Delta Urged to Merge

The carrier denies holding talks with United after a hedge fund says the airlines should link up.
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Updated from 3:31 p.m. EST

A hedge fund has called for a merger between two airlines that have strongly backed industry consolidation --

Delta

(DAL) - Get Report

and United Airlines parent

UAL

(UAUA)

.

In a letter sent to Delta executives, hedge fund Pardus Capital Management urged Delta to "enter into a merger transaction with another carrier" and suggests that the other airline be United.

A merger is "imperative" because of the rapid rise in fuel prices and "the increased risk to the business as a standalone entity," said the letter from Pardus president Karim Samii and principal Shane Larson.

Late Wednesday, Delta denied published reports that it has already engaged in merger talks with United. "There have been no talks with United regarding any type of consolidation transaction and there are no such ongoing discussions," said CEO Richard Anderson, in a prepared statement.

Even if the sides had been studying a deal, Bush administration antitrust regulators, though flexible, might have a hard time approving a tie-up between the country's second- and third-largest airlines. In the past, internal Delta consolidation studies have concluded that authorities wouldn't permit a merger with United, a source told

TheStreet.com

.

Points in favor of a United merger were that "United has the Pacific and is lacking in the Southeast," qualities that match up well with Delta's Pacific weakness and Southeast U.S. strength, the source said. "But the combined size would be too big to pass a regulatory test," he said.

Shares of Delta were earlier up more than 13%, but after it said it wasn't speaking with United, they pulled back. Lately, the stock was ahead by 5% at $19.69. UAL also trimmed its gains and was adding 2% at $44.33.

At any rate, helpful Pardus even took the liberty of designing a methodology for Delta, suggesting that it issue 2.395 shares for each share of United. Additionally, Pardus nominated the Delta management team to run the combined companies. Pardus holds 7 million Delta shares and 5.6 million UAL shares, said a spokesman for the firm.

Anderson was noncommittal about the Pardus proposal, although he agreed that high fuel costs increase the need for consolidation.

"We appreciate receiving Pardus' views on the best course for Delta's future," he said in a statement. "Delta believes that the right consolidation transaction could generate significant value for our shareholders and employees and that strategic options should be evaluated."

Delta also disclosed that its board has established a special committee to review alternatives, including consolidation. The committee is headed by Daniel Carp, nonexecutive chairman. Delta has also retained financial and legal advisers to assist in the review.

United spokesman Jean Medina declined to comment specifically on the Pardus letter, but noted: "We have said for the last four years that we believe consolidation is necessary for the industry, and others independently are reaching the same conclusion."

In the past, internal studies by Delta have concluded that a merger with

Continental

(CAL) - Get Report

would make the most sense, while a deal with

Northwest

(NWA)

could also have value because it would provide access to the Pacific, sources said.

Delta bid unsuccessfully for Continental in 1998, then acknowledged it was again studying a merger effort in 2000.

But the Pardus letter panned Continental and Northwest combinations, based on analyses done for the firm by consultants Gordon Bethune, a former Continental CEO, and by Simat Helliesen & Eichner.

A combination with Northwest would offer savings, but wouldn't create as expansive a network as a United merger would. The letter said joining with Continental would raise costs and create management succession issues, the letter said.

Delta has become a backer of consolidation since Anderson took over as CEO in September, while United CEO Glenn Tilton has long supported the concept. By contrast, Anderson's predecessor, Jerry Grinstein, has said mergers are last resorts enabling carriers to survive when they would otherwise fail.

Last year, Grinstein told reporters that he had rejected an approach by Tilton some time before Delta's 2005 bankruptcy filing. "He said, 'Are you interested in talking

about a merger?' And I said not at all," Grinstein recalled.