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

United Continental Holdings is giving up market share in Los Angeles by subleasing four gates to American Airlines.

Jun 5, 2014 at 1:20PM

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.

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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).

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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.

New American Livery

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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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.

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