The airline industry finally got some good news -- unless, of course, you're UAL ( UAL).

Bankruptcy will make life difficult for the parent of No. 2 U.S. airline United and the cadre of banks, suppliers and partners that rely on the company as a source of revenue. But bad news for United Airlines may well be good news for the rest of the airline industry, which faces less competition with the second-largest carrier in Chapter 11 protection.

For a change, Wall Street analysts and industry watchers -- many of whom have said the U.S. airline industry can only support five or six major carriers, instead of eight today -- were making positive comments in the wake of the government's rejection of UAL's request for assistance. Because UAL will be forced to cut capacity, jobs and push forward with a painful reorganization, analysts feel the industry outlook will improve -- providing a glimmer of hope that surviving airlines can start recovering after losing $15 billion over the last two years.

"Competitors will be helped somewhat in the near- to intermediate-term," said Philip Baggaley, credit analyst with Standard & Poor's. "You'll have some traffic diverting to rivals. The lower wages and compensation that will be negotiated with United's unions will influence the bargaining at other airlines. It will be easier to resist requests for higher pay and ask for concessions. It's also likely to reduce industry capacity."

According to Credit Suisse First Boston analyst Jim Higgins, UAL could cut capacity as much as 12%, which is double what the carrier previously announced. "Cuts will help better match supply with industry demand," he said.

As a result, the airline stocks rallied significantly on Thursday. The American Stock Exchange Airline Index was up 5.1% on Thursday afternoon, pushed higher by AMR ( AMR), parent of American Airlines, which rose 9% to $7.67. Continental Airlines ( CAL), Delta Air Lines ( DAL) and Northwest Airlines ( NWAC) all had better than 5% gains.

The Big Winner: American

More than any other carrier, the one most likely to benefit from UAL's bankruptcy is the nation's largest, American Airlines. These two rivals fight head-to-head in Chicago, United's biggest hub, and in California, one of the nation's largest and most competitive travel markets. With UAL cutting flights and services, many analysts feel that American can steal back some market share, without cutting too deeply into profit margins.

Prior to the Air Transportation Stabilization Board's rejection of UAL's request, some industry watchers expressed concern that a UAL bankruptcy would trigger a domino effect where more carriers would go bankrupt. The thought was that a bankrupt UAL would gain significant price advantages against rivals, especially AMR, and use it to drive them out of business.

But most Wall Street analysts dismissed this idea, arguing that UAL management will act rationally, understanding the risk to the overall industry in triggering a price war. "We do not subscribe to the domino theory of bankruptcy in the airline industry," wrote Higgins. "Ultimately, what it takes for UAL's competitors to maximize revenues is almost exactly what it takes for UAL to do the same -- any damage UAL does to its competitors' top line would hurt it as well -- and we believe UAL understands that."

While this theory won't actually be tested until UAL files Chapter 11, it does make some sense, considering that USAir has made numerous attempts to raise prices, not lower them, while in bankruptcy.

AMR will also benefit on the labor front, since UAL's unions will likely have their wages reduced while the company restructures. American's pilots are flying under an open contract and will be far less likely to be demanding at the negotiation table, not while pilots are being sacked at UAL.

The Best of the Rest

From a competition perspective, American has the most overlap with United, but nearly every carrier stands to see some kind of benefit in the coming months.

Northwest, which has the best liquidity position of any of the legacy carriers, competes on many of the same routes as United, especially in the West and Midwest. And like American, it also needs to renegotiate a contract with its pilots this summer. The major risk to this thesis is if UAL decides to trigger a price war in certain markets, but again, this is seen as an unlikely scenario because it would also harm UAL.

Continental, which has less of a financial cushion than Northwest, also has to renegotiate a labor contract with pilots and will see an indirect benefit from capacity cuts. Of the legacy carriers, Delta may see the least upside when UAL enters bankruptcy because its route structure doesn't overlap much with UAL's.

"The carrier is currently faced with industry-leading pilot wages and although the company is in the midst of approaching labor for concessions, labor is likely to drag its feet," said Salomon Smith Barney analyst Brian Harris. "The contract does not become amendable until May 2005."

The Risks May Outweigh the Rewards

A UAL bankruptcy may hold some positives for the industry, but it's certainly neither a signal that the industry is on the verge of recovery, nor a sign of a bottom. Because airlines are leveraged to the economy, with business travelers buying high-margin tickets only when business is good, the industry is not out of the woods.

With the U.S. rattling sabers about a war in Iraq, airline investing is still quite a risky proposition. A war would raise overall costs because fuel prices will spike, while also sapping demand because travelers shy from the skies during wartime. In a worst-case scenario, if the war carries on long enough and terrorists attack again, Baggaley says there could be further bankruptcies.

UAL's bankruptcy will also further tighten the credit market for other carriers, since a number of the larger industry financiers, such as Boeing ( BA) and General Electric ( GE)-unit GE Capital, will probably have UAL-related writedowns. ( See related story. )

"It's positive for competitors, but on the other hand it will throw the market for aviation finance into further turmoil," said Baggaley. "They will have lesser opportunities to obtain financing. But at this point, the airlines are relying mainly on what you might call inside lenders, like manufacturers. And not the public market."

While the UAL situation provides some relief for rivals, it doesn't really alter some of the fundamental problems facing the industry, namely, slumping demand and the decline of the lucrative business traveler.

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