America West Deal Could Be a Template

If US Airways and America West (AWA) can realize the high hopes of their merger, they may spur further consolidation in the troubled U.S. airline industry.

Having secured the blessings of regulators and a bankrutcy court, the carriers' combination into a new and improved US Airways became effective Tuesday. The new company is now trading under the symbol LCC on the New York Stock Exchange.

The deal combines scrappy low-cost carrier America West with US Airways, which has an extensive route network and has used its two trips through Chapter 11 this decade to slash costs. The pair have also attracted fresh capital from a slew of investors, including some hedge funds that believe the merged airline will be able to compete nimbly in an industry that has been shaken by record high fuel costs and stiff price competition.

If the deal flies right, it could set the stage for other combinations, according to industry analysts.

"If it works, it'll be a watershed event, and other mergers will follow," says Roger King, analyst at Credit Sights, an independent research firm based in New York that does no investment banking.

King notes that American Airlines parent AMR (AMR), Continental Airlines TICKER TYPE="EQUITY" SYMBOL="CAL" EXCHANGE="NYSE" PRIMARY="NO"/> and Delta Air Lines (DAL) all have strong networks over the Atlantic Ocean and in Latin America, but they need to beef up their Pacific presence.

On the other hand, Northwest (NWACQ), which recently filed for Chapter 11 on the same day as Delta, and United Airlines parent UAL have enviable routes over the Pacific Ocean.

King says potential mergers might marry carriers from the first group with those from the second.

Recent speculation has centered on Delta and Northwest joining forces after each uses Chapter 11 to restructure and carve away costs. The two airlines' decision to seek bankruptcy protection on the same day in the same Manhattan court has only increased that speculation.

But Robert Mann, a former airline executive and founder of research firm R.W. Mann & Co., says he doesn't foresee a Delta-Northwest pairing. Instead, as the two airlines restructure in bankruptcy, they could draw the attention of other carriers with better business plans, in the same fashion that US Airways caught America West's eye. The US Airways-America West combination might also lead to an infusion of fresh capital from outside sources.

Still, the challenges facing the new US Airways are significant, and airline mergers have a notoriously poor track record.

King notes that meshing employees with different levels of seniority is always a tough process, with the potential that employees at two merging airlines can turn on one another.

That scenario could prove particularly troublesome here because even though the effective acquirer is America West, employees at US Airways tend to have been on the job much longer than their new co-workers.

Fuel presents another problem. When America West and US Airways unveiled their merger plan in May, crude oil was trading around $47 a barrel, and America West said the merger plan would create an airline able to make a profit even with oil above $50 a barrel.

But the plan may not have envisioned crude oil's rise to more than $70 a barrel in the wake of Hurricane Katrina and its current level around $64 a barrel. What's worse is that the marginal cost of refining jet fuel has risen recently.

Another issue is the morale of employees at US Airways, who have had to accept steep concessions and the termination of their pension plans in bankruptcy. One employee recently complained that even as workers had made plenty of sacrifices, US Airways' management failed to improve the airline's efficiency or strategy.

But Mann, who is advising America West's pilots on the merger, says that morale appears to have improved at US Airways, as employees who might have feared a liquidation and end to their airline are getting another chance with a new management. Recent improvements in US Airways' operational performance bear this out, according to Mann.

America West is already trying to spread its enthusiastic, slightly goofy corporate culture -- which appears modeled after industry success story Southwest Airlines . In a recent memo to employees, management informed employees about a ticket-counter-decorating contest to mark Tuesday's merger. Workers are also being encouraged to imitate reality television and perform "extreme makeovers" at various airline hubs and work stations.

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