Now Boarding: Merger Mania

For more than a decade, analysts have predicted a massive consolidation of the airline industry that would whittle the roughly 130 carriers now flying the U.S. skies to a smaller clutch of much bigger carriers. Among the many reasons consolidation hasn't happened are the complexities of merging disparate aircraft fleets, overlapping hubs, and the morale-sapping process of combining different unionized workforces.

But with us Airways Group (LCC )'s hostile $8 billion bid on Nov. 15 for bankrupt Delta Air Lines Inc. (DALRQ ), merger mania may finally occur. Most of the other so-called legacy carriers are out of bankruptcy, and analysts believe that us Airways' surprise bid will start a merger wave that would leave the legacies better able to compete against discounters like Southwest Airlines Co. and JetBlue Airways Corp. (JBLU ) "The industry is fragmented and primed for consolidation," says Ray Neidl, an analyst for Calyon Securities in New York.

Analysts say that Delta's initial reluctance to enter bankruptcy may end up costing it its independence. Some rival carriers readily used Chapter 11 as a way to break unfavorable aircraft leases, dump pensions on the government, and renegotiate labor contracts that put them at a competitive disadvantage to the discounters. But Delta, which has long prided itself on its paternalism, held out until late 2005 in hopes of preserving its employee pensions. That put it a good year or two behind the restructuring efforts of rivals like us Airways and United, which are now reporting strong profits, and may have left Delta more vulnerable now that the industry's fortunes are improving. "They should have taken their medicine earlier," says Roger King, an analyst for CreditSights.

US Airways Chairman W. Douglas Parker' audacious bid for the much larger Delta would vault his airline from an industry also-ran to the nation's largest carrier by number of passengers. It would also have the largest market share in 155 of the nation's 420 airports. In addition, snaring Delta would also give us Airways a stronger presence in Europe and South America--high-margin international routes that are largely immune from the discounters.



For Delta, however, the overture comes at an inopportune time. Its managers have been telling creditors and their own board that the airline's growth potential as a standalone entity would yield better returns than what creditors would receive from a competitor's bid. "If we close the revenue gap [with other airlines], we will be the most profitable airline in the industry," Delta Chief Operating Officer James M. Whitehurst said recently.

Will creditors buy that logic? Clark Orsky, a high-yield analyst with KDP Investment Advisors in Montpelier, Vt., says that Delta's creditors will "put a lot of pressure on management to prove their plan is better." San Francisco aviation consultant Michael Roach points out that the bid is a 25% premium above the level at which Delta's unsecured debt recently traded.

Parker's may not be the final bid. Facing the prospect of a bulked-up Delta, analysts believe that other carriers might feel they have no choice but to strike deals of their own before the most attractive partners are spoken for. "You don't want to be left out when the music stops," says Robert W. Mann Jr., a New York-based airline consultant. United might counter with a Delta bid of its own, or failing that, could try to combine with Continental. If United makes a move, analysts expect American Airlines or Continental to pursue Northwest Airlines. Let the merger games begin.

By Dean Foust, with Lorraine Woellert in Washington and Brian Grow in Atlanta

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