Flurry of mergers could reshape airline industry

Laurence Zuckerman

Monday, June 5, 2000 | 11:05 a.m.

International merger

British Airways and KLM Royal Dutch Airlines are exploring a possible merger that would link two of the largest international airlines, the Wall Street Journal reported today.

The road to the future of the domestic and perhaps even the global airline industry now appears to pass through Minneapolis.

That is where Northwest Airlines has its headquarters. And in the wake of last week's announcement by the UAL Corp., the parent of United Airlines, that it plans to buy US Airways for $4.3 billion, the chairman of Northwest, Gary L. Wilson, and the chief executive, John H. Dasburg, are suddenly the men to see.

Speculation about other airline deals began minutes after UAL announced its agreement with US Airways. Few competitors play the game of copycat more obsessively than the airlines, which instantly match each other's prices and take only slightly longer to offer the same amenities from mystery meat sandwiches to greater (or less) leg room.

So it is no surprise that executives at AMR Corp., the parent of American Airlines, have already had preliminary talks with their counterparts at Northwest, as executives speaking on condition of anonymity have confirmed. One person close to the talks said that Northwest made it plain that it was looking for a big price, an indication of the strong hand the airline executives believe they hold. The negotiations have adjourned while AMR considers its next move.

"Their view is that the pricing of the US Air deal is essentially the floor," the person said.

Spokesmen at AMR, Northwest and Delta Air Lines would not comment on the speculation. They have been quiet since the United-US Airways deal was announced, which may be because their bosses have not yet decided to try to block the deal or propose their own mergers.

For American and Delta, the second- and third-largest domestic carriers after United, the US Airways deal is a direct threat. Should it be consummated, United -- which is already the world's largest airline and boasts the most successful international airline alliance -- would become about 50 percent bigger than its nearest competitor.

That means that if you are a frequent flyer based in Chicago, where United and American have a roughly equal share of flights from O'Hare Airport, United, with its larger network, would suddenly look much more attractive than American. The same would apply on the East Coast, where Delta customers would be attracted to United after it was supplemented by US Airways' large network of flights from Maine to Florida.

"This development is simply too large/threatening for AMR and Delta to do nothing," Brian Harris, an analyst for Salomon Smith Barney, wrote to his clients this week, referring to the UAL-US Airways deal.

The same fears were behind a series of hastily arranged domestic alliances two years ago. On Super Bowl Sunday 1998, Northwest beat out Delta and bought a controlling stake in Continental Airlines, forming an alliance between the country's fourth- and fifth-largest airlines. Three months later, United and Delta and American and US Airways announced their own separate alliances.

But the concern about the threat from a Northwest-Continental combination subsided after the antitrust division of the Justice Department sued to force Northwest to sell its stake in Continental. That suit is still pending and has led many to believe that the United-US Airways merger will not be approved either.

But for the moment Northwest still owns its stake in Continental, which gives it control over that airline's destiny and thus unusual leverage in the next round of deals. Most analysts and airline executives believe that the most natural merger combinations are American and Northwest and Delta and Continental. But Delta cannot make a move for Continental without talking to Northwest.

AMR is widely seen as leading the charge because of its heated competition with United. "American Airlines spends every waking hour measuring themselves against United," said one rival airline executive who insisted on anonymity. "There is no way they are going to let this one go unanswered."

American, which is particularly strong in the Southwest, would complement Northwest's large presence in the upper Midwest, where it has hubs in Minneapolis and Detroit. Northwest would also give American a large presence in the Pacific.

Another little noticed factor is Northwest's strong alliance with Royal Dutch KLM. The two carriers have been granted antitrust immunity to combine their operations across the Atlantic. KLM, which recently backed away from plans to merge with Alitalia, is looking for another partner and there has been speculation that it might combine with British Airways, which is now American's principal global partner. If British Airways and KLM should merge, Northwest would probably have to be included.

American could try to outbid UAL for US Airways but the consensus in the industry is that UAL's offer of $60 a share is already high. One AMR executive who insisted on anonymity said that the company had recently looked at making a bid for US Airways but thought it was not worth the price at $25 a share.

American and Delta could also lobby the Justice Department to oppose the United-US Airways deal but that is a risky strategy if they should fail. The other advantage of an American-Northwest deal, which most people believe would pave the way for a Delta-Continental merger, is that it would present the Justice Department with the prospect of seeing the country's six largest airlines reduced to three.

"I can't imagine Joel Klein letting that happen," said the executive, referring to the head of the Justice Department's antitrust division. A return to the status quo is much more attractive to American and Delta than seeing United swallow US Airways.

Northwest's enviable position has already sent its share price soaring. Friday it closed at $35.4375, up $6.375 in Nasdaq trading. It has risen $11.3125, or 47 percent, since UAL announced its bid for US Airways on March 24. Analysts say that AMR and Delta have to move within 30 to 45 days to get their deals before the Justice Department alongside the United and US Airways.

Wilson of Northwest is known for driving a hard bargain but Northwest is still only valued at $2.9 billion. AMR could offer a 50 percent premium over its price before the recent climb and still pay less than $4 billion.

"American is facing a fork in the road," said the person close to its negotiations with Northwest. "They either have to come back with the big price it's going to take to get Northwest to talk, or they have to conclude that they are going to try to stop the US Air deal."