Bird Hunting Season?

For U.S. airlines, the drumbeat of retrenchment has been echoing for years. Now, with USAir Inc.'s sudden announcement on Oct. 2 that it is holding preliminary merger talks with both United Airlines and American Airlines, a new period of consolidation may be about to begin. Even the possibility that United or American may pull off a deal to buy ailing USAir could well force rivals to contemplate bulking up, too. "Once you pull that trigger, you've got all the other gunslingers out there," says Jon F. Ash, managing director of consulting firm Global Aviation Associates Ltd.

Indeed, the USAir merger talks are likely to have far-reaching ramifications. The talks could help redraw the international aviation map, if USAir partner British Airways PLC is forced to cut a new deal with another U.S. carrier. Watching its major rivals on the move, Delta Air Lines may have to consider getting into the act, especially given that a combined United-USAir or American-USAir would hold nearly 30% of U.S. domestic traffic. Ditto weaker carriers such as Continental and TWA, which is scarcely in better shape than USAir. Most of all, the talks are forcing executives to abandon their all-consuming focus on retrenchment. The big question now, says a former top airline executive: "How do you position your [carrier] with a large enough presence and market share to win in the next downturn?"

Of course, any deal is still a long shot. Antitrust issues, thorny labor problems, and financial obstacles may prove insurmountable. Many investors are hardly enthusiastic about a possible combination. The day after announcement of the talks, USAir's stock jumped, but that of UAL, parent of United, fell 3.5%, while shares in AMR, parent of American, dropped 3%.

BIG LOSSES. If a deal does come off, analysts see all sorts of intriguing combinations being considered in its wake. Northwest Airlines, now one of the industry's most profitable carriers, could make a nice fit with Delta or Continental, which has dramatically improved operations, analysts say. Continental's hubs in Houston and Newark would complement Northwest's strongholds in Minneapolis, Detroit, and Memphis. And Delta could benefit from Northwest's strong routes in the northern U.S. and the Pacific. Indeed, if a USAir deal isn't squelched by political or antitrust concerns, "everyone will be stumbling over themselves" to find their own merger partners, predicts one airline executive.

USAir itself will be pushing hard to make something happen. Its motivation is clear: survival. Although USAir finally flew into the black in the second quarter, it has posted losses of nearly $3 billion in the past five years, suffered two fatal air crashes, and scuttled talks this summer to wrest $2.5 billion in concessions from its unions. Chief Executive Seth E. Schofield, who had planned to resign, now will stay on until the merger talks are concluded.

Meanwhile, USAir's scramble to hook up with a stronger rival is already having widening reverberations. For instance, British Airways, which owns 21.5% of USAir, has been helped mightily by its three-year partnership with the U.S. carrier, despite recently having to write down half its $400 million investment: It claims its stake in USAir has brought it $100 million worth of benefits from sharing facilities and feeding passengers into its international routes. Without USAir, "BA's whole transatlantic network would be in jeopardy," says a former United executive.

CACTUS DANCING. BA itself, like other foreign carriers, is excluded under U.S. law from doing a full buyout. If United were to buy USAir, it likely would have to choose between sticking with current partner Lufthansa and switching to BA. And if American does the deed? Sources close to the carrier say it was talking with BA about an alliance before it ever contemplated a deal with USAir. But American and BA are big competitors in the transatlantic market. And then there's the possible culture clash between BA's domineering chairman, Sir Colin Marshall, and AMR Corp.'s strong-willed Robert L. Crandall. "It would be like rolling around with a cactus," says Chris Avery, a London-based analyst with Paribas Capital Markets Group.

The pitfalls of a USAir deal may weigh heavily against the enticements. USAir's East Coast network would fill gaps for United and American and boost transatlantic traffic. But that could be more than offset by USAir's sky-high costs and intransigent labor force, says Steve Lewins, an analyst at Gruntal & Co. "I hope the stock prices come down so far so fast that the idea gets abandoned quickly," he says. A deal also would undermine American's and United's plans to boost their below-investment-grade credit ratings by adding about $7.9 billion of debt and leases to the acquirer's balance sheet.

Financing problems pale compared with the labor complexities. A USAir pilot-union source points out that a merger would lead to inevitable conflicts in merging seniority lists, and he worries about possible job losses. Then there would be the effect on cost-cutting if employees get riled up. American is trying to gain $300 million in cost savings from its pilots, and it has vowed not to invest more in the airline business until it brings costs down. United last year sold a majority stake in the carrier to its unions, after wresting $5 billion in labor concessions. Employees there might resist any deal that dilutes their investment. "How does [a possible deal] work for us as shareholders and employees?" asks a source close to United's pilot's union. "It has to pass both tests."

Still, the pressure will be intense for some sort of USAir buyout, even if the carrier ends up being sold off in pieces. American is particularly worried about the prospect of USAir falling into United's hands. Nabbing the carrier for itself would give American coveted slots at Chicago's O'Hare, New York's LaGuardia, and Washington's National Airport. That could help American narrow the gap with United in Chicago, where it is a struggling No.2 despite its massive hub there. Mulling a USAir deal is "a top-burner issue" at American, says a source close to the company.

The nation's two largest carriers may yet pass on doing a deal for USAir, despite their intense rivalry. But they have opened the door to a possible shakeup in an industry that lately has seemed downright staid.

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