When it comes to Wall Street analyst commentary on the proposed merger of American and US Airways, I have come to appreciate the work of John Godyn at Morgan Stanley. He is a pragmatist. His analysis and commentary are not fraught with emotion and Henny Pennyish ramblings as if the sky is falling if a deal does not get done. He models the industry assuming a deal does not get done. Certainly Godyn would prefer a deal versus no deal. However, he assigns a probability of less than 50 percent of a deal happening, much like this observer.
This week’s Wall Street analysis and media coverage caught my eye. First US Airways’ Captain Bill Pollack, a man I know and respect, wrote an op-ed in the USA Today in support of the merger. The subtitle reads: “Airline employees have made concessions to survive. It's time our sacrifices paid off.” Godyn hosted American’s flight attendant union, APFA, to a lunch to discuss the merger. Like Pollack, the unions tout what they claim are enormous benefits to the consumer but fail to define them. Then a note comes across my desk: “Today, Representatives Marc Veasey (D-TX) and Ed Pastor (D-AZ) and 66 of their Democratic colleagues sent a letter to President Barack Obama calling on the Department of Justice (DOJ) to allow American Airlines and US Airways to move forward with a merger.”
Imagine what Jim Oberstar is thinking now? Imagine, 68 Democrats supporting a merger of two airlines that will ultimately put 87 percent of domestic supply into the hands of four companies. A party that prides itself in being the protector of the consumer. Let’s stop kidding ourselves; this merger is about labor and the notion, and a near-term truth, that a consolidated industry can pay more than a fragmented industry.
This would-be merger is perhaps the most sophisticated labor deal ever struck in the deregulated airline industry. But don’t be fooled by the rhetoric. This is not about the consumer. This is not about small communities. This is about a very clever strategy by a management team to win over labor in order to achieve an exit strategy for US Airways - a highly performing company in search of an identity in tomorrow's industry. In my view, Doug Parker’s US Airways was no true competitor to the network giants, even before they merged. So to get there, he agreed to write a check to the airline unions that US Airways – I mean the “New American” - may not be able to afford . . . now, or in the future.
What’s wrong with this picture? For one, union interests run contrary to consumer interests even if simply when labor costs go up, consumers pays more. The unions say the merger is necessary to compete with the Delta and United duopoly. What does that mean? Even Parker agrees that mature industries yield few growth opportunities, so the synergies that the “New American” touts are likely to come from a share shift away from incumbents rather than generating new business. Do we really think that Delta and United are going to sit back and surrender their market to a “new competitor” without a fight? I don’t think so either.
But the check to labor has been written.
As Glenn Engel points out in his work, “being important is better than being big.” This is based on the fundamental economics of the S-Curve in which each capacity share point above 30 percent in a given market drives a greater than 1 percent share of revenue up, at least until some point when the law of diminishing returns takes over. In a merger that touts little to no overlap, where is the consolidation of two carrier’s positions that results in outsized revenue gains to the tune of $1 billion?
That’s right, the check has been written.
In Godyn’s note he talks with the APFA about the lack of a Plan B: “Consistent with what we heard from the APA, the APFA is universally focused on ‘Plan A’ which is to help management raise the probability that LCC is successful and is not actively pursuing any standalone plan alternative,” he wrote. “They also reminded us that no standalone plan had actually been formally submitted and approved by the creditors. Thus, if the deal does not go through, a new reorganization plan would need to be created and approved by creditors.”
Godyn continues: “Why are labor costs omitted from the complaint? The APFA expressed real concern that if a deal did not go through the short-term ramifications could cause existing labor contracts to be revisited and the pension to be put at risk, depending on how the new plan of reorganization is shaped as well as the judge. A restructured labor contract could not only include lower wages but also workforce reduction – not to mention labor discontent.”
Exactly right because this a labor deal.
It is time that we start thinking about Plan B. Let’s assume that, because a number of senior US Airways’ executives have already moved to Dallas and enrolled their kids in school, Parker et al will run the “New American.” But he has a track record in this type of case, and that is that the company will likely get smaller before it gets bigger. [An idea that will make Wall Street happy.] A network considered inferior to others cannot pay its workers the same as can larger competition. The workforce will likely need to get smaller rather than reap the benefits promised. Parker’s conundrum is his exuberance to parcel out the synergies before they were realized. Remember that share shift idea.
Suddenly, Plan B gets somewhat complicated even with the Golden Boy in charge. In the event a merger is blocked, what if another party enters the fray and files a separate plan of reorganization? That could happen in a Plan B scenario and my guess is capital would likely be treated more favorably than labor in that case. So it may not be only Tom Horton who ends up on labor’s dart board.
I have long been critical of labor leaders who indulge in the overpromise and under deliver message. But it is no different than Parker and his merry band buying labor favor without first proving on the battlefield that it can win the revenue necessary to fund those promises. Remember, this is a labor deal. And US Airways may have reached too far in its assumption that it can accomplish what Delta and United did after being number 4 at the altar. I am not aware of fourth mover benefits. Think of the concept of the S-Curve and the idea that being important is better than being big.
The merger’s proponents are right that the “New American” will be able to offer more destinations. They are right that it will be able to offer more services in competition with Delta and United. But proponents also are right in acknowledging that Plan B would result is something far less than labor has been promised.
Where the unions get this wrong is in the assumption that because they have been to the table and made concessions they are entitled to the same compensation paid to employees of Delta and United, which have generated the revenues to support higher labor costs. Other than an expanded network, where/what are the benefits for consumers? I see many benefits for US Airways’ flyers; I see fewer for today’s American flyers. Other benefits like investing in a re-fleeting and international growth are being implemented.
The DOJ is right to at least challenge the combination. It may not win, but it is right to challenge. The industry’s structure is much more concentrated than when it considered and approved the prior three mergers. If this is indeed the last big deal in the US airline industry, it deserves a very close look. Based on the combinations that preceded it and the string of events that have impacted the industry since the first merger was approved, it is really difficult to find any consumer benefits other than the fact that a profitable industry is finally investing in products that the consumer wants and desires.
In advocating for the merger, unions are doing what they should be doing to reap the promises the new management team made. I would be doing the same. But they should stop hiding behind the consumer because their interests are not aligned. It will take customers to pay off Doug’s dubious deal and, as a result, customers will pay more - a necessary fact for decades. And that’s the reality.
Note to readers: I am long in the equities of Delta Air Lines, United Airlines, Sprit Airlines and Hawaiian Airlines. Thank you to many readers that have reached out over the past months encouraging me to return the keyboard. It is nice to be back.