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Why United, Continental May Not Be a Storybook Romance

By Paul M. Barrett
     May 6 (Bloomberg Businessweek) -- On May 3, Continental
Airlines (CAL) Chief Executive Officer Jeff Smisek, a guy known
for driving around Houston at 130 miles per hour, boasted how
he'd telephoned his counterpart at United Airlines (UAUA), Glenn
Tilton, to break up the potential marriage of United and US
Airways (LCC). "I gave Glenn a call and told him I was a much
prettier girl," Smisek told Bloomberg News.
     It would be unsporting to deny Smisek, 55, his Broadway turn
as Maria in West Side Story. Yet the reality of the airline
industry is anything but pretty. The vital function of flying
passengers for work and pleasure remains a terrible business, and
the merger of Continental and United won't do much to solve the
     Over the past decade, the domestic airline industry has
amassed no less than $60 billion in red ink and shed 160,000
jobs, according to the Air Transport Assn., a Washington trade
group. United and Continental each suffered losses for the past
two years, and as borrowers they receive miserable credit
ratings. On average, journeys between clogged airports take
longer than they did years ago because of tarmac delays, circling
before landing, and other factors, the ATA says.
     Warren Buffett, as usual, has pithily summarized the
situation. "You've got huge fixed costs, you've got strong labor
unions, and you've got commodity pricing," he told The Telegraph
back in 2002. Buffett learned his lesson after a disastrous
investment in US Airways in 1989: "I have an 800 number now that
I call if I get the urge to buy an airline stock," he said. "I
call at two in the morning, and I say: 'My name is Warren, and
I'm an aeroholic.' And they talk me down."

  Bankruptcy Knack

     The one skill the carriers have consistently demonstrated,
says Adam Epstein, a consultant and tech financier who flies
frequently from his base in San Francisco, is using the
Bankruptcy Code to rearrange their money-losing operations.
Thirty-seven airlines, including United, have filed for Chapter
11 protection from creditors since 2000, according to the ATA;
nine have been liquidated. "Maybe more should have just gone
away, rather than reorganize," Epstein says.
     Mergers are another way to thin a bloated industry, but the
streamlining has been painfully slow and uneven. The trouble with
commercial air travel traces to 40 years of government fare and
route regulation, which ended in 1978. Unable to compete on
prices, the carriers tried to outdo each other on services. The
complimentary booze flowed. Federal rules protected profits, so
the companies had little incentive to contain costs. Salaries for
pilots, flight attendants, and mechanics soared. Labor
concessions in recent years have corrected some of the wage
distortion, but not all of it.
     In the 1980s and 1990s, upstarts such as Southwest Airlines
(LUV) challenged the longtime carriers, setting off intermittent
price wars, strikes, and egotistical overexpansion. To this day,
the industry hasn't gotten control of its crippling fixed costs.
Even with sophisticated financial hedging techniques, it has
suffered from high and volatile fuel prices. Freak storms, not to
mention Icelandic volcanoes, can gouge millions from collective
     After three decades of turbulence and the disappearance of
PanAm, Eastern, TWA, and other hallowed brands, the airlines
still have too many seats in the air. The dominant system of hub
airports?Continental has them in Houston and Newark, N.J.; United
in Chicago and Los Angeles?has proven to be expensive to maintain
and prone to infuriating travel snags.

  History Not Encouraging

     The only airlines that seem to have a winning formula are
Southwest, JetBlue (JBLU), and a handful of others that fly from
point-to-point, keep expenses and fares low, and generally enjoy
decent relations with their employees.
     Though combining United and Continental makes plenty of
sense on paper, history isn't encouraging. Most big airline
mergers have yielded mediocre to poor results, not because the
particular mix was a terrible idea, but because the entire
business is hexed. US Air still juggles two sets of employees
five years after merging with America West?and their lowly
customer service ranking from J.D. Power & Associates (MHP)
reflects the confusion. The two lowest-rated full-fare carriers
in the quality-assessment firm's 2009 survey were US Air and
United. Delta Air Lines' (DAL) 2008 hook-up with Northwest
Airlines has gone more smoothly. The new Delta reported that it
narrowed its loss in the first quarter to $256 million, down from
$794 million in the quarter a year earlier. That passes for good
news in the airline trade.
     Given the alternative of struggling independently, United's
deal with Continental seems smart, says Vicki Bryan, a senior
analyst with GimmeCredit, a bond research firm in New York.
Annual cost savings and new revenue could reach $1.2 billion by
2013, the companies project. They promise "improved profitability
and sustainable long-term value for shareholders." The combined
carrier should benefit from greater reach on the most lucrative
international routes. "The airline industry has long been
oversupplied, and that has kept airfares essentially unchanged
for the past 20 years," says Bryan. "Without pricing power, there
are only two ways that airlines can address this: higher-quality
revenue [such as that from profit-rich routes to Asia and Europe]
and lower costs." The United-Continental deal could produce both.

  Consolidation: How Far?

     How much real consolidation occurs remains an open question.
Seeking to buy peace with their unions, United and Continental
emphasized that job reductions would be limited primarily to
retirements and attrition. Some savings might come from further
trims to amenities. Smisek, in his short four months as CEO of
Continental, has curbed customer incidentals, which until
recently were generous by air-travel standards. Catching up to
its rivals, Continental has eliminated free food in economy class
on most domestic flights. It also started charging extra for
roomier exit-row seats and matching those annoying bag fees. "The
merger looks like win-win for the two airlines," says consultant
Epstein, "but I don't think passengers are going to feel better
     The modest-priced carriers notwithstanding, it's a mystery
how the American airline business continues to attract capital
with very little hope of a decent return. One explanation comes
from Tom Petzinger Jr., who runs Launchcyte, a biotech-financing
company in Pittsburgh. Earlier in his career, Petzinger wrote
about airlines for The Wall Street Journal and in 1995 published
a book on the topic called Hard Landing. "I hate to use the word
'romance,' in a business context," he says, "but I think that's
what it is. There are naive investors who refuse to believe you
cannot make good money delivering human beings over the surface
of the planet. The assumption makes sense. The economic realities
say otherwise. There are just too many other people with the same
investment view, and too many planes flown by too many pilots.?
The lesson keeps getting learned the hard way."
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