UAL, US Airways Could Have Bumpy Flight to Merger Completion

As UAL (UAL Quote) moved Wednesday to acquire US Airways (U Quote), Wall Street analysts pointed to several potential obstacles that could derail the deal.

They listed possible labor discord, antitrust issues and the tough task of making the marriage work as potential pitfalls and cited previous failed airline consolidation efforts as proof of the difficulties that carriers face when they try to merge.

A deal between US Airways and American Airlines fell through last year because of enormous cost overruns. That failed bid came one year after a code-sharing deal between the nation's biggest airline, United, of which UAL is the parent, and Delta Air Lines (DAL Quote) flopped after Delta management refused to grant the pilots' union a voting seat on the board of directors.

As a result, some people on Wall Street were skeptical that United Airlines would be able to complete its deal for US Airways. UAL said earlier on Wednesday that it would pay $4.3 billion in cash for US Airways and assume $7.3 billion in debt and operating leases.

Still, investors in US Airways were enthusiastic, driving the share up about 80%, because the price UAL was willing to pay was more than double the airline's stock price on Tuesday.

But among the issues that tempered that enthusiasm was labor difficulties, which could put the brakes on the merger. A unified workforce could have difficulty agreeing to seniority lists and bidding rights for schedules.

Rick Dubinsky, chairman of the United Airlines Master Executive Council, a unit of the Air Line Pilots Association, said in a statement that he was "deeply disappointed."

"Before today, the company and the UAL-MEC faced the enormous challenge of reaching a satisfactory pilot contract that rewards our pilots for the sacrifices we have made to return United to profitability," he added. "The proposed merger will make that task even more difficult by requiring the integration of two very different pilot groups into a single airline." The union represents about 10,000 United pilots.

"Although United's and US Airways' boards have approved this transaction, the rank and file are the ones that have to work together and agree to the new work ranking they may have in this new airline (which) determines their seniority in bidding for flying time," said Susan Donofrio, an analyst with Deutsche Banc Alex. Brown. "This has been one of the stumbling blocks of previous potential mergers."

And, if labor problems don't scuttle the transaction, analysts said regulatory concerns could.

"The deal is not an antitrust cake walk," wrote James Higgins, an analyst at Donaldson, Lufkin & Jenrette, in a research report. "There is a real question as to whether regulators will approve such concentration in an industry whose competitiveness is already a concern to many."

The combined carriers would control 30% of U.S. airline capacity, with American, the nation's second-largest carrier, lagging behind with 20% capacity, Higgins said. He downgraded his rating for UAL to an underperform from a buy. It could not be determined if DLJ does any underwriting for the companies.

UAL and US Airways, however, managed to preempt regulators' criticism over direct route overlap into and out of Washington, D.C. In its announcement, United said it would sell some of its assets to a US Airways board member, Robert Johnson. Johnson, the founder, chairman and chief executive of BET Holdings II, a media holding company, would then create a new airline, to be called DC Air. That carrier would operate out of Washington Reagan National Airport.

The companies did not disclose how much Johnson would be paying for the carrier's assets.

Yet, concerns about the possible obstacles did little to temper the demand for shares of US Airways, which has recently faced labor problems and larger-than-expected losses. Under the terms of the deal, UAL will pay $60 a share for all the outstanding shares of US Airways, a 130% premium based on US Airway's closing price Tuesday of 26 5/16. Shares of US Airways of Arlington, Va., rocketed 21 15/16, or 83%, to 48 1/4 by Wednesday afternoon. (US Airways finished up 22 11/16, or 86%, at 49.)

Shares of Chicago-based UAL were off 8 7/16, or 14%, to 51 15/16. (UAL closed down 7 3/16, or 12%, at 53 3/16.)

The news also helped buoy shares of Northwest Airlines (NWAC Quote), which is now seen as a target should the industry further consolidate.

"We think the transaction is likely to set off a wave of consolidation in the industry," Candace Browning, airline analyst at Merrill Lynch, wrote in a report. "Northwest, with a strategic asset in the Pacific, strong domestic hubs and a 13.5% economic interested in Continental (CAL Quote) is a very attractive acquisition candidate."

Northwest was up 2 3/4, or 11%, at 26 7/8. (Northwest finished up 4 13/16, or 20%, at 28 15/16.)

Browning upgraded Northwest to an accumulate/buy from a neutral/accumulate. A Merrill Lynch spokesman said he did not know if his company has done any underwriting for Northwest.

Shares of AMR (AMR Quote), parent of American, were off because of investor concerns about lost market share following the merger between US Airways and UAL. That concern sparked speculation that AMR might offer a counterbid for US Airways. AMR was down 3 5/16, or 10%, at 29 5/16. (AMR closed down 2 9/16, or 8%, at 30 1/16.)

UAL and US Airways said they expected to complete the deal in 2001, noting that the purchase would add to United's earnings in the second year following the closing.