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DoJ Opposition to AMR, U.S. Airways Merger Could Spur Consolidation

Updated from 12:13 p.m. Eastern Time with additional data and commentary throughout.

NEW YORK ( TheStreet) -- If the Department of Justice's lawsuit to block the proposed merger between American Airlines (AAMRQ.PK) and U.S. Airways (LCC) plays out similarly to the regulator's opposition to AT&T's (T) failed merger with T-Mobile (TMUS), investors in the airline industry might want to prepare for a string of consolidation among smaller carriers.

When the DoJ blocked AT&T's acquisition of T-Mobile on anti-trust grounds, it set off a 18-month whirlwind of consolidation among laggard wireless players that included the takeover of Sprint (S), the merger of T-Mobile with MetroPCS and most recently, AT&T's proposed acquisition of Leap Wireless (LEAP).

In barring the AT&T/T-Mobile combination, the DoJ voiced a clear opinion that it wanted three-to-four viable nationwide wireless carriers, prompting a consolidation among regional players and cash strapped networks such as Clearwire (CLWR). Investors, most notably, John Paulson of hedge fund Paulson & Co. took the failed AT&T and T-Mobile merger as reason to accumulate large positions in potential takeout targets at battered down share prices.

The same scenario could play out in the airline industry now that the DoJ has voiced strong objections to American's proposed merger with U.S. Airways, which would have created the world's largest airline.

The proposed deal comes on the heels of significant consolidation among carriers that includes the merger of United and Continental, in addition to Delta (DAL) and Northwest and would result in four airlines controlling more than 80% of the United States commercial air travel market, according to the DoJ.

According to the antitrust regulator, the proposed $11 billion merger between US Airways and American would substantially lessen competition for commercial air travel in local markets throughout the United States and result in passengers paying higher airfares and receiving less service.

Attorneys General in six states, including Texas, where American Airlines is headquartered; Arizona, where US Airways is headquartered; Florida; the District of Columbia; Pennsylvania; Tennessee; and Virginia also oppose the merger.

"Today's action proves our determination to fight for the best interests of consumers by ensuring robust competition in the marketplace," U.S. Attorney General Eric Holder, said in a statement. Major airlines have raised fares, imposed new and higher fees and reduced service, and the DoJ indicated it expected further increases were American and U.S. Airways to merge.

Stiff state and federal opposition to the creation of what would be a new air travel behemoth to supplant UnitedContinental (UAL - Get Report), however, doesn't mean consolidation can't happen in the industry, as carriers try to regain pricing power in a nascent U.S. economic recovery.

American and U.S. Airways could divest some overlapping routes and landing rights, especially in Washington's Reagan National Airport, in a possible antitrust remedy that could create opportunity for other carriers. American and U.S. Airways said they will continue to press for the merger in court.

" The end game of the Justice Department is NOT to derail the merger, but to obtain concessions via divestitures. It's that simple," Anthony Michael Sabino, a professor at St. John's University's Peter J. Tobin College of Business, said in an e-mail.

Even if the merger is eventually blocked by the DoJ, it might create consolidation opportunities among smaller airlines.

Investors betting on consolidation should consider setting their sights on regional and discount carriers. Already, JetBlue (JBLU - Get Report) is speculated as garnering the interest of foreign air travel giants. Firms like Hawaiian Airlines (HA) and Alaska Air (ALK) could be attractive because of their regional focus.

Discount carriers like Republic Airways (RJET), SkyWest (SKYW - Get Report) or Sprit Airlines (SAVE - Get Report) could also become the target of merger-hungry carriers, or consolidation among mid-tier players.

Sharp stock-price losses across the airline industry in the wake of the DoJ's announcement on Tuesday indicate investors see a blocked merger of American and U.S. Airways as negative for industry-wide pricing power and margins.

Still, as with the telecom sector, the DoJ's intervention could create an opportunity for those betting on the continued rationale for consolidation.

Investors should watch to see if a major hedge fund investor assembles a large stake in smaller regional and low-priced carriers. Such a move could indicate that the DoJ may have slammed the brakes on mega air-industry mergers, there is still room for consolidation.

-- Written by Antoine Gara in New York

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