A Megadeal In The Skies

BA and American may team up-and change the face of global aviation

The world's largest airlines have long pursued a vision of the perfect alliance. Find the right partners, the thinking went, and an able executive could create a profitable network of globe-girding carriers ferrying passengers in and out of the world's major hubs. But the successful partnership has been a rare event, while meager payoffs or even huge losses on hastily forged deals have been far more common. The blockbuster deal that would transform the industry has eluded everyone.

Until now. AMR Corp.'s American Airlines Inc. and British Airways PLC, once fierce rivals, are on the verge of forming an alliance that could force other carriers to react fast or risk irrelevancy. According to sources at both companies, the two are working on what amounts to a virtual merger. The companies would pool costs and revenues, plan key strategies such as route structures, fares, and marketing, and feed passengers to each other. To cement the partnership, they may swap equity stakes of up to 20%. While other carriers have adopted a similar strategy, no other alliance combines the physical reach, financial muscle, and aggressive poise of American and British Airways, which have $30 billion in sales between them.

HEATHROW ACCESS. The negotiations involve both government and company officials. Senior executives feel that a deal "is reasonably close," says Patrick V. Murphy, assistant secretary for aviation and international affairs at the U.S. Transportation Dept. Everything depends on signing a politically sensitive "open-skies" treaty, which will allow British and U.S. carriers unrestricted access to hubs in each country. Before granting the antitrust immunity, the two carriers need to plot routes and fares together. U.S. negotiators are insisting on open skies, which could help pry open Heathrow airport to more U.S. carriers.

An open-skies pact hasn't been struck yet. But if all falls into place, American Chairman Robert L. Crandall and BA CEO Robert Ayling will redraw the map of airline alliances in Europe and North America. "This is bigger than anything that has happened before," says Keith McMullan, managing director of consultants Avmark International Ltd.

For starters, American could snap up BA's current partner, USAir Inc. USAir Chairman Stephen M. Wolf told shareholders at the annual meeting on May 22 he prefers that "USAir remain a stand-alone carrier." But he did not rule out a merger. Sources say Wolf has already put the carrier up for sale after concluding that USAir was too small and weak to survive on its own. Wolf's preferred buyer is American, but he will accept a higher bid from any carrier, such as United. KLM Royal Dutch Airlines may team up with American and BA, too. KLM has a good operating partnership with Northwest Airlines Inc., but these ties are fraying. The Dutch carrier is suing Northwest's key shareholders for trying to block KLM's purchase of more equity in Northwest.

Even without the participation of USAir and KLM, an American/BA combination would produce a monster airline. According to airline consultants SH&E Inc., the pair controlled 11.3% of the traffic generated last year by the world's major American, Asian, and European carriers. They would dominate the lucrative routes between major East Coast cities and Canada to Europe, with 24% market share between them. With additional passenger feeds from American, BA could strengthen an already enviable position on highly profitable routes eastward from London to Africa, the Middle East, and Asia. In Latin America, where American is dominant, BA's European passengers will boost American's traffic even further.

Only in Asia are the carriers considered weak. Crandall has long regretted withdrawing from the bidding for Pan Am's Asian routes, which United bought. But American's new alliance with Singapore Airlines and BA's 25% stake in Qantas could be the foundation of a major new Pacific Rim airline.

Several factors account for the new good feelings between American and BA. Sir Colin Marshall stepped down in January as BA's executive chairman, turning over day-to-day management to Ayling. Marshall and Crandall did not see eye to eye, but Ayling, 49, gets along well with Crandall, whom many regard as opinionated, and his No.2, Donald J. Carty.

Washington's strategy of approving other alliances, and thus pressuring Whitehall to accept an open-skies treaty, also appears to be working. On May 21, the U.S. granted antitrust immunity to an alliance between UAL Corp.'s United Airlines and Germany's Lufthansa, allowing them near-complete freedom to coordinate fares and routes. Washington also tentatively granted similar authority to Delta Air Lines and Sabena, Swissair, and Austrian Airlines. While BA reported record pretax profits of $883 million for last year, company officials worry these rival partnerships will steadily eat away at the passenger traffic and profits BA gets from routes to Heathrow.

DOMINANCE? BA's alliance with USAir is rocky. The two are not allowed to work closely because there is no open-skies agreement between the U.S. and Britain. And while BA claims $130 million in profit from the relationship, last year it wrote off half its $400 million investment in the troubled carrier.

Negotiators still have problems. The biggest: antitrust objections. Consultants SH&E figure BA and American have well above half the New York-to-London market. Between Miami and London, their share is 75%. "There are incredible layers of complication," says one top antitrust lawyer. Adds Jon F. Ash, managing director of consultants Global Aviation Associates Ltd.: Northwest, Continental, Delta, and Trans World Airlines "are going to be apoplectic."

And with Heathrow virtually full, the possibility of an open-skies agreement with Britain may still not satisfy American demands to open the airport to more carriers. Without more Heathrow slots, "open skies doesn't mean anything," says consultant Ash. To deliver the benefits of open skies, U.S. negotiators may force American and BA to give up some routes and Heathrow slots to other U.S. carriers.

The shape of the alliance will depend partly on the outcome of talks between U.S. and British officials, who began a new round of meetings on May 20. It will depend on what the carriers are willing to give up to satisfy competition authorities. "The devil is in the details," says one U.S. Transportation Dept. official. Those details could change an industry.

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