Airline Pricing Buoyed as AMR Merger May Pare Seats 3.9%

A combination of AMR Corp.’s American Airlines and US Airways Group Inc. promises to strengthen the U.S. industry’s ability to raise fares as the combined carrier eventually cuts back on flying.

Capacity, measured by the number of seats flown a mile, probably would be reduced by 3.9 percent within several years as redundant or underperforming routes are pruned, according to the average estimate of six analysts surveyed by Bloomberg.

While American and US Airways said they would maintain all hubs and expand service to some new cities, the history of recent combinations suggests that the new American will make fewer flights in coming years. Paring the supply of available seats, as United Continental Holdings Inc. and Delta Air Lines Inc. are doing this quarter, helps maintain pricing power.

“You’ll definitely see declines in capacity,” Helane Becker, an analyst at Dahlman Rose & Co. in New York, said in an interview before the deal was announced. “That’s the whole idea behind consolidation. We get fewer decision-makers and get rid of some of that excess capacity.”

The AMR-US Airways deal announced today would leave United Continental, Delta and the new American as the only U.S. airlines with overseas networks and full-service cabins, down from six carriers in 2008.

Fare Increase

U.S. domestic fares averaged $356 in 2012, 11 percent more than in 2010, when former United parent UAL Corp. merged with Continental Airlines Inc. and Southwest Airlines Co. agreed to buy AirTran Holdings Inc., based on data compiled by Bloomberg. The Southwest deal was completed in 2011.

Additional consolidation from an American-US Airways tie-up will help United and other airlines, Chief Executive Officer Jeff Smisek told employees today in a memo. While US Airways will have to leave United’s Star Alliance in favor of American’s Oneworld, an exit because of a merger is “good news for United,” he said.

“We, our co-workers, our customers and our shareholders have benefited from the improved financial health that consolidation has brought to our industry,” Smisek wrote.

“Having a very stable industry with three big competitors and Southwest is all you really need,” said Gordon Bethune, a retired Continental CEO, in an interview.

United and Delta both initially said they would preserve all hubs, and later trimmed flying at some cities as fuel prices rose and the recession damped demand. Another way airlines can cut back is by reducing how many times a day they fly between cities, which lowers capacity without pulling out of a market.

Fewer Passengers

United’s Cleveland hub handled 44 percent fewer passengers on its planes and commuter partner ExpressJet’s in the 12 months ended in October from five years earlier. Delta’s Cincinnati passenger traffic shrank by 70 percent in the same period, according to the U.S. Bureau of Transportation Statistics.

United and Delta both favored an AMR-US Airways deal. Delta’s support was part of a longstanding consolidation push that included its purchase of Northwest Airlines Corp. in 2008, CEO Richard Anderson said at a Dec. 12 investor event. Delta itself studied whether to bid for AMR and US Airways last year, people familiar with the matter said then.

Stock Rally

Speculation about a tie-up has helped propel a rally in airline stocks led by Tempe, Arizona-based US Airways. The Bloomberg U.S. Airlines Index gained 22 percent in the 12 months through yesterday, compared with 12 percent for the Standard & Poor’s 500 Index.

AMR rose 63 percent to $2.12 at the close in New York. US Airways slid 4.6 percent to $13.99, and has gained 55 percent in the past year as the S&P 500 advanced 13 percent.

Merging with US Airways will restore American’s title as the world’s biggest airline, which it ceded to Delta and then United, without resorting to its original restructuring plan for boosting departures by 20 percent over five years at five U.S. hubs.

“American’s stand-alone growth plan was unrealistic,” said Jeff Straebler, managing director for aerospace in the bonds and corporate finance group at John Hancock Financial Services in Boston. “Any chance of success relied on United and Delta not responding, which was unlikely. A market-share fight would have brought back the bad old days, adversely impacting industry profitability.”

Pacific Opportunity

One area of growth for the new American may be on Pacific routes, where capacity could increase as much as 20 percent in the coming years, Straebler said. US Airways doesn’t have a trans-Pacific network.

Almost all of the capacity reductions by American and US Airways probably will be on domestic routes where there is more competition from Southwest and smaller carriers such as JetBlue Airways Corp. and Virgin America Inc., according to the analysts surveyed by Bloomberg.

U.S. Senator Mike Lee, a Republican from Utah who is the ranking member on the Senate Judiciary Committee’s antitrust subcommittee, said the size of the proposed merger “poses potential risks for the market” and would be a problem if it led to higher fares, diminished service to regional markets or too much coordinated conduct among competitors.

Senate Commerce Committee Chairman Jay Rockefeller, a West Virginia Democrat, said the deal will be reviewed “very closely.”

Likely Approval

While the merged airline may have to give up some flight slots to meet antitrust requirements, the deal is likely to win Justice Department approval, said Alison Smith, a partner with McDermott Will & Emery in Houston who previously worked as an antitrust lawyer at Justice.

The regulator has allowed three other airline mergers within the past five years, including the Delta-Northwest tie-up and the United-Continental combination.

“Since the 1990s, the Justice Department has evaluated airline mergers based on whether they reduce competition on individual routes,” Smith said in a telephone interview. “If the Justice Department believes that the merger may reduce competition between AMR and US Airways on overlapping routes, it might require the parties divest certain takeoff and landing rights.”

Such divestitures might include flight slots at Ronald Reagan Washington National Airport, according to the analysts surveyed.

Western Shift

Cutbacks also may be coming at US Airways’ Phoenix hub because American’s hubs in Los Angeles and Dallas could handle that traffic instead, according to Straebler and Michael Derchin, an analyst at CRT Capital Group LLC in Stamford, Connecticut.

US Airways CEO Doug Parker triggered the current round of consolidation when he was running America West Holdings Corp. in 2005 and combined with then-bankrupt US Airways. United, Delta and Northwest all reorganized under court protection before their combinations.

Savings from restructuring, fare increases and new revenue sources such as baggage charges and rebooking fees helped the industry return to profit starting in 2010. Those gains pared the U.S. carriers’ $53 billion in collective losses from 2001 through 2011, according to the Airlines for America trade group.

Airline executives have “learned the pitfalls” of adding capacity that outpaces demand, said James Corridore, an equity analyst at Standard & Poor’s in New York.

“If you add capacity just to add capacity, it will lead to another cycle of destructive pricing and industry losses,” Corridore said. “That’s a game nobody wins.”