The Deal: An Unscheduled Departure

NEW YORK (The Deal) -- Assumptions can be dangerous. So it is surprising that despite the turbulence facing the potential merger of US Airways Group (LLC) and AMR (AAMRQ), industry pundits and analysts predict so confidently that the Department of Justice will settle its lawsuit seeking to block the $11 billion merger.

Tempe, Ariz.-based US Airways secured a deal with the bankrupt parent of American Airlines in February after more than a year of pushback from AMR management. With initial smooth flying, the deal appeared to be on its way to forming a third truly national U.S. air carrier network. The merger had the backing of labor and quickly won AMR creditor support. But it was thrown into doubt last month when the DOJ went to court to try to block it on antitrust grounds.

Few saw the DOJ action coming, and the weeks since have provided no shortage of twists and turns. But the consensus among an overwhelming majority of industry watchers on what happens next is remarkably clear. In nearly all analyst reports, social media posts, newspaper columns and television appearances, they predict the airlines and the DOJ will settle the case, allowing the deal to eventually proceed.

That consensus among airline industry players, however, contrasts markedly with the opinions of antitrust experts who have represented merging clients before the DOJ and litigated merger cases. They are decidedly more skeptical. These observers contend that while some of the DOJ allegations might lend themselves to a settlement, the core of the DOJ's case -- that the merger would increase the likelihood of coordinated behavior among remaining network airlines, leading to higher fares and fees and reductions in service -- does not suggest an obvious settlement.

For their part, neither the government nor the airlines are saying anything beyond the conventional boilerplate in their court filings that they are willing to consider a settlement if the other side presents the right deal.

"Any discussions about settlement to resolve this litigation, whether internal, with DOJ directly or through the mediator, would be private and we are not going to comment on them in any way," a spokesman for the airlines said.

Going into the deal industry players had plenty of reason to assume the government would not intervene. For all of the political bluster that typically accompanies airline M&A, only one deal -- United Continental Holdings Inc. predecessor UAL Corp.'s proposed purchase of US Air in 2001 -- has been scuttled due to antitrust concerns, and a stalling economy and internal issues may have had more to do with UAL's decision to abandon that transaction than did antitrust concerns.

More recently deals including UAL's purchase of Continental Airlines ( CAL) and Southwest Airlines's ( LUV) acquisition of AirTran Holdings received less regulatory scrutiny than expected, leading many in the industry to conclude that the government had signed off on the airlines' thesis that consolidation was to be encouraged to create a healthier, more stable industry.

Justice in filing suit against AMR and US Airways made it clear that assumption was wrong. But there remains a widely held belief inside the industry that the DOJ has a weak case. Attorneys for the airlines, echoed by industry analysts and pundits, have loudly trumpeted what they see as flaws in the government's arguments that they say make going to court a poor option for regulators.

That was certainly the position of Richard Parker, the airlines' lead litigator, when he spoke to reporters on Aug. 14. "They got this one wrong, very wrong," the O'Melveny & Myers LLP partner said. The DOJ's prediction of higher fares and coordination on pricing does not take into account the benefits to consumers that will come from joining the fourth- and fifth-largest domestic carriers and creating an airline comparable in size and network to those operated by United Continental and Delta Air Lines Inc. "There will be more flights to more destinations, domestic and international. And communities, including smaller communities, will be better served."

And, the thinking goes, the DOJ will not be able to prove the harms the government said will be posed by the merger. "At trial the evidence is going to show the industry is uniquely difficult, impossible, to coordinate because fares are changing every day," Parker said.

Conventional wisdom among transportation sources is that the government's best chance to prevail in the US Airways/AMR case was to run out the clock, postponing the trial to early 2014 and forcing AMR to forego a merger and instead emerge from bankruptcy as a standalone airline. But the court's decision to schedule a trial in November, according to that line of thought, puts Justice in a bind and makes it more likely the government would be willing to compromise and avoid defeat.

Wolfe Research LLC senior airline analyst Hunter Keay argued in August that much of the DOJ's case relies on "anecdotal and vignette-driven arguments," saying it is reminiscent of the Oracle Corp./PeopleSoft case, which Justice "lost in an embarrassing fashion."

Keay has since said he received pushback from antitrust sources on the comparison, but stands by his conclusion. "With the caveat that we probably know as much about antitrust law as the DOJ seems to know about airlines, we believe the proposed merger ... will go through," he said.

Aviation analysts said the DOJ was overstating its case when it said there are more than 1,000 markets where the merger threatens competition, saying that most of those markets are third-tier city pairs like Austin, Texas, and Riverside, Calif., a route that serves fewer than a dozen passengers daily.

Hong Kong-based aviation consultancy Aspire Aviation said the government analysis also counts flights to two airports in the same market, for example, flights to both Los Angeles and Orange County, Calif., as separate markets. Counting markets instead of airports reduces the list from more than 1,000 to 700 potential competitive issues, and Aspire said that in only 17 of those routes the merger would combine the market share leader and the low fare leader.

And experts warn that while both US Airways and a restructured American are well positioned to compete today, over time their independent positions are likely to erode and leave Justice without the two vigorous competitors it hopes for.

US Airways' recent success, they argue, is built on unsustainably low wage rates that were a product of past bankruptcies. American, meanwhile, in a standalone scenario would likely emerge from Chapter 11 burdened by significant debt and would be unable to expand to rival Delta and United.

The DOJ in building its case against the deal includes projections from American's standalone reorganization proposal, which was built as a rival to US Airways' overtures. Vaughn Cordle, a partner at Ionosphere Capital LLC, said that relying on those rosy forecasts is a mistake.

"No serious analyst believed American's former executives when they said they would aggressively grow their key hubs after they emerged from bankruptcy as an independent airline," Cordle wrote. "It was a narrative designed to help the American CEO and core team remain in control and also placate various stakeholders, especially labor."

If American is forced to go it alone and does expand as planned, Cordle said that the growth would destroy shareholder value which in turn would force management to reverse course.

"Hence this growth story was pure fantasy; a fantasy that the DOJ now ironically uses as their own evidence that the airline could remain viable and strong as an independent airline," he said.

All in, analysts have concluded that either by settlement or after victory in court the deal is likely to be consummated, with a settlement seemingly more palatable to regulators.

"We think there is still an excellent chance this case never goes to trial since it can and should be resolved with a negotiated settlement, but if it does we expect the airlines to prevail," Vicki Bryan, a senior high-yield analyst at Gimme Credit LLC, said in a recent note.

But a number of antitrust practitioners take the opposite view -- that there is no way this case doesn't go to trial.

If there is a settlement, the agreement will likely only address DOJ concerns that are easily addressed, such as concentration at Reagan National Airport or reduced competition along specific routes, which could be fixed by divestitures to other airlines.

From the airlines' court filings, in fact, it appears they tried to do just that. While antitrust sources said that a settlement on those issues is still possible, such a move would serve only to narrow the issues at trials. There is not obvious settlement for the DOJ's conviction that eliminating US Airways and American as separate network carriers would harm competition and that US Airways has a unique hub system that makes it a disruptive player in the market.

One source said the DOJ would rather risk losing a trial than drop its concerns about lost network competition in order to win a few slot and city pair divestitures. "It would be such a black eye to file a challenge on those grounds and then walk away," the source said. "I can't imagine them doing that."

How strong the DOJ's case will be in court is harder to predict, the antitrust lawyers said. Although the DOJ has a cohesive theory of how consumers will be harmed, whether U.S. District Judge Colleen Kollar-Kotelly buys it will depend on evidence contained in company documents and the impact of depositions -- all factors that won't be known until they are presented at trial.

-- Written by Lou Whiteman and Bill McConnell

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