The proposed merger between AMR Corporation (OTCBB:AAMRQ) and US Airways Group Inc (NYSE:LCC) is reaching the final stages of the antitrust review process. The Department of Justice has been taking depositions recently, in an effort to gather testimony that will inform its decision of whether or not to approve the merger.
The biggest antitrust concern by far relates to the combined carrier’s dominance of Washington’s Reagan National Airport. The airport operates under capacity controls, and US Airways Group Inc (NYSE:LCC) already controls more than half of the slots there following a slot swap with Delta Air Lines, Inc. (NYSE:DAL) that was completed last year. Following the merger, the new American Airlines would control 68% of the airport’s slots.
US Airways Group Inc (NYSE:LCC) CEO Doug Parker — who will lead the combined carrier — has argued strongly that the government should not require the carriers to sell off slots at Reagan Airport as a condition of the merger. However, on balance it is very clear that the merger will decrease competition at the airport, which is not very competitive to begin with. As a result, the DOJ is ultimately likely to require some slot sales to other airlines, allowing low-cost carriers like Southwest Airlines Co. (NYSE:LUV) and JetBlue Airways Corporation (NASDAQ:JBLU) to increase service at Reagan Airport.
Washington’s preferred airport
The crux of Doug Parker’s argument against slot sales is that American and US Airways Group Inc (NYSE:LCC) would have only 25% of the seats in the Washington market. He includes all three Washington-area airports — Reagan Airport, Dulles Airport, and Baltimore-Washington Airport — to arrive at that figure. United Continental Holdings Inc (NYSE:UAL) operates a hub at Dulles, and Southwest Airlines Co. (NYSE:LUV) has one of its largest focus cities in Baltimore, offsetting the dominance of US Airways Group Inc (NYSE:LCC) at Reagan Airport.
However, anyone who has lived in Washington, D.C., knows that Reagan Airport is vastly more convenient than the area’s other two airports. Whereas BWI and Dulles are both more than 25 miles from downtown, Reagan Airport is just 5 miles away and is directly connected to the Washington Metro system.
As a result, high-paying business travelers prefer to travel from Reagan Airport when possible. US Airways Group Inc (NYSE:LCC)’ dominant position at this desirable airport has made Reagan Airport the second-most profitable airline hub in the country, according to US Airways President Scott Kirby. (It trails only United Continental Holdings Inc (NYSE:UAL)’s hub at Newark Airport, which is also slot constrained. Not surprisingly, United and Continental had to agree to lease 18 Newark slot pairs to Southwest Airlines Co. (NYSE:LUV) as a condition of their merger in 2010.)
The “loss of service” threat
Executives at US Airways and American have tried to bolster their case to keep all of their slots at Reagan Airport by arguing that if they lost slots, they would have to cut service to some small East Coast and Midwest cities. As a result, more than 100 lawmakers representing such “at-risk” cities have petitioned the DOJ to allow the merged carrier to keep all of its slots at Reagan Airport.
However, despite their pleas to the contrary, the two carriers probably could shed some flights at Reagan Airport without cutting service to any cities. Two of the 12 nonstop routes on which US Airways and American overlap involve Reagan Airport. In fact, the two airlines are the only carriers flying from Reagan Airport to Raleigh-Durham and Nashville.
In the case of Raleigh-Durham, US Airways and American offer seven peak-day round-trip flights each, the vast majority of which are on inefficient small regional jets (offering 50 seats or less). The combined carrier could use larger regional jets or mainline aircraft to offer the same amount of capacity (or more) with half as many flights. This would free up seven slot pairs that could be sold without impacting service. The two carriers’ combined eight round-trips per day to Nashville also primarily use 50-seat regional jets, and could also be trimmed by deploying larger airplanes.
The two carriers could thus free up 10 slot pairs just by rationalizing capacity on the two routes where they compete today. If the DOJ demanded additional slot sales, it might lead to service cuts at smaller airports. However, that negative effect might still be outweighed by the increase in competition on routes to larger cities, as more passengers travel on those routes and would benefit from lower prices.
Barbarians at the gate
The main reason why the new American Airlines wants to hold on to all of its slots at Reagan Airport is not to continue service at small airports, but rather to prevent competition at larger ones. Southwest Airlines Co. (NYSE:LUV) and JetBlue Airways Corporation (NASDAQ:JBLU) have both expressed an interest in expanding at Reagan Airport. For example, Southwest Airlines Co. (NYSE:LUV) bought two slot pairs from Spirit Airlines Incorporated (NASDAQ:SAVE) last year in order to introduce service to St. Louis: the first competition for American’s route between the two airports.
Southwest Airlines Co. (NYSE:LUV) could also be interested in flying to Nashville (where it is by far the largest carrier), a route for which the new American would otherwise have a monopoly. Southwest might even reintroduce competition on the route to Raleigh-Durham; it has a 24% market share there. Nonstop routes to cities like Dallas, Indianapolis, Charlotte, Pittsburgh, and Hartford — all currently monopolized by American or US Airways — could also be attractive to low-cost carriers.
The real scoop
One of the reasons why many smart investors have historically avoided airline stocks is that it is hard to generate a competitive advantage, or a “moat”. Instead of working to create competitive advantages for the new American Airlines, the company’s management has essentially asked the government to build a moat for it by giving it a dominant share of the slots at Reagan Airport.
This is a savvy business move, but regulators at the Department of Justice are likely to see through it. If American and US Airways have to sell off slots at Reagan Airport as a condition of their merger, low cost carriers like Southwest and JetBlue Airways Corporation (NASDAQ:JBLU) will benefit, as they have had trouble growing there because of the slot constraints. Travelers in the cities that finally see competition on routes to Reagan Airport will also be big beneficiaries. American’s management team might complain, but it would be a clear failure of the antitrust system if the carrier is allowed to amass a dominant share of the slots at one of the country’s most desirable airports.
The article Washington: The Key Battleground of the American-US Airways Merger originally appeared on Fool.com is written by Adam Levine-Weinberg.
Adam Levine-Weinberg is short shares of United Continental Holdings (NYSE:UAL) and is long Sep 2013 $33 Puts on United Continental Holdings. The Motley Fool recommends Southwest Airlines. The Motley Fool owns shares of SPIRIT AIRLINES INC. (NASDAQ:SAVE).
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