One good merger needs another
In 2008, Delta Air Lines, Inc. (NYSE:DAL) and Northwest Airlines both exited the bankruptcy process and announced their intent to pursue an all-share merger. Northwest shareholders would get 1.25 Delta shares per Northwest share, and the new airline would become the world’s largest under the name Delta Air Lines.
Both United and Continental recognized the benefits that could be realized through airline integration, and pursued on-and-off merger talks before finally reaching a deal in 2010, giving Continental shareholders 1.05 United shares per Continental share.
However, the United-Continental merger has been encountering airline-merger turbulence over the past few years. Instances of computer glitches and reservation-system crashes have left passengers angry, while integration costs made United the only major U.S. airline to post a loss for 2012. And even so, the two carriers are not fully integrated yet, leaving investors to wonder whether United Continental Holdings Inc (NYSE:UAL) will eventually take off again.
When savings outweigh costs
No one ever said merging two multibillion-dollar airlines would be easy. Airlines have their own cultures, their own systems, and their own unexpected surprises. Reconciling all these differences will inevitably cost time and money upfront to realize benefits later. Delta experienced a similar pattern with its Northwest merger, as US Airways Group, Inc. (NYSE:LCC) did with its 2005 America West merger. Today, Delta is flying as an integrated airline and US Airways, despite not having unified its work rules, has been able to post profits and is pursuing a merger with American Airlines.
It is important to realize that merger-related costs are not recurring expenses. Some of United Continental’s costs related to things such as a pilot’s payment agreement and the repainting of aircraft. Presumably, once the aircraft are painted in the new United Continental colors, they should not need to be repainted any more often than if no merger had occurred.
As these costs move out of United Continental Holdings Inc (NYSE:UAL)’s quarterly reports, the company should begin to realize savings from the merger. Whether the airline reaches the $1 billion goal still remains to be seen, but analysts are already predicting increasing earnings over the next few years.
| Year | Earnings |
| 2011 | $2.26 |
| 2012 | ($2.18) |
| 2013 | est. $3.37 |
| 2014 | est. $4.84 |
Source: 4-traders.com.
Other examples
The airline merger making headlines today is not the years old United Continental merger, but the expected US Airways American Airlines merger. When Delta merged with Northwest, it claimed the title of world’s largest airline. United took the position when it merged with Continental and American Airlines will hold the crown after the latest merger is finalized.
While this airline empire-building is expected to produce savings down the road, following in the footsteps of the Delta and United mergers, the US Airways merger will likely produce major integration costs over the next few years. Additionally, US Airways will have to manage this merger while confronting labor issues existing within the current US Airways. How successful will the merger be? That will only become clear over the next five to 10 years. But US Airways investors should expect some turbulence along the way to their potentially sunny destination.
A merger pattern
Since 2008, the number of major airlines in the U.S. has been reduced significantly. Delta merging with Northwest, United with Continental, Southwest with AirTran, and the expected US Airways with American Airlines. These mergers tend to follow a pattern over a few years of benefits stated, costs incurred, and benefits realized. Delta has entered the final stage and is pursuing other opportunities with Virgin Atlantic and running its own oil refinery. United Continental Holdings Inc (NYSE:UAL) is moving closer to the end of costs incurred with greater earnings expected over the next few years. And US Airways is beginning the process and will enter the costs stage after the merger is approved by regulators. Mergers have reshaped the airline industry and potential airline investors need to recognize the costs and benefits of airline mergers on their potentially high-flying investment.
The article Skies Clearing for This Merged Airline originally appeared on Fool.com and is written by Alexander MacLennan.
Alexander MacLennan owns shares of Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned. Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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