Merger Fever Is Spreading Fast at U.S. Airlines : Under Deregulation, Only Strongest Will Survive, Experts Say

It was more than half a century ago and the names are long forgotten.

There was Robertson Aircraft of Missouri, which flew the mails in a biplane between Chicago and St. Louis; Southern Air Transport, the product of a merger between Texas Air Transport and St. Tammany Gulf Coast Airways; Colonial Western Airways, a passenger carrier in Upstate New York. In 1930, these and scores of other airlines merged to become what is now American Airlines.

About the same time, Pitcairn Aviation, with 792 miles of routes stretching from New Brunswick, N.J., to Atlanta, merged with North American Aviation to become Eastern Air Transport--later Eastern Airlines.

Deregulation Cited

Now history is repeating itself. The merger spotlight, for so long focused on oil companies, has swung to the airline industry, airline officials and analysts agree. Some of them feel the trend will continue until there are only about half a dozen “super” airlines left. It’s just a matter of time before the big get bigger and the small are devoured, they predict.

“The wolf is in the chicken house now,” says Frank Borman, chairman of Eastern. “I am not saying they will fall like tenpins but there will be a period of several years during which such mergers and acquisitions and other consolidations will go on.”

The mergers will occur because in a deregulated industry, airlines will be healthiest with “large fleets and large route structures adaptable to efficient hub-and-spoke operations, with a commensurate low-cost structure,” says George James, president of Airline Economics, an airline consulting firm in Washington.

Eyeing Airlines Stocks

At the same time, corporate raiders are eyeing airlines stocks. The industry was slow in recovering from the recession but air travel has boomed along with the economy and the outlook is for more growth. After a string of solid quarterly performances, several airline stocks are considered undervalued.

The wave of consolidations is already in progress. Since 1978, when the industry was deregulated, there have been 12 mergers involving 22 airlines, according to Airline Economics.

The latest notable case occurred last month when, after a protracted battle to avoid a takeover by New York financier Carl C. Icahn, Trans World Airlines agreed to be acquired by Texas Air, parent company of Continental Airlines and New York Air. Icahn, however, has not given up.

For the last two weeks, stock market investors appear to have been betting on more airline mergers.

For instance, the stock of NWA Inc., parent of Northwest Airlines, jumped $5 a share on June 26, up 10.2% to $54.25, apparently on the strength of rumors about a takeover by American, Delta Air Lines or corporate raiders. NWA stock, which had opened the year at $40.50, closed at $53.625 on Friday.

Merger Denied

American and Delta quickly denied that they were discussing a merger with NWA, whose officials also said they knew of no reason for the unusual interest. The active trading and upward direction of Delta’s own stock reflected talk that it, too, may be a takeover target. Other airline companies whose stock has been unusually active are Pan Am Corp. and UAL.

Airline executives agree that the merger pace in their industry will quicken.

“I think there are going to be a tremendous amount of consolidations going on in this industry,” says Herbert D. Kelleher, chairman of Southwest Airlines.

Lee R. Howard, executive vice president of Airline Economics, agrees. “There are going to be more consolidations of all forms, “ he says. “The competition is tough out there in this deregulated environment.”

It is the dropping of government regulation, says Kelleher, that is “the primary stimulus for all of this consolidation.

“Since no one has a protected position any longer, everyone can go wherever they wish, charge whatever they want,” he says. “Others are saying: ‘We’d better get together and protect ourselves.’ Under deregulation, many carriers got into a very weak financial condition.”

Borman says the first phase of deregulation--”the appearance of new entrants”--is now diminishing. The next phase--”the period of consolidation”--is under way, he says.

Airline Economics’ James says the effects of deregulation were delayed for several years because of high fuel costs, the air traffic controllers’ strike and the worst recession since World War II.

“Now that you are past those obstacles, everything is up for grabs in a consolidation environment,” he says.

It was government regulation that put an end to the first wave of mergers that were a staple of the infant industry. The small, pioneering carriers that sprang up in the 1920s and 1930s gradually merged into larger entities until 1938 when the Civil Aeronautics Board was founded.

For 40 years after that, the industry was largely controlled and protected by this federal agency. It divided up routes among the carriers, set fares and conferred antitrust immunity. Treated as if they were public utilities, airlines could stay in business even if they lost money for years.

All that ended seven years ago when the airlines were once again deregulated. New airlines quickly surged into the nation’s airways. But with competition once again ruling the marketplace, only the fittest are surviving.

Of the 36 non-commuter airlines certified by the CAB in 1978, only 24 remain today. In all, 164 new airlines have been certified since deregulation made safety the only standard by which the government judges applications for new entrants. Of these, only 74 are still operating. The rest have been liquidated, or merged, or sought protection under bankruptcy laws or just given up.

This year the pace is quickening. Already, 27 airlines have ceased operating or gone into bankruptcy, compared to 34 for all of last year. The industry’s profits last year showed that only a handful of carriers are prospering. While the nation’s scheduled airlines set records for profits in 1984, just four companies--United, American, Delta and U.S. Air accounted for 62% of $2.3 billion in operating profits, with another 26 airlines sharing the remainder, according to Airline Economics.

“Failures are a form of consolidation,” adds Howard of Airline Economics. “It leaves the market that those guys had to the ones remaining.”

A merger for the weak is a less drastic solution: Southwest agreed to acquire Muse Air in March, saving Muse from bankruptcy. At the same time, it eliminated a competitor and gained a dominant position at Dallas’ Love Field and Houston’s Hobby Airport.

Similarly, Air Florida, which already had filed for bankruptcy protection last July, was rescued in September by Chicago-based Midway Airlines. For Midway, the deal offered gates at New York’s La Guardia and Washington National airports, and a use for part of the $40 million in cash that it had collected.

However, not every trip down the aisle will be the result of impending bankruptcy. Some airline executives say they expect some alliances will be made to improve competitive position. Carriers will merge “not necessarily because they are forced to but . . . because they will be able to establish a much stronger position if they combine forces,” says Kelleher.

Indeed, recent merger or acquisition activity among the larger airlines--the TWA takeover and the deal announced in April for UAL to buy Pan American World Airways’ Pacific division, for instance--is likely to accelerate the consolidation process.

Louis Marckesano, airline analyst with the Philadelphia brokerage house of Janney Montgomery Scott, says that one or two deals such as the proposed TWA-Texas Air merger “causes everybody in the industry to get out their calculators and start playing games, matching routes, labor forces and all the intangibles that go into a successful merger, with the idea that they are going to have to find a partner or be left behind.”

Says Gerald Grinstein, chief executive of Western Airlines: “It is conceivable that this kind of movement towards some huge carriers is going to cause significant apprehension among some smaller carriers and they are going to look at ways of overcoming the problems of scale by consolidating.

“I think there is going to be a ton of merger talk. There is no question that in the airline industry they are going to ask themselves ‘How do we make ourselves stronger against this oligopolistic tendency?’ ”

One answer to that question that stops short of outright merger is already a bona fide trend: Small commuter airlines are entering marketing alliances with major airlines. These regional carriers agree to operate routes feeding directly and exclusively into those of the big airlines.

Although the idea of such symbiotic arrangements are only about a year old, 41 commuter lines already have agreements with bigger partners. Delta works with three, United has announced but not yet implemented five, and U.S. Air, with eight, has the most.

Under these arrangements, passengers may not even know that part of their journey will be on an independent commuter carrier. For example, American Airlines passengers flying on what appears to be a subsidiary of American, called American Eagle, complete with its own tickets and matching livery on the aircraft, could actually be on planes owned any of three airlines: Metro Airlines of Houston, Chaparral Airlines of Abilene, Tex., or Air Virginia of Lynchburg, Va.

Michael Derchin, a vice president of First Boston Corp. and one of the most respected airline analysts, sees other sound reasons for mergers and acquisitions to occur in the airline industry.

For one thing, he says, airlines are often inhibited from expanding because of a shortage of capital or of facilities such as airport slots. In the case of foreign routes, frequently there are governmental constraints.

“Mergers and acquisitions can potentially solve these problems,” Derchin says. He cites the Pan Am--UAL deal, which, if approved by government agencies, would give UAL instant access to an area of the world that it could otherwise not enter speedily because of constricting government agreements.

Airlines have also been acquired to prevent them from merging with a competitor. In 1979, for instance, Pan Am outbid Eastern and Texas International, now Texas Air, to acquire National Airlines.

Finally, the seasonal downturns of traffic experienced by many airlines can also be overcome by mergers between airlines whose routes complement each other’s, Derchin notes.

“Generally, east-west carriers, like TWA, peak in the summer, and north-south airlines, like Eastern, peak in the winter,” he says. “The merger of an east-west airline with a north-south carrier would provide instant cross-utilization possibilities for equipment, facilities and people that are otherwise difficult to achieve in a short period of time.”

Not all suitors will come from within the airline industry, observers say. Carl Icahn may be just the first corporate raider to recognize the airline industry as fertile ground for so-called asset plays, in which the cost of acquiring enough stock to control a company appears to be less than its assets might bring if sold piecemeal.

TWA, in opposing Icahn’s takeover bid, insisted that he is interested only in making a quick profit by selling off the carrier’s assets--its planes, facilities, airport gates and routes. Icahn has denied the charge, saying he is interested in operating the airline. But he has never pledged not to sell at least some of TWA’s assets.

Derchin agrees that “most airlines are worth more than their stock market value.” He maintains, however, that an airline is difficult to break up for cash.

Derchin argues that when a fleet of aircraft is put up for sale, prices for used airliners are driven down sharply; the transfer of international routes requires approval from the Transportation Department and the President, an uncertain and lengthy procedure, and airport authorities similarly may put obstacles in the way of a transfer of gates.

In addition, he says, new owners are often subject to strong opposition from its labor force and potentially would face huge severance requirements; airlines may have a large liability in the form of paid-for but unused tickets, and airlines in debt, as most airlines are, would be forced to pay off their creditors before paying their owners.

One problem speculators face in trying to measure the worth of airlines is to find a reliable standard. In recent years, profits have been uncertain; so too has been the value of goodwill since airlines are able under deregulation to drop unprofitable routes; and more and more, tangible assets like airplanes are leased.

In that respect, United’s deal for Pan Am’s Pacific division was helpful. Its $750 million price included a large number of planes but enabled industry officials to put a $400 million price tag on the routes. With all the talk of merger and takeovers, airlines are nervous. Several have moved to build up their defenses.

Even the nation’s biggest airline company, UAL, was worried that it might become the target of a raid. It has taken a number of steps to make itself less vulnerable, including proposing the sale of company-owned hotels in its Westin Hotel chain, placing $962 million in excess pension fund assets in a trust for corporate expansion and increasing the number of authorized common shares.

According to Richard J. Ferris, UAL’s chairman, the pension assets and the hotels were “attractive nuisances and we decided we’d better get rid of them.” They would have been attractive to a raider because they could be quickly sold for cash to pay for the takeover, the executive said.

Ferris said that, although the steps reached fruition only recently, UAL had been working on them for many months.

“We were attractive about a year and a half ago,” he says. “Our stock was selling in the mid-30s and our book value was about $43. You become concerned if you are selling below book value and you have a lot of quickly realized assets sitting around. You could be attractive. We were not fending off any known raider. There was activity in our stock.”

As a results of the steps, Ferris estimates, UAL has removed itself from the “upper quartile of attractiveness to the lowest quartile.”

Another airline company trying to put anti-takeover defenses in place is Eastern. But the proposals have not drawn the needed majority of shares outstanding and the firm has twice adjourned its annual meeting in recent weeks hoping that more votes in favor will arrive. Airline managements have found allies on Capitol Hill. At the height of the Icahn-TWA tug-of-war, bills were introduced in both the House and Senate to make the takeover of airline companies more difficult.

The idea of special anti-takeover legislation for airlines finds no favor with Robert L. Crandall, American’s chairman and president.

“I don’t think the airlines ought to be subject to any different kind of regulation than other companies are, basically. If you can take over a steel company or a dog food company or a shoe-manufacturing company, then I think you ought to be able to take over an airline.”

Crandall says he feels differently, however, about international routes, which he does not believe should be freely transferable.

“Those are public assets granted by the government to a particular citizen,” he says of the routes. “If that citizen doesn’t want them any more, I think that citizen ought to give them back to the government so they can be reassigned to some other citizen.”

Not even all airline managers are opposed to being taken over.

A few years ago, Southwest’s board considered a number of anti-takeover measures. It approved some but not all of proposed defenses.

“The board felt--and I agreed--that it was unfair to our shareholders to adopt them all,” Chairman Kelleher says. “Our shareholders deserved the opportunity to take advantage of a very substantial profit on a takeover.”

“I don’t think that takeover should be barred. I think in many cases they produce a healthy result . . . better management, more financial strength and they might save jobs.”