As United Continental (NYSE:UAL) merges the operations of its predecessors (United Airlines and Continental Airlines) the integration of its labor groups has been one of the toughest tasks. Full integration is necessary for United to realize the synergies it expects from the merger. While United's management originally hoped to complete integration in 12-18 months, significant work remains to be done more than two years after the merger was finalized on Oct. 1, 2010.
Two weeks ago, United took another step toward completing the integration of its labor groups. The company announced that it had reached a tentative agreement with the IAM union, which represents more than 28,000 fleet service workers, customer service agents, and storekeepers for United. While it is critical for United to complete these new labor contracts, it has only done so by writing big checks to its labor groups. These costs may be filed away as "special items" in United's earnings reports, but they are eating away at United's cash flow nonetheless.
United completed a new labor contract with its pilots last year. The pilot agreement boosted pay by an average of 43.2%, but also included a $400 million lump sum payment: roughly $40,000 per pilot. Including other costs, the ratification of the agreement led United to take a $475 million charge last year. The primary justification for the lump sum payments is that they represent retroactive pay; in other words, they make up for raises that employees would have received while negotiations were occurring.
This month's IAM agreement will also include a significant amount of retroactive pay. The IAM states that the current contract ought to have been completed as early as 2010, and employees have lost substantial income (in the form of foregone raises) due to the delay. According to a preview of the agreement released by the IAM last week, workers will share a total of $130 million in retroactive pay. The wage raises included in the agreement are fairly modest (5%-10%), but workers will also receive additional protection against layoffs and perks like more vacation time.
The short-term costs of United's new labor agreements are significant, and it could take many years for United to make up for these front-loaded costs in future savings. While United ended last year with plenty of unrestricted cash ($6.5 billion), that is down by $2.2 billion from the end of 2010, and is offset by United's heavy debt burden. The one-time costs of United's new labor agreements are just one reason why United is probably a value trap.
Another major airline merger is on the horizon, with American Airlines (NASDAQOTH:AAMRQ) and US Airways (NYSE:LCC) having recently announced their intention to merge. There are plenty of reasons to believe merger integration will be very expensive for American and US Airways, just as it was for United and Continental. With labor groups at both carriers having earned much less than the industry average for a long time, "retroactive" pay bonuses could soon haunt American and US Airways, too.
Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.