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Why This Airline Merger's Benefits Still Haven't Taken Off

Creating the world's largest airline sounds like the dream of any businessperson with an aviation obsession. For United Continental Holdings (NYSE: UAL  ) , however, the dream has become a nightmare at times, as merger troubles overshadowed the airline's integration process. With United Continental shares underperforming most industry rivals, can it teach investors any lessons about the perils of airline mergers?

Smooth flight (was) expected
After a successful merger between Delta Air Lines and Northwest Airlines, 2010 looked like another year for airline megamergers. United Airlines and Continental Airlines announced their all-stock merger (the Delta-Northwest merger and the proposed US Airways (UNKNOWN: LCC.DL  ) /AMR (UNKNOWN: AAMRQ.DL  ) merger were/are all-stock as well). The deal would form the world's largest airline, with a massive network and a fleet to match.

Billions in cost synergies were bandied about, as the two major carriers dreamed of cutting out waste and realizing economies of scale in an industry with traditionally thin margins. Soon after the merger, however, turbulence began, and United Continental shareholders were along for the ride.

Technical glitches mean unhappy flyers
It's difficult enough for offices to merge email systems, so the integration of major airline reservation systems represents what can only be described as a monstrous technical challenge. Unfortunately, this was a major stumbling block for United Continental, drawing plenty of press coverage.

Whether it was making reservations more difficult, slowing down the process, or just plain crashing, the reservation system integration became a major issue at the airline. The problems managed to link the United Continental merger with flight delays in the public's mind. For a feeling of just how much the press hammered the airline over this, check out these headlines.

Last month, the airline was fined $350,000 for delaying customer refunds. Not too surprisingly, United Continental blamed the issue on merger trouble.

Earnings disappointments
As a merging megaairline, United Continental was expected to be an earnings powerhouse, with annual earnings approaching $6 per share. Various merger costs have prevented this from happening, however, as the airline now fights to make half that amount.

Earnings outlook revisions have prevented Wall Street from severely punishing the airline's stock, instead only causing it to underperform the other major carriers. Fool writer Adam Levine-Weinberg has some good insights on the situation at United Continental and its poor earnings pattern.

What it means for American Airlines Group
Much has been made of the proposed merger between US Airways and AMR, parent company of American Airlines. That deal is awaiting a courtroom trial, but the travails of previously merged airlines can provide insight for what could happen in a US Airways/AMR merger.

First, the stock will probably rise on news of the merger's completion, since Wall Street loves big mergers that create big airlines. In the case of this merger, it also has the benefit of reducing competition leading to better price control by major carriers.

Investors should take talk of merger benefits with a grain of salt. While the merger will strengthen each airline's network and likely be a gain in the long run, the new American Airlines Group should expect to incur its fair share of integration costs and possible technical issues.

I still see the merger as a net positive for US Airways shareholders (who would gain a greater international network) and for AMR shareholders (who are only likely to see any value in their shares if the merger happens.) Airline investors are advised to watch for developments during the integration process, though, since there will almost certainly be challenges along the way.

Awaiting completion 
After three years, the United Continental merger has annoyed customers with system issues and disappointed shareholders with lackluster earnings. The turbulence seen in this merger should serve as a warning that airline mergers do not always go as smoothly as they are pitched. US Airways and AMR shareholders need to keep this in mind, should that merger be granted approval. Despite this, airline mergers are a long-term positive for an industry where intense competition has spelled bankruptcy in past years.

Holding United Continental now takes a lot of patience, but it could pay off if the airline can make quicker progress and actually meet currently set estimates. And I still see US Airways and AMR shares as good values if the merger is completed, since each side would gain a larger network, and all carriers would gain greater pricing power.

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Read/Post Comments (6) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On September 17, 2013, at 10:11 PM, huffamoose7 wrote:

    They over think this article. United sucks and treats their customers like a second rate bum by nickel and dime'ing you. I was a Continental person by heart and soul. Once United took over it all changed and so did I. It's all about customer service.... Why did Larry Kellner leave Continental? Or was he pushed out? That's why it went down hill. AMR and US Air are both bottom of the barrel and they sell that way. They should be fine in the the merger as they aren't changing their business model. They are happy with terrible service and the prices reflect their ineptness. Delta and NW had the same business goals which is why they are number 1 now. Customer service is job one.

  • Report this Comment On September 18, 2013, at 12:51 AM, Beartracks49 wrote:

    Huffamoose, you fail to understand that when the merger happened, virtually the entire Continental management team began running United Airlines. What you are experiencing is unfortunately, a national airline team suddenly overwhelmed by being a global aviation enterprise. Simply put, they can't wrap their heads around what it takes to properly manage it.

    I keep trying to see the allure of Continental whose fans lament the merger with United, but all I see is walking over dollars to pick up dimes and a management preoccupied in spin, talking of rainbows and unicorns rather than grappling with the realities of intelligently running a business.

  • Report this Comment On September 18, 2013, at 1:00 AM, YeezyJohnson wrote:

    Part of the reason United seems to treat their customers as 2nd rate bums is because the management(continental) treats their front line support and operations employees the same or worse. At a time when Delta is giving their employees raises, United is trying to cut their pay and answers with "if you don't like it, there's the door" A good analogy to the Continental management team take over would be to think about the Beverly Hillbillies TV show. A bunch of country-fied hicks moved to the big leagues and don't know have a clue what they are doing.

  • Report this Comment On September 18, 2013, at 6:57 AM, Beartracks49 wrote:

    Yeezy, I am in agreement. One interesting thing that I found ironic was that when the Continental management came to town, the first thing they touted was that they wanted United to be a place where everybody wanted to work at and have high workplace satisfaction scores. After the first two employee surveys, even though the questions were phrased in such a way as to elicit a positive answer, we no longer receive the satisfaction surveys. I guess if you don't like the answers, don't ask the questions. A 40+ year employee once opined "they want to get rid of anybody who remembers the good old days". I fear she was right.

    What is unbelievable is that the management team had a merger roadmap: take the Delta Route or the US Airways/America West Route. We know what they chose. The reservations system fiasco came after a meeting of all reservations system stakeholders met to plan for the integration. The consensus was to either use United's Apollo or build a new, 21st century computer system. Continental's decision was to choose Shares, the inadequate system used by Eastern Airlines back in the 1980s. The reason? Cost. They already owned it. How many millions have been lost on that fiasco, not to mention good will.

    The articles about underperforming United will unfortunately continue until the Continental management team and their philosophies have been replaced. What started out as so much hope from the employees at United that they could finally use their energies and talents to build upon United's strengths, was quickly replaced with the realization that they've met the new boss-- same or worse than the old boss. Very sad and frustrating.

  • Report this Comment On September 18, 2013, at 1:29 PM, AcuraT wrote:

    There is a simple reason why Delta/Northwest was the better merger of the two: the two airlines were better than Continental-United.

    With Delta/Northwest you had two airlines come out of bankruptcy with clean balance sheets. They both were making money (not a lot, but some). There was no "weak sister" in the two of them. Both airlines had a good mechanically operational fleet, although in particular Northwest's was old it was well maintained.

    With Continental and United, the "weak sister" was United. Although United bought Continental, Continental was the better run airline and most of the upper ranks were taken over by Contiental. United was still losing money hand over fist when they bought Continental coming out of bankruptcy. United had a bad fleet of planes that had a lot of mechanical problems that needed repair. The management is moving as fast as possible to shore that up with plane purchases.

    The computer integration (as mentioned in the article above) had relatively few issues at the new Delta. The new United however, was a disaster. Shares, Continental's system, was ancient but used after the merger - because it was fully owned by Continental. United had sold Apollo years ago to stave off bankruptcy (unsuccessfully). Operations are a huge part of an airline's operation. The computer integration was cost driven not technology driven - and that may have been a big mistake. In the end, Delta for the most part got it right - United has not.

    With US Airways and American it is going to be a challenge to be as successful as Delta. For one, American is STILL in bankruptcy. For #2, the much smaller airline (US Arirways) is taking over American. It is not as if they cannot be successful - it just will be very challenging to merge the two especially when the bigger one (American) has so many operational issues losing money coming in.

  • Report this Comment On September 26, 2013, at 5:02 PM, HerbOxmels wrote:

    Earlier this year I had a real bad experience w/ "United's" reservations office in India.

    I wrote a HUGE letter of complaint and addressed it to

    Jeff Smisek / CEO

    Continental Airlines

    They are UA in name but CO in operation. By the way all I got was some B.S. excuse letter back. They really don't care about you as a customer

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