This Will Be the Next Big Airline Merger

Delta (NYSE: DAL  ) and Northwest (NYSE: NWA  ) last night approved a $17.7 billion merger that will unseat AMR's (NYSE: AMR  ) troubled American Airlines as the nation's largest domestic carrier.

But that isn't news to you, right? Pilots for both airlines have been negotiating a combined seniority list for months. Northwest's management, meanwhile, has been publicly salivating over the possibilities.

Now that a deal is done -- in principle, at least -- analysts and reporters are today speculating that further combinations will follow. A deal between UAL (Nasdaq: UAUA  ) and Continental (NYSE: CAL  ) is seen as being the most likely, according to The Associated Press.

How about an explanation?
It'd be nice if these Kreskins gave us at least one reason why a UAL-Continental merger makes as much sense as a Delta-Northwest deal does.

Why would UAL and Continental combine now? Because oil costs more than $113 a barrel? Because an "Open Skies" agreement with the European Union allows for more foreign competition in our airspace? Because low-cost carriers have made it necessary to cut costs however and wherever possible?

Yes, yes, and yes.

But there's also this, which you'll find tucked away in the "risks" section of Continental's most-recent 10-K annual filing:

Our ability to engage in a business combination is currently restricted by our Series B preferred stock held by Northwest Airlines. Additionally, the ability of any third party to acquire us could be limited by our stockholder rights plan and Northwest's ability to block our redemption of the rights under certain circumstances. The execution of a definitive agreement by Northwest with respect to a transaction constituting a change of control of Northwest would, under certain circumstances, enable us to redeem the Series B preferred stock held by Northwest for a nominal sum, eliminating Northwest's right to prevent us from engaging in a business combination. [Emphasis added.]

Translation: Even if we were interested in a deal with United, Northwest would have to approve it. Unless, of course, Northwest went away.

Cleared for take-off
Now, combine that with this tidbit from UAL's most-recent 10-K filing: "If other airlines participate in merger activity, and United does not, those airlines may significantly improve their cost structures or revenue generation capabilities, thereby potentially making them stronger competitors of United." [Emphasis added.]

That, too, is filed under "risk factors." The rub? Both UAL and Continental see risks in not combining in the wake of a merger of peers.

What's more, they've been talking about a deal since at least 2006, when Goldman Sachs was hired to explore "strategic alternatives" for United.

The rationale for a UAL-Continental merger remains as sound today as it was then. Both airlines fly similar aircraft. And since each carrier features distinct hubs from which they fly, there would be less integration work and fewer layoffs. Have a closer look:

Aircraft

United

Continental

Airbus A-319

55

None

Airbus A-320

97

None

Boeing 737

94

267

Boeing 747

30

None

Boeing 757

97

58

Boeing 767

35

26

Boeing 777

52

20

What you don't see there is Continental's order of 25 of Boeing's (NYSE: BA  ) oft-delayed 787 Dreamliner aircraft. United has yet to commit to the 787. It wouldn't have to, were a deal for Continental to be reached.

Ring the synergy bell, please.

(Ding!)

Thank you. Now, let's talk hubs:

Hub

United

Continental

Chicago

X

 

Cleveland

 

X

Denver

X

 

Guam

 

X

Houston

 

X

Newark

 

X

San Francisco

X

 

Washington, D.C.

X

 

Los Angeles

X

 

Overlap? What overlap?

(Ding!)

As of publication time, calls to Continental PR asking whether management had plans to redeem the so-called "golden share" Northwest will forfeit in its merger with Delta weren't returned.

My guess is that Continental can't comment. And that's fine. Let the talks continue as they have. This deal will get done. The sooner, the better, I think.

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