in response to this bid. Richard Gritta of the University of Portland, thank you very much.

RICHARD GRITTA: You're very much welcome.