US Air Goes After Delta

If a bid for the bankrupt carrier closes, it likely would create the world's biggest airline.
Author:
Publish date:

Updated from 2:10 p.m. EST

US Airways

(LCC)

has proposed an unsolicited $8 billion merger with bankrupt

Delta Air Lines

(DALRQ)

, a deal that, if completed, would likely create the world's largest carrier.

The Tempe, Ariz.-based airline, formed in a smaller transaction just 14 months ago, said Wednesday that a merger would generate $1.65 billion in annual savings and benefits. More than half of the savings would be lost if Delta leaves bankruptcy as a standalone carrier, because it would forego the right to reject leases under bankruptcy law, US Airways said.

In total, US Airways offered $4 billion in cash and $4 billion in US Airways stock to Delta's unsecured creditors.

"There are not many industries more fragmented then the one we participate in," US Airways CEO Doug Parker said on a conference call. "In an industry this fragmented, we think there are opportunities for mergers."

Parker said the 2005 merger of the former US Airways with America West Airlines produced the industry's best performing airline, largely because the old US Airways had the opportunity to reduce capacity by ridding itself of aircraft leases in bankruptcy.

"Our timing is driven by fact that Delta is in bankruptcy,

which presents a unique opportunity to realize values," he said. The Delta name would be retained, he noted.

Delta CEO Gerald Grinstein reiterated prior comments that Delta has no interest in a merger, issuing a statement saying the US Airways proposal will be reviewed but that his company's goal "has always been to emerge from bankruptcy in the first half of 2007 as a strong, standalone carrier."

Grinstein said the bankruptcy court has granted Delta "the exclusive right to create the plan of reorganization until Feb. 15, 2007. We will continue to move aggressively towards that goal.''

Parker said he wants the chance to present an offer to Delta's creditors and management. "We've explained the synergies, and they said they want to keep running a standalone," he said. "We believe we have an alternative that is better, and we think it's important that the creditors see that. We've put our money where our mouth is.

"This alternative, we believe, is much more compelling than a standalone plan," Parker said. "The creditors will see that, and the management and employees as well will come to see that, once we get a chance to sit down and work with them."

Delta's creditors committee is led by

Boeing

(BA) - Get Report

and has eight other members, including Pratt & Whitney,

Coca-Cola

(KO) - Get Report

, the Air Line Pilots Association, the Pension Benefit Guaranty Corp. and Fidelity.

Parker formally issued his proposal in a letter that he faxed to Grinstein on Wednesday. The letter noted that Grinstein refused to meet with Parker after a previous letter in September.

"I was disappointed that you declined to meet or even enter into discussions in your letter of Oct. 17, 2006," Parker wrote. "Because the benefits of a merger of US Airways and Delta are so compelling to both of our companies' stakeholders, we believe it is important to inform them about our proposal." Therefore, we are simultaneously releasing this letter to the public."

Stocks throughout the sector surged on the news, and the Amex Airlines index was up 5.2%. Shares of US Airways rose 16.8% to $59.46.

UAL

(UAUA)

, the parent of United Airlines, climbed 9% to $39.99.

During a conference call with analysts at the Citigroup Transportation Conference, United Airlines CFO Jake Brace said his company wasn't surprised by the US Airways bid. "The industrial logic of mergers in the airline industry is compelling," he said. "There is probably no need for more than two, three or maybe four network carriers, the most likely number being three.

"We believe that consolidation makes sense for the industry,

and if it makes sense for us to participate in it, we will," Brace added. "We've been very open in talking about that."

TheStreet.com

reported July 27 that Parker felt he had an obligation to consider a merger with Delta or another bankrupt carrier,

Northwest Airlines

(NWACQ)

, because "tremendous value can be created through consolidation."

US Airways said about $935 million in network savings and benefits would be created by combining its network with Delta's, a process that would involve a 10% reduction in combined capacity. At least a portion of that would result from a reduction in the use of 50-seat aircraft, President Scott Kirby said.

Because capacity cuts have fueled the airline industry's current cycle of profitability, the reduction is likely to have broad appeal within the industry. Another $710 million in synergies would result from combining airport facilities and eliminating redundant systems and overhead.

To facilitate the merger, Citigroup has agreed to provide a $7.2 billion financing package. That would be used to refinance Delta's debtor-in-possession credit facility, to refinance US Airways' existing senior secured facility with GE Capital, and to provide the funding for the $4 billion cash portion of the offer.

While US Airways would seek expense reductions in most areas, Parker said the carrier "would take labor costs to the highest common denominator in all groups," creating "a negative synergy" of $90 million. In an interview, Kirby said the number is based on the assumption that all of the unions on the property at US Airways would also represent workers at Delta, which has traditionally been nonunion except for its pilots.

A major beneficiary would be the International Association of Machinists, which represents mechanics and fleet service workers at US Airways. In a prepared statement, IAM General Vice President Robert Roach said that Parker had contacted him and "indicated a desire to work with the machinists' union."

Roach said that before it could conclude a successful merger, US Airways would have to wrap up ongoing talks with the IAM regarding the integration of America West and US Airways employees.

The combined airlines would theoretically operate a series of hubs and focus cities that initially appear to have overlapping missions. Delta's Atlanta operation and US Airways' Charlotte base are the two principal Southeast hubs. US Airways has a hub in Philadelphia and a strong presence at New York's La Guardia, while Delta has a hub at New York Kennedy and a solid position at La Guardia.

Additionally, US Airways has hubs in Phoenix and Las Vegas, and Delta has a hub in Salt Lake City. US Airways has a focus city in Pittsburgh, and Delta has a hub in Cincinnati. Delta also has an expanding international presence, while US Airways has minimal global routes outside of Caribbean service from its Charlotte hub.

Kirby said the new carrier would divest either the US Airways shuttle or the Delta shuttle, both of which serve LaGuardia and other key Northeast airports. But he said the other operations would be retained. The airline would maintain hubs in both Charlotte and Atlanta, he said, but would restructure so that more connecting traffic passes through Atlanta.

Because capacity is restrained in Atlanta, Charlotte would likely become even more focused on serving smaller markets with regional jets, although it wouldn't lose any destinations, he said.

The deal would have to be approved by the Justice Department, which must determine whether it would be anticompetitive. Regarding the DOJ, Parker said, "We don't anticipate any problems that cannot be resolved." He didn't directly answer an analyst's question about whether US Airways was prepared to divest any of its operations.

Kirby said he didn't envision being asked to divest the Charlotte hub. "I would be shocked if they said

that," he said. "I don't think that is a realistic possibility."

US Airways said its proposal represents a 25% premium over the current trading price of Delta's prepetition unsecured claims, assuming $16 billion in unsecured claims, and a 40% premium over the average trading price of the claims during the last 30 days.

Although the merger proposal wasn't disclosed until Wednesday morning, trading in shares of Delta, which are now found on the "pink sheets," has been extremely active for the past several days. A US Airways spokesman said that even if the merger occurs, Delta's shares will have no value.

Should Delta continue as a standalone company, its existing shares will be worthless when it leaves Chapter 11. New stock will be issued, and the current shares will cease to trade. Holders of the common stock will likely get nothing, as is often the case in bankruptcies, because they are essentially last in line for claims.