4 Questions for United and Continental

This morning, UAL Corp. (Nasdaq: UAUA  ) and Continental Airlines (NYSE: CAL  ) made official what many of us have long expected. The two carriers will combine in what the companies call a "merger of equals," unseating Delta (NYSE: DAL  ) as the world's largest airline by revenue.

If approved, the deal would give Continental shareholders 1.05 shares of UAL Corp. Current UAL shareholders would own approximately 55% of the combined airline, which executives say should realize $1 to $1.2 billion in "net annual synergies" by 2013, with $800 to $900 million of that coming in the form of additional revenues.

"This merger will help break the cycle of instability," Continental CEO Jeff Smisek said in touting the merger during a conference call with analysts.

Smisek will take over as chief executive of the combined enterprise while UAL CEO Glenn Tilton continues as non-executive Chairman for a period of at least two years.

Merging equals, creating inequality
More than anything, this deal combines two carriers with extensive global networks while plugging holes on two continents. United gets stronger in South America, and Continental gets stronger in Asia.

The deal also puts pressure on AMR Corp. (NYSE: AMR  ) and US Airways (NYSE: LCC  ) , once thought to be a potential United partner. Each carrier will have to go it alone in a market that's become known for consolidation, high fuel prices, and packed-to-the-gills airplanes.

But this merger stings for US Airways more than it does American. Last month, US Airways CEO Doug Parker told pilots that a provision in their contracts that would allow for higher wages following a business combination wouldn't be retained were a deal reached with UAL or any other airline, TheStreet.com reported.

The implication? Parker wants to make his airline as attractive a takeover candidate as possible, even more so now that he's been spurned by Delta and United.

American is much more likely to be an acquirer than acquired, and US Airways, as the last of the hub-and-spoke carriers, may be all that's left worth buying. And that's not saying much.

"Hub-and-spoke" refers to a system designed around "hubs" where carriers originate most flights daily and through which connections are made. Point-to-point carriers such as Southwest Airlines (NYSE: LUV  ) differ by offering a series of direct flights through city pairs. These differences in route structure make it unlikely that American or any other of the Big Legacy carriers would make a bid for a low-fare rival.

Four questions that need answering
Regulators will take into account all this and more into account when deciding whether to approve the UAL-Continental combination. Investors will get their say in September, when shareholders vote on the deal.

Much as I favor the proposed acquisition, I'm not ready to rubber-stamp this arrangement just yet. Smisek and Tilton still have four questions to answer:

1. How much capacity will be cut?
UAL and Continental project as much as $900 million in revenue synergies. Does anyone believe this will come from new routes? I don't. More likely is that the carriers will normalize their flight schedules and cut flights on duplicate routes, reducing available seat miles and thereby artificially boosting demand. Tell me I'm wrong, sirs. Go ahead, I dare you.

2. What does this mean for the fleets?
Together, UAL and Continental had plans to purchase 50 of Boeing's (NYSE: BA  ) new 787 Dreamliner aircraft. Will the new carrier need this many efficient long-haul jets, or should we expect Smisek and Tilton to cut back on orders while they assess their combined route structure? I'm guessing the latter but I'd like an answer. So would Boeing investors, I suspect.

3. Will prices go up?
This goes in hand with the first question but pricing isn't just a matter of capacity. Fewer airlines mean fewer fare wars, which could lead to higher overall prices. I'm fine with higher fares, if only because seat pricing hasn't kept pace with the cost of fuel. Regulators may be less understanding.

4. How will management be compensated?
This is the one that bothers me most. A merger of this size is bound to be a complex beast. Executives will be due healthy payouts at the end of it all, and that's fine. But United, in particular, has a history of paying for underperformance. Shareholders should boycott this deal unless a full and fair accounting of how management is to be paid is included with the proxy materials.

Tell us how you'll be measured, sirs. As shareholders -- nay, owners -- we'll tell you whether what you propose is worth paying for.

Will you fly the new United? Discuss in the comments box below.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy is taxiing. Are you ready for take-off?


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  • Report this Comment On May 03, 2010, at 5:31 PM, raodyssey wrote:

    Both CEO's gushed about their potential fairy tale wedding this morning and they will be well rewarded on this deal, particularly UAL's Tilton. Labor issues for these carrier's are looming but nobody wants to ruin the party. Take United, who up until very recently was the poster child for a dysfunctional airline with shares in the $3 range as little as nine months ago. UAL lost $11.7B since 9/11 and spent three years in bankruptcy. The bad blood they created with labor cannot be underestimated. Take United pilots for example. They lost their pensions, 40-60% of their pay depending on position, and a third of their numbers in a system where seniority is everything. Similar horror stories can be had in UA's other labor groups.

    Now these employees will have the most negotiating leverage they've had in decade to get this deal to work and all their contracts are expired. One would expect quite a bit of payback is in order. Continental does have its own labor issues but not nearly as bad as UA.

    In the end Labor will absorb much of the expected synergies. Thats if $100 oil, The bigger Iceland Volcano, or the next airline revenue eating unknown event doesn't get to it first...

  • Report this Comment On May 04, 2010, at 8:55 AM, ARJTurgot wrote:

    I don't think there is any way to make money on airlines, other than shorting the stock. raodyssey - you failed to mention that pretty much all of their customers hate them too...

  • Report this Comment On May 04, 2010, at 11:15 AM, plange01 wrote:

    only one question will they merge or declare bankruptcy first? which order?

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