More Is Less: The US Airways Delta Bid

US Airways contends that a merged emergence from bankruptcy offers far greater profit potential than a stand-alone Delta.
Roy HarrisNovember 15, 2006

In offering $8 billion in cash and US Airways Group stock to merge with the bankrupt Delta Air Lines, US Airways chief executive officer Doug Parker and CFO Derek Kerr seek to repeat past glory.

In September 2005, Parker and Kerr’s previous airline, America West, made a similar, successful move to bring US Airways out of bankruptcy. And the two executives, friends since high school, see that path for Delta—as the combined airline would be called—also offering the most promising flight path to profitability through a merged emergence from Chapter 11.

Parker calculates that in two years a Delta-US Air combination would produce fully $1.65 billion in synergies—$935 million coming from “network rationalization” such as reducing the combined fleet size, thus sharply improving results in the key area of revenue per available seat-mile. The other $710 million would come from expense reductions like consolidating IT, reducing of overhead, and combining facilities.

The ability to reduce fleet size is much greater when an airline is in bankruptcy and can return aircraft and cancel leases with impunity. Indeed, Parker, the former CFO of America West, told analysts Wednesday that “over half of these benefits could be lost if we wait until Delta emerges from bankruptcy.”

Any US Air-Delta deal would have a long way to go, even though US Airways already has arranged for financing. Citigroup has agreed to provide $7.2 billion in new financing for the transaction. The funding would be used to refinance Delta’s debtor-in-possession credit facility, refinance US Airways’ existing senior secured facility with GE Capital, and finance the $4 billion cash portion of the offer. (The remainder of the price would be 78.5 million US Airways shares.) The final decision on whether to approve the US Airways offer would be made by Delta creditors.

Delta CEO Gerald Grinstein, a veteran airline man who headed the old Los Angeles-based Western Airlines before Delta bought it in 1987, rebuffed an earlier US Air overture. In a statement Wednesday, he said that “Delta’s plan has always been to emerge from bankruptcy in the first half of 2007 as a strong, stand-alone carrier.”

But the US Airways case for repeating the success of the America West-US Air combination is compelling, in Parker’s view, offering far greater profit potential than a stand-alone Delta. That was the lesson of US Air-America West, which has significantly outperformed United Airlines, a carrier that in February chose to emerge from Chapter 11 alone.

Parker told analysts that the United experience was “strikingly different”—and poorer. US Airways has outperformed the industry with a pretax margin of 4.9 percent, while United’s margin has been 0.5 percent. Further, the total equity return post-merger for US Air-America West has been 164 percent. United’s return? Just 2 percent.

“As much as we like to say it’s brilliant management” on the part of US Airways, Parker told analysts, “we were able to bring US Airways out of bankruptcy with significant synergies, which United wasn’t able to do.” US Air’s synergies were $600 million in the first year, as the airline was able to shrink its fleet size by 14.9 percent.

“There are not many industries more fragmented than airlines,” Parker told analysts. No carrier has as much as a 20 percent market share in the U.S. But while creating a much larger airline would give the new Delta significant clout, it is the profit potential that stands to really impress.