If US Airways Can't Merge With American, Then It Should Consider Buying Hawaiian

Six months ago, US Airways (NYSE: LCC  ) announced its intention to merge with fellow legacy carrier AMR (NASDAQOTH: AAMRQ  ) , the parent of American Airlines. As the smallest of the network carriers, US Airways has long been interested in joining forces with another major carrier: either American, Delta Air Lines (NYSE: DAL  ) , or United Continental (NYSE: UAL  ) .

However, the U.S. Department of Justice has become increasingly concerned about the tacit coordination between major airlines that has enabled numerous fare and fee increases over the last several years. Accordingly, earlier this week, it filed a federal antitrust lawsuit to block the AMR-US Airways merger.

There is still a good chance that the American-US Airways merger will go through, with a few concessions by the merging carriers. One airline analyst, Dan McKenzie of Buckingham Research, suggested this week that there is now a 50-50 chance of the merger occurring. However, if the two companies are forced to ultimately abandon their merger attempt, US Airways should seriously consider another M&A candidate: Hawaiian Holdings (NASDAQ: HA  ) .

Merger rationale
The main purpose of the American-US Airways merger was to allow the smaller two network carriers to join together to better compete with United and Delta. When dividing the country up into west, central, and east regions, neither American nor US Airways is in the top two spots for domestic market share in any region.

By contrast, the merged carrier would be No. 1 in the east and central regions (but No. 3 in the west). This enhanced network was expected to help the combined carrier win back lucrative corporate market share.

A secondary reason for the merger was that it would allow American and especially US Airways to raise the pay rates of their employees to the industry standard. US Airways employees have historically earned less than peers at larger carriers. US Airways executives have repeatedly explained that the company's hubs are in smaller cities and that it therefore needs lower costs to offset a 10% revenue disadvantage compared to the other major carriers.

An alternate plan
If the DOJ will not budge, US Airways will need another strategy. Clearly, if it cannot merge with American, it will not be allowed to merge with Delta or United either. Low-cost carriers would also probably be out of play because a merger that removed a low-cost carrier would be equally anti-competitive.

Instead, US Airways could consider buying Hawaiian Airlines. Hawaiian has one major advantage that no other potential M&A target can match: a robust international network. Today, US Airways flies to three continents: North America, South America, and Europe. Hawaiian flies to two, North America and Asia, as well as Oceania.

In fact, whereas American and US Airways combined fly to just five destinations in Asia, Hawaiian Airlines already serves seven Asian destinations -- mostly in Japan -- and it is planning to add service to Beijing next year. Hawaiian also flies to five cities in Oceania, spread out among Australia, New Zealand, Tahiti, and American Samoa. Neither American nor US Airways flies anywhere in Oceania (although they have alliance partners that fly there).

In other words, buying Hawaiian Airlines would add two new regions and 13 international destinations to the US Airways route map. With Hawaiian's strength in Hawaii and US Airways' good position on the East Coast, a merger would probably enable US Airways to add service between Honolulu and its East Coast hubs in Philadelphia and Charlotte. This would in turn allow connections between virtually any US Airways destination and any Hawaiian Airlines destination.

Lastly, buying Hawaiian would be relatively cheap for US Airways. Hawaiian has a market cap of around $375 million, but the company had cash and cash equivalents of $478 million at the end of last quarter. In other words, US Airways could pay a significant acquisition premium without dipping very far into its own coffers; for the most part, it would just have to assume Hawaiian's debt.

A few drawbacks
While Hawaiian Airlines seems like a desirable acquisition target for US Airways if its merger with American falls apart, it's not a perfect match. First, while Hawaii is a good connection point between the U.S. and Oceania, it is out of the way for travelers moving between the U.S. and Asia. By allowing overnight stopovers, US Airways could appeal to travelers who want a free Hawaii "vacation day". In any case, it's better than the status quo of having no exposure to Asia.

A bigger risk is integrating the two brands. Hawaiian is known for better customer service than most U.S. airlines -- for example, the carrier still serves complimentary meals in coach -- and it has routinely beaten US Airways in the annual Airline Quality Rating study. US Airways would need to find a way to maintain Hawaiian's service quality, which helps produce a revenue premium for Hawaiian on most of its routes.

A third potential issue is that Hawaiian currently has partnerships with all of the network airlines to provide connections between Honolulu and the other Hawaiian islands. These partners might be leery of relying on a direct competitor like US Airways. However, Hawaiian Airlines dominates the market for inter-island flights within Hawaii. As a result, competitors wouldn't have a good alternative for inter-island connections.

Foolish bottom line
This whole discussion may be moot: American and US Airways may be permitted to merge after all. However, if they don't, US Airways should consider buying Hawaiian Airlines, primarily to gain access to its route network in Asia and Oceania. While US Airways would still be smaller than competitors -- with a little over $2 billion of annual revenue, Hawaiian wouldn't move the needle much in terms of scale -- it would have a much broader international network. This would help US Airways in negotiations with corporate travel managers.

Obviously, merging with American is still the top priority for US Airways. But if that proves impossible in the current regulatory climate, Hawaiian Airlines could be a nice consolation prize.

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Read/Post Comments (10) | Recommend This Article (1)

Comments from our Foolish Readers

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  • Report this Comment On August 15, 2013, at 1:25 PM, surf808 wrote:

    It will be a sad day if Hawaiian was bought by US Airways. They are known for much more than just "free food". I fly them regularly and they have nice planes, are efficient, on time, pleasant and most importantly they embrace aloha.

    US Air and American are both low functioning when it comes to travel experience from customer service to gate agents to their old worn out planes. Maybe a merger can improve both companies, but I really hope that Hawaiian has the wherewithal to avoid any of the mainland carriers, esp US Airways.

    Mahalo

  • Report this Comment On August 15, 2013, at 3:55 PM, mwwestiii wrote:

    Fools,

    You do understand that the DOJ must, in court, show evidence that the AMR-LCC merger is anti-competitive and they will rebutted by the AMR-LCC anti-trust legal team? The burden of proof is on DOJ. They just can't block the merger, they must win the case in front of a judge.

    If you listened to yesterday's AMR-LCC press conference call with the three AMR-LCC anti-trust lawyers, you would realize DOJ has a very weak case and will most likely settle before trial - this merger will go through.

  • Report this Comment On August 15, 2013, at 6:20 PM, mariposa12345678 wrote:

    DOJ is waving tax-payer's money to block AMR-LCC merger.because airline industry is very competitive & they are international,consumer have lot of choice to pick the right airlines they want.

  • Report this Comment On August 15, 2013, at 10:43 PM, lmyc wrote:

    This article is nonsense. Hawaiian serves only low yield vacation traffic. The idea that USairways would buy them is absurd. Honolulu is not a viable connection point.

    Also, last time I checked, Oceana was not a continent.

  • Report this Comment On August 16, 2013, at 9:42 AM, TMFGemHunter wrote:

    @mwwestiii: Both sides are posturing. I don't think the DOJ's case is as strong as they made out during their press conference. But it's not as weak as the AMR/US Airways execs/lawyers claim, either.

    I think this will most likely be settled by giving up slots in DC and maybe one or two other smaller concessions. But there's a realistic chance that the merger will fall apart, or the companies won't be willing to make the necessary concessions.

    Adam

  • Report this Comment On August 16, 2013, at 9:56 AM, TMFGemHunter wrote:

    @lmyc: The whole point would be to put business travelers on Hawaiian's transpacific network. Right now, Hawaiian is serving as a "destination carrier"; Hawaii is a vacation destination, not a major business market. So of course most of the traffic today is leisure-oriented.

    American only flies to Beijing from Chicago. While Honolulu isn't an ideal connection point, for people traveling from the West Coast to Beijing, Honolulu makes a lot more sense than Chicago.

    Adam

  • Report this Comment On August 16, 2013, at 11:11 AM, ChicagoJetBlast wrote:

    The author makes it sound like USAir just got an increase on the credit line on their credit card and they need to go out and buy something.

    Hawaiian would add some Asian markets to USAir's route map but no one will ever connect thru HNL on the way to Asia when they can go non-stop from four west coast cities plus DEN.

    At Hawaiian's mainland cities, USAir only adds PHX, CLT and PHL as destinations without an additional conection. People will not connect 2-3 times when there are many non-stop or 1-stop options available with other carriers.

  • Report this Comment On August 16, 2013, at 4:57 PM, nytflyt wrote:

    For Hawaiian and all it's employees this would be a nightmare scenario, wiping out a brand icon with a pretty good track record and gluing it on to an operation that is an unmitigated train wreck.

    Would USAir be will to pay the premium the Hawaiian brand would command? There is also the debt and debt service.

    However, the scary part is; if the price was right Ranch Capital would sell.

    Great for shareholders a disaster for employees. The traveling public would find a reduction in overall service.

  • Report this Comment On August 17, 2013, at 11:19 AM, DVCAZ wrote:

    U.S. Airways owns all the names of all the airlines the old (nasty) U.S. Air grabbed up as they swallowed up airlines in the 80's. I like this idea because Asia is a market with vast and growing importance. If U.S. Airways did go for a deal with Hawaiian we would hope that the quality of service from Hawaiian would start to blend into the new airline, and, if....U.S. Airways dusts off one of the airline names they are not using (just to keep anyone else from using them!) like...P.S.A. and bring back the slogan, "Catch Our Smile" perhaps pleasant service will overtake stuffed shirts as well as re-brand the airline's personality by refreshing its image. Southwest would also finally get a competitor. The sweet part is that the very model Southwests creator stole from the creator of PSA would be back to bite S.W. in the Tuchas!

  • Report this Comment On August 21, 2013, at 11:16 AM, TMFGemHunter wrote:

    Last comment on Honolulu as a connection point: geography isn't everything. Dubai is a pretty inconvenient hub for traveling between Europe and Asia (with the exception of India), yet Emirates has done phenomenally well there. If the service quality was in-line with what Hawaiian offers today, I think a Honolulu hub would work.

    Adam

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