In August, the Department of Justice filed a lawsuit to block the proposed merger of US Airways (UNKNOWN:LCC.DL) and American Airlines parent company AMR (UNKNOWN:AAMRQ.DL). Three months later, the airlines and the DOJ have settled the lawsuit on the grounds that the new American Airlines Group will divest assets at certain key airports. But a key component of the settlement is threatening to be shaken up by other airlines. We'll look at what this means for consumers and investors.
The settlement plan
The ultimate goal of the DOJ is to protect consumers from industry collusion and the restriction of competition. But as an industry Catch-22, the previous mergers that created the larger Delta Air Lines (NYSE:DAL) and United Continental Holdings (NASDAQ:UAL) were already raising the possibility that the two larger carriers would from an effective duopoly over many international routes.
Not everyone was on board with this theory but there were other factors that pushed for a merger between US Airways and AMR. As a way to prevent the three large legacy airlines (Delta, United Continental, and American) from forming too great of pricing power, slot divestments from US Airways and AMR were required.
But to prevent these slots from simply going to Delta and United Continental where the three legacy airlines would have essentially traded slots among themselves, the DOJ has been quite vocal that these slots are designated for low-cost carriers. In turn, the DOJ hopes that these low-cost carriers will restrict pricing growth.
The immediate reaction came in shares of closely affected airlines. While shares of US Airways were about even on the day of the announcement, they have since risen near new post-recession highs. Of course, shares of AMR were the biggest winners surging around 25% as the merger provided the best way for AMR common shareholders to realize value.
But beating US Airways shares were shares of JetBlue Airways (NASDAQ:JBLU), which rose sharply on news the DOJ was pushing for divested slots to be given to be given to low-cost carriers such as JetBlue.
As I discussed in a previous article, legacy airlines are not going to sit back and watch the valuable slots being divested by US Airways and American Airlines all go to low-cost carriers. Delta Air Lines has already made public its opinion that all airlines should have the ability to compete for these slots.
It seems lawmakers in Washington have jumped into this fray as well coming down on the side of legacy airlines. The lawmakers are arguing that giving the slots to low-cost carriers would provide competition on larger routes at the expense of air service to small communities.
Indeed the agreement between US Airways, AMR, and the DOJ centers more around the maintaining of competition than it does around service guarantees. With many lawmakers being representatives of small districts, many of which already have limited air service, the motivation to maintain service to their districts is strong. Not only do constituents like greater air service, but many representatives themselves also enjoy this air service, especially considering many of the divested slots will comes from the Washington National Airport, the most local airport for Washington, D.C.
Slots at Washington National Airport and New York LaGuardia Airport are both highly valuable and in scarce supply. Since airlines try to maximize the value out of these limited assets, it is quite likely that the divested slots will be ones serving smaller communities, since larger flights can generate more revenue for the airline.
JetBlue is expected to strongly press for these slots, as they provide a way for the comparatively small airline to grow into slot restricted airports. Southwest Airlines is another top contender for divested slot acquisitions as the airline tries to expand its network into more centrally located airports. Meanwhile, large carriers like Delta and United Continental are also eager to expand their own networks and continue to lobby for a greater chance at bidding.
It's tough to see how the letter submitted by the lawmakers would change the minds of the DOJ. After all, back in May, lawmakers also urged the DOJ not to force US Airways and American Airlines to give up any slots at Washington National in the first place (the settlement calls for 104 slot divestments at the airport).
Investors in Delta and United Continental would like to see the DOJ free up at least some slots for bidding by all airlines, as it would expand their networks and increase their presences at in-demand airports. Investors in US Airways and AMR would also benefit from a change in DOJ policy, as it would give all legacy airlines greater control and pricing power. Southwest and JetBlue investors, meanwhile, would benefit from the DOJ's holding its ground on slot policy, as any slots given to legacy carriers are slots not given to Southwest and JetBlue.
Finally, this is an issue that can divide consumers. Those in large markets are set to be the primary beneficiaries of the shifting of slots shifted to low-cost carriers. Greater competition on these routes should help to keep prices under control and provide a greater variety of product for flyers. On the other hand, consumers in small markets could see service cuts as US Airways and AMR divest the least profitable slots (small flights serving small communities) and low-cost carriers pick the slots up to serve more profitable large markets.
Alexander MacLennan owns shares of AMR and Delta Air Lines and has options on Facebook, Delta Air Lines, and US Airways Group. The Motley Fool recommends and owns shares of Amazon.com, Apple, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.