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United Continental Holdings Inc. Is Retrenching in L.A.

United Continental Holdings  (NYSE: UAL  ) recently closed its persistently unprofitable Cleveland hub, and some analysts have urged further cutbacks. The struggling legacy carrier may be taking this advice to heart by closing its smallest remaining domestic hub: Los Angeles.

United Airlines is giving up four gates at Los Angeles International Airport later this year. Photo: The Motley Fool

United later this year will begin subleasing four gates it controls at the crowded Los Angeles International Airport to American Airlines (NASDAQ: AAL  ) . United and American have been jockeying for the top market share position at this highly fragmented but strategically important airport. By giving up valuable gate space at LAX, United is all but throwing in the towel.

The battle for Los Angeles
Los Angeles is arguably the most competitive U.S. air-travel market. In terms of passenger market share, United Continental and American Airlines have been evenly matched recently. They led the market last year, with each holding a roughly 20% share (combining the American/US Airways passenger boarding numbers).

Delta Air Lines has been bulking up in Los Angeles recently. Photo: The Motley Fool

However, Southwest Airlines (NYSE: LUV  ) and Delta Air Lines (NYSE: DAL  ) -- the other members of the big four that dominate the U.S. airline industry -- are not far behind, each holding 12%-13% of the market. Delta Air Lines has been gradually adding flights in the past year or so in its clear effort to bolster its presence in L.A.

Helping a rival?
Los Angeles International Airport is one of several major airports in the U.S. where gate space is the limiting factor preventing airlines from growing. As part of its settlement with the Department of Justice over the merger with US Airways, American agreed to give up two gates at LAX that will go to low-cost carriers.

The loss of gate space would have forced American to reduce its flight schedule in Los Angeles. By subleasing four gates from United, American can maintain its current flights and even grow somewhat. Meanwhile, United has already cut several cities from its L.A. route map.

In the short run, it may make sense for United to eliminate some unprofitable flights in L.A. if it can instead make money by subleasing its gate space. However, due to the economics of airline hub operations, this decision could make the rest of United's L.A. hub operation less viable in the long run.

Why market share is key
There are two main issues here. First, after cutting its flight schedule, United will not be able to offer as many connections in Los Angeles. This will have a marginal effect on the demand for all of United's other flights out of Los Angeles. For example, a traveler looking to go from San Jose to Sydney will no longer be able to fly United with a connection in Los Angeles.

The second -- and more serious -- problem is that high-value corporate customers care about how many flight options each airline offers. American is already running neck and neck with United, and Delta is nipping at their heels. By retreating while its top competitors expand in L.A., United risks losing lucrative corporate clients who find better flight choices at American or Delta.

American's growing market share lead in LA will help it win corporate contracts. Photo: American Airlines

By shrinking its L.A. footprint rather than trying to improve results while maintaining its current scale (or even growing), United risks losing the critical mass necessary to operate a hub in Los Angeles. As a result, the airline's small downsizing this year could be a preview for a much larger downsizing in the future.

Foolish takeaway
Following the de-hubbing of Cleveland, Los Angeles is United's smallest domestic hub, with fewer than 200 daily departures; it's set to shrink further later this year. Meanwhile, United is subleasing four gates to its biggest rival, American Airlines, which will allow American to grow in the future.

United's management must realize that shrinking while its rivals are growing could put it at a long-term competitive disadvantage in Los Angeles. This course of action only makes sense if United is ultimately willing to shut its L.A. hub for good. In a few more years, that may be its only viable option.

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Read/Post Comments (5) | Recommend This Article (8)

Comments from our Foolish Readers

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  • Report this Comment On June 09, 2014, at 5:28 PM, silver328 wrote:

    Finally , someone takes note of United and its more than questionable leadership decision making.

    If you look back and take notes of the United-Continental merger , you will find a string of mistakes and wrong decisions. This L.A. gate leasing is just one of the more obvious ones. In fact , if you truly look to the problems plaguing the airline , you will find they all stem from the same source , the new leadership and their business plans.

    Right from the beginning , Continentals leadership came into United knowing that they knew better and that the old United was wrong and they were right. Making choices like dismantling the ticketing and check-in computer system and rolling it back Continentals 20 year old system. Choosing Continentals maintenance ways and moving that system back 20 years as well. In fact , virtually all ways in which legacy United had tried to keep up with the times by upgrading systems , have been downgraded and made to work Continentals way.

    The logic given by the new leadership? United had more recently been in bankruptcy , thus , it was inferior.

    The list goes on and on with changes that caused more and more problems , customer dissatisfaction , and employee aggravation.

    To step back and truly take it all in , it is mind boggling how anyone could run a company so poorly and still be kept in place? ... unless... it is being ran this way with a purpose ... a purpose of gaining what the leadership is truly seeking... what could possibly be gained by slowly and purposefully destroying a company? Kill the Unions , at ANY cost.

    The CEO of Continental-United stated from the very beginning the Unions had no place in his company. The arrogance and self righteousness has no bounds with the elite CEO's these days , and the point of getting their way has reached a point of insanity.

    All's that need be done to prove this theory is to look at history. Continental has had its fair share of low-lights in the airline industry , and to see where this plan originates , one need merely look at the end result of Continentals bankruptcy of the last century.

    Continental was dragged through the muck and destroyed by poor management and the recession... but , an unexpected thing happened upon reorganization , the unions lost their foothold as all the old employees were let go and new ones hired.

    I'm sure you get the idea , kill the airline to kill the "enemy"... then rebuild and look like the hero that saved the company from the brink.

    I see no other logical explanation for the way the airline is being ran. Simply put , no one could be allowed to "lead" a company in this manner without some knowledge of the ultimate plan. The board MUST be in the know of this plan as there is no logic to allowing this continue as long as it has.

    So I ask you , what is to be done when arrogance and self righteousness is at the helm? History is bound to repeat itself , but when it is used to destroy a near century old business and the livelihood of 10's of thousands of employee's whom helped build it , where does it end?

  • Report this Comment On June 10, 2014, at 1:01 AM, Behopeful wrote:

    Where does it end, you asked silver328!? It ends when you stop pointing fingers. #theNEWunited

  • Report this Comment On June 11, 2014, at 12:57 PM, LexVolo wrote:

    Adam - There is another possibility that does not imply UA's retreating from the battle for LAX.

    LAX excels as an O&D airport (it's the largest in the world as measured by O&D traffic). However, its facility and geography make it a difficult place to connect passengers, especially compared to SFO, UA's other west coast hub; and having two connecting hubs in proximity is a challenge from the standpoint of airline network strategy and economics (which is part of our background); then add Denver (a facility expressly built to be a connecting airport) to the UA network strategy mix. UA needs to shed a hub, but it doesn't need to shed LAX O&D customers who, over time, it expects to be quite profitable.

    Just speculating here, but UA could be pursuing a two pronged west coast strategy, whereby it focuses on serving the O&D market via LAX, and prefers to connect passengers over SFO. That would allow it to shed flights at LAX as it reduces connecting traffic, while not reducing the seats available for the more profitable local market. Fewer flights for connecting passengers translates to lower gate demand, but not necessarily to reduced focus on the battle for LAX passengers.

  • Report this Comment On June 12, 2014, at 9:39 AM, TMFGemHunter wrote:

    @LexVolo: I agree that this is a possibility. Clearly, while UA has hubs in big markets, its hub configuration is "geographically challenged"!

    However, there are still some anomalies. For example, United is starting LA-Melbourne on the Dreamliner this fall. There's probably a decent sized local market for that route, but United is going to be competing with both Qantas and Virgin Australia. Clearly, it needs a lot of connecting traffic. If United is making SFO its West Coast hub and refocusing LA on O&D traffic, then why route the Melbourne flight through LAX?

    More generally, it seems to me that focusing on O&D traffic would entail a change in the mix of flights, but not necessarily a reduction in the total number of flights (which is not very large in the first place). The fact that the extra gates are going to American just rubs salt in the wounds. If American adds destinations/frequencies, it's going to have a better pitch for corporate travel accounts.

    That's my two cents.


  • Report this Comment On June 21, 2014, at 11:11 AM, ih8mayo wrote:

    How is 4 gates 'closing' a hub? How is it 'throwing in the towel'?

    Check your money losing facts. UA is participating in major renovations of T7 at LAX that will make it a superior facility to both Delta and American's operations. $400+ million worth.

    No one. No one has a hub at LAX. Please tell us where someone can gin up 35% market share at LAX?? The gates aren't there. The market isn't shifting enough.

    It's a focus city for all. Anyone who has / does call it a hub for any airline is just using marketing speak.

    Even AA disagrees with your assertion "market share is key":

    "We are less worried about being the biggest in L.A. but in being in the right markets"

    And UA itself went on the record to say LA *isn't* a hub. There is no hub to 'shut down.'

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Adam Levine-Weinberg

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry!

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