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A Recent Swelbar Interview

The ANALYST is the flagship publication of ICFAI University Press* which caters to a niche segment comprising finance professionals, bankers, academicians, economists, corporate executives and students. Just published.

The ANALYST: Delta Air Lines and Northwest Airlines have recently agreed to merge in a $3.1 billion deal. How do you see the deal?

Swelbar: I see the deal as the real beginning of the second phase of the restructuring of the US airline industry. The first phase began with the bankruptcy filings in 2002 and concluded with the emergence from bankruptcy of Delta and Northwest in early 2007. The industry (largely the legacy carriers) shed nearly $20 billion of cost during this period with nearly 60% of that being reductions in employees, rates of pay and benefit reductions. But the necessary cost reductions were designed to address a revenue environment that was increasingly influenced by the low cost carrier sector of the industry that had grown to nearly 30% of industry capacity. This created more competition with an industry that was producing $30 billion less in revenue as the relationship of revenue to GDP fundamentally shifted beginning in early 2001. The restructuring cuts were not made with the idea that oil would increase from $45 per barrel to $117 per barrel today. And it is the cost of oil today that is the catalyst underscoring that the restructuring work to make the industry sustainably profitable is far from done.

The ANALYST: What are the parameters considered at arriving at the deal?

Swelbar: I will answer this as the catalysts to consolidation: high oil; a softening economy both domestically and globally; increased global competition; and tightening credit conditions to name a few. The US domestic market, where all US carriers have the strong majority of their capacity deployed, remains a highly fragmented and hypercompetitive market. Therefore it is a most difficult space to realize higher fares absent the push from higher fuel. Today fares are on the increase domestically but not near enough to offset the cost of higher commodity prices. Therefore the industry is exploring two different paths: 1) consolidation of industry capacity through merger and acquisition activity; 2) consolidation through liquidation of airlines; and 3) consolidation of industry capacity by removing uneconomic capacity. Both strategies are being employed simultaneously and can be expected.

The ANALYST: What are the expected synergies of this deal?

Swelbar: Delta and Northwest, while announcing some capacity cuts prior to announcement of the deal, are betting that the linking of two end-to-end networks is the way to drive increased revenues without increasing flying expense. This is possible through a larger network providing for an increased number of new city pairs to sell. On the cost side, the combined carriers see that the ability to best match aircraft size to city pair markets will provide a cost savings going forward. As to other benefits, the North Atlantic alliance with Air France, KLM, Alitalia and CSA will remain and can only become more robust. Obviously Northwest's delivery position for new transoceanic equipment is a benefit. But most of all this is a step, among many, to continue to work toward finding a more stable platform for employees, communities and stockholders that stand alone plans cannot begin to guarantee. Is there risk? Yes. But there is arguably more risk with a stand-alone plan.

The ANALYST: What could be the challenges to this merged entity?

Swelbar: The obvious challenges are the age old challenges that present themselves when the US airline industry looks to consolidate: the regulators and organized labor. Change is difficult but an industry that took $20 billion of cost out of their combined operations and produced only two years of industry profitability underscores that the current industry structure is far from healthy. In addition the Congress is sure to raise consumer issues. But concerns that consolidation will raise prices are muted by the industry's fuel bill increasing by nearly $20 billion in 2008 versus 2007. Fares have to go up, otherwise we will have a bankrupt industry rather than a few bankrupt carriers. And the US market under deregulation has proven time and time again that if one carrier tries to gouge consumers in certain markets, there will be a lower cost provider ready and willing to exploit that market opportunity.

The ANALYST: How do you see the future of US airlines industry?

Swelbar: Honestly, I am concerned. Our market remains the most regulated, deregulated market in the world – or so it seems to me. And some of that regulation stems from parochial interests on Capitol Hill that somehow believes that if there is a runway, a terminal building and security that the airport is somehow entitled to air service – not whether the economics make sense. Consolidation along the lines of Delta and Northwest and others that might follow is but one step along the way. Globalization is an economic force that cannot be ignored. Recognition that the airline industry is a global industry would be a good start for the US policy makers. Recognition that US airlines need to be freed of the shackles that largely tie them to the US market need to be unlocked. Unless labor and policy makers can move their mindset away from believing that the US airline industry can support jobs and remain US-centric will only ensure that we continue to experience the boom and bust cycles that have been the rule for the industry over the last 30 years. And that has not proven to benefit anyone.

The ANALYST: Any other comments?

Swelbar: Unless something changes along the way that paves the path for a more globally focused US industry, I am afraid that we will see another icon like Pan Am or TWA disappear from the US landscape. Thank you for the opportunity to talk with you.

*this interview was done $20 per barrel ago.