Merger Odds Rising for Delta Air Lines

Some experts say there has never been a better time to fix the ailing industry through a few careful matchups.

Delta CEO Grinstein is among those who've long predicted the industry will shrink to two or three major network carriers, but he said Delta plans to remain independent.

In a recent interview, he sought to knock down the idea that Delta sees a merger as a bankruptcy exit strategy.

"If you were going to merge, this would be the time to lay the groundwork for it, because you'd shape your fleet to add somebody else's," Grinstein said. "We aren't doing that. We want to create as independent a company as we possibly can, and then have the strength to decide what we're going to do if there's going to be consolidation."

He predicted big mergers will be "beyond '07."

Airline mergers have long made "tremendous intellectual sense," according to CreditSights analyst Roger King. The number of traditional hub-and-spoke airlines needs to shrink, he said, because "too many airlines and too many hubs generate too much overhead for the current fare levels."

But big airline deals have often faltered in the past either because of political opposition, as happened with the proposed United-US Airways proposal, or because huge operational issues tripped them up, such as combining aircraft fleets and work forces with differing wages, work rules and unions.

Delta and Continental tiptoed to the brink of a merger in 1998, but Continental opted for a marketing alliance with Northwest, in part because of labor issues.

Government opposition to big airline mergers seems to be softening, said King. But the "real door buster," he added, is the bankruptcy process.

He and other experts say the industry's biggest players now can use Chapter 11 cases to slash costs, attract capital, prune fleets and simplify issues such as combining union work forces.

In bankruptcy court, Delta and Northwest have sought concessions from union employees, aircraft lessors, bondholders and suppliers. They are widely expected to seek to terminate their underfunded pension plans, as United and US Airways did, although both say no decision on that has been made.

The merger of America West and US Airways has provided a precedent for how to combine bankruptcy and merger strategies, said Aboulafia. The melding of US Airways' Chapter 11 and America West's merger deal allowed the would-be partners to retool lease, supplier, union and finance contracts and reap nearly $2 billion in cash infusions from investors, suppliers and asset sales.

"With bankruptcy, the good news is you can cut costs and merge. That is to say, you don't have to explain yourself to unions and equipment lessors," said Aboulafia. "Thanks to bankruptcy, you can make things happen while merging."

But while the current spate of bankruptcies may help usher in a wave of mergers, airline analysts disagree on the specifics of who might be involved in those deals.

King said his favorite potential merger is between Delta and United, which just emerged from three years in Chapter 11. That would combine their massive Chicago and Atlanta hubs and United's Asian routes with Delta's European destinations. But he thinks the marriage would be so huge that federal regulators still would probably block it on antitrust concerns.

United could also look at Continental, which has a strong European and Latin American network, in a deal that might pass antitrust regulators, said King. Northwest's Asian route network, meanwhile, would make it an attractive target for American or Continental, he speculated.

A merger between Delta and Northwest, both in bankruptcy, is "fraught with too many legal uncertainties" to be likely, he said.

Miller agreed that Delta and Northwest "are so weak that they might become weaker" in a merger.

He said both Continental and Northwest have route networks that would fit well with Delta's, but neither is a likely merger partner anytime soon.

"They are the only two domestic carriers that would even look through Delta," he said. Delta's Atlanta hub and its reach in the Southeast are the "big prize," he said.

Continental is in better shape and is expected to report a profit next year. But "nobody wants to acquire a money-losing operation. Delta has to work on its internal issues first," said Miller.

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