Six months ago, US Airways (UNKNOWN:LCC.DL) announced its intention to merge with fellow legacy carrier AMR (UNKNOWN:AAMRQ.DL), 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 (NASDAQ: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).
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.