Battle of the Airlines – Mergers & Consequences

When it comes to domestic airlines, there are four main players in the US – Delta Airlines (DAL), US Airways Group (LCC), United Continental (UAL) and American Airlines, which filed for bankruptcy protection in November. However, if DAL has its way, that all could soon change.

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Delta Looks to US Airways for Possible Acquisition Deal

DAL, a member of the SkyTeam Alliance, is the world’s largest airline by traffic when counting domestic and international travel according to the International Air Travel Authority (IATA). It transports just under 111.16 million passengers on domestic and international flights a year, 90.13 million of which are domestic. Delta Airlines (DAL) has been studying US Airways Group (LCC) as a possible acquisition target according to the Wall Street Journal.

In comparison, LCC carries roughly 51.81 million passengers (domestic and international combined), 45.53 million of which are domestic. If the number of passengers carried stays the same, an acquisition of LCC could put DAL at 135.66 million domestic passengers a year, easily beating out domestic rival Southwest Airlines (LUV) as the number one domestic carrier in the US. The deal would also push the number of Delta’s passengers carried internationally to the sixth in the world, up from its current eighth-place ranking.

The $1.45 billion market cap LCC is priced low relative to its earnings, with a forward P/E ratio of just 3.65, but it is priced a little high relative to its book value – Yahoo Finance reports LCC’s P/B ratio at 9.84 – however, its price to sales ratio is more encouraging at 0.10. LCC recently traded at $8.99 a share, on a mean one-year target estimate of $12.95. David Tepper’s Appaloosa Management is a fan of LCC.

DAL has not approached LCC.  According to the Wall Street Journal, it “is still weighing which deal if any would make most sense and have the best odds of success.” DAL’s last acquisition was Northwest Airlines in 2008. Ken Heebner’s Capital Growth Management initiated a $135.08 million position in DAL during the third quarter, suggesting the savvy fund manager is hopeful for what lies ahead for the company. Heebner also opened a holding in LCC during the third quarter, a position worth roughly $26.84 million.

Delta Looking at the Field, Including American Airlines

Delta (DAL) isn’t stopping there though. According to the Wall Street Journal, DAL has also been considering a similar move with AMR Corp., the parent company of its rival American Airlines. AMR Corp (AMR) entered bankruptcy protection in late-November.

OneWorld member American Airlines transports roughly 86.13 million passengers a year on international and domestic flights, ranking it third in the world. It is ranked fourth amongst domestic carriers, transporting over 65.77 million passengers domestically each year. If the number of passengers stayed the same, the union would transport over 41.37 million passengers internationally each year, which would bring DAL from eighth in the world, to third, coming in just behind Lufthansa’s 44.46 million passengers a year and Ryanair (RYAAY)’s 71.23 million passengers. This brings up some concern that a DAL-American combo would draw scrutiny from anti-trust officials. However, the Wall Street Journal writes, “Delta has conducted an antitrust analysis and believes with concessions, it would have a good chance of obtaining regulatory approval.”

US Airways Could Make a Play for American Airlines

US Airways (LCC), which is part of the Star Alliance, is open to being a buyer or a seller, and reportedly has considered teaming up with American Airlines. After all, it is not as if LCC hasn’t considered partners or acquisitions in the past. LCC itself is the product of a merger between the old US Airways and America West Airlines in 2005. Shortly afterwards, in 2006, LCC made a hostile bid for Delta worth $8.7 billion, but the deal fell through. More recently, in 2010, the company was in talks with United Airlines, but the latter opted to partner with Continental instead, forming United Continental (UAL), the airline stock popular with Ed Shapiro and Paul Reeder’s PAR Capital Management.

If LCC and American Airlines partnered together, the union would be on par with Delta (DAL) or UAL. The merger would increase the volume of passengers carried on domestic flights to over 111.30 million a year, just enough to nudge Southwest (LUV) out of the top domestic spot. The volume of passengers carried internationally would go up to just under 30 million, enough to push the union to the sixth spot amongst international carriers.

Airlines Under Pressure

The airlines are just in talks right now – any deal would be at least a year in the coming – but the pressure is clear. There has been a string of mergers and acquisitions in the air travel industry over the last seven years as airlines seek to become more competitive, offering more routes and lower fares. The consolidations have helped airlines survive money-losing routes, increased fuel costs and tighten control on hub airports, but it has also significantly reduced the number of major US carriers.

Case in point, United Continental (UAL) announced in early November a range of new international flight routes that will launch in the first half of this year. These new routes were included in the company’s previously announced capacity guidance. “Since our merger last year, the new United’s unmatched global route network and U.S. hub structure have allowed us to offer our customers more flights to more places they want to go,” said Jim Compton, executive vice president and chief revenue officer. “By adding these new international routes, we continue to put the right aircraft in the right markets to serve our customers’ needs.” Delta (DAL) and US Airways (LCC) may be trying to follow in UAL’s footsteps.

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