Research Roundup: US Airline Mergers
The airline industry is back in the spotlight with reports of potential mergers, but not everybody sees this a good news for the companies.
The New York Times today cautioned that a merger between, for example, Delta and Northwest, may not add any lasting value. The Times says “close scrutiny of the business rationale for airline mergers suggests that any improved profits from consolidation will likely be short-lived, at best.”
A Standard & Poors report issued last week finds that US Airline Mergers Offer Rewards, But Also Large Risks.
Two rumored possible mergers, Delta with United and Delta with Northwest would result in a significantly broader and more comprehensive route system, S&P said. “An important caveat, though, is that if Delta were to combine with either United or Northwest, it would likely trigger a responsive merger of two other large airlines (most likely Continental Airlines with whichever of United and Northwest is not involved in the Delta merger). That, too, would create a very strong route network, generating its own traffic diversion.”
Revenue gains driven by traffic diversion are inevitably a “zero sum game,” with the benefits to one airline coming at the expense of others.
S&P also notes that opportunities for rationalizing routes, increasing prices and cost cutting are limited.
“Announcement of a proposed merger involving Delta and a partner (or, for that matter, between any two airlines of similar size) would very likely result in Standard & Poor’s Ratings Services placing its ratings on both companies on CreditWatch.”
In its analysis of the Delta merger reports, CreditSights is more optimistic: “There is no doubt that consolidation is a long-term industry solution, it is just that a multitude of pesky problems ranging from unions to long tenor leases to politicians to entrenched management bureaucracies keep getting in the way.”
Well down the road is the pot of gold: FAA air traffic limitations, key airport saturation, and continued domestic capacity constraint will drive up fares for any airline left flying.
Fitch Research agrees that “some merger-related synergies are clearly achievable in most legacy carrier combinations, particularly on the revenue side with post-merger capacity rationalization supporting long-term passenger yield growth.”
Still, execution risk related to industry merger and acquisition activity remains high in light of organized labor’s desire to capture a greater share of the financial upside in any prospective merger transaction.
Fitch’s just-released Airline Credit Navigator provides company-by-company analysis. In Fitch’s opinion “Overall, the US legacy carriers confront this period of revenue and fuel uncertainty from a position of relative strength with respect to cash on the balance sheet. Across the board, US airline unrestricted liquidity represents a larger share of annual revenues and total assets than at any time since the start of the decade.”
Avondale Partners is bullish on the impact on stock prices, noting that whatever airline might be chosen to merge with Delta, other airline stocks would benefit.
From current depressed levels, our price targets for all six legacy airlines are upwards of 100% above current levels.
Bear Stearns recently upgraded Delta to Outperform, based in part on the possibility of a merger, but noted that “Airline investors, like Hollywood writers, remain on strike, refusing to build new positions or add to old ones, despite airline shares hitting new multi-year lows each day.”
Delta finds itself in the catbird seat for industry consolidation at a time when its relative and absolute valuation look compelling.
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