Thursday, May 26, 2005

Take-Off for America West and US Airways…or Emergency Landing?

The recently announced merger between US Airways and America West Holdings would create the 6th largest airline carrier, with $850 million in equity. With the infusion of external equity, the new ownership structure will have 41% owned by these new equity investors, 45% by current America West shareholders and the remaining 14% by US Airways’ creditors. The deal, expected to close in the fall of 2005, is estimated to net approximately $600 million in cost savings and revenue synergies, which is optimistic by many accounts. US Airways is attempting to emerge from bankruptcy, for the second time since September 11, 2001, while America West Holdings is making an effort to break into the realm of major carriers and expand on its strategy as the low-cost carrier. The combined company is targeting to be a major carrier, while competing at the price and cost levels of Southwest Airlines.

The deal is seen as risky by analysts due to US Air’s bankruptcy spell and high cost structure. The new company will have 90% of its capital structure in debt, so it is highly leveraged and needs to focus on building equity. Doug Parker, the current CEO of America West, who will assume the title of CEO of the new company, has a history of risky, but successful endeavors. After becoming CEO of America West only days before September 11, Parker secured loan guarantees from the government to avoid bankruptcy.

What should this new airline be named? Consumer research suggested that the name US Air has better global brand recognition than America West for a global carrier. However, US Air has damaged its brand with a series of service issues. For instance, US Airways has been previously rated as the worst carrier with respect to lost baggage and below average in on-time ratings. Some experts still think it makes sense to go with the US Air name because of its name recognition. Others believe that since neither airline has a great reputation for service, they should start over with a brand new name. Creating a new brand name could be an expensive and risky option. Ultimately no matter what name they choose, the company needs to address the true underlying issues related to customer service.

While America West’s strength is its coverage of the West, US Air has typically had a stronger share of the eastern seaboard, with New York, Boston and Washington, DC shuttle flights considered as its key assets. The combined airline will use a traditional hub and spoke system with hubs in Phoenix, Philly and Charlotte. The plan calls for America West to service the domestic market, while the US Air entity would focus on the international market.

As part of the deal, the new airline will also reduce its fleet by 58 planes to 361, which is seen as good for the overall industry. The reduced capacity in the industry should help several players increase capacity and profitability. According to Merrill Lynch, who raised its rating on AirTran Holdings, the industry could benefit by the potential reduced capacity on the East coast. Delta will probably be hurt the most by the deal with the increased pressure in several competing markets, but in general, most carriers should benefit.

Potentially the most difficult variable of the merger will be retaining and motivating employees, while not escalating costs. US Airways is a much older company, and has a workforce that is older on average. If time of employment or start date is used to categorize employees, America West pilots, flight attendants and mechanics could feel the brunt of the layoffs. Union negotiations will also be challenging when combining these large companies, with complicated contracts. In order to compete at the level of Southwest Airlines and become profitable, the new company will have to significantly reduce its cost structure.

There appears to be a concerning disconnect in the strategy and tactics behind this merger. America West has said they want to use this merger to better compete with the discount airlines. The problem is that their entire structure, from the high cost structure of US Airways to the use of the hub and spoke system, is contrary to the model for success in that segment of the airline market. The successful discount carriers have succeeded by developing much lower cost structures and flying point-to-point routes.

On a broader scope, the deal does not seem to be indicative of additional mergers in the industry, as many carriers are struggling with their own cost structures and bankruptcies. However, the deal will force competitors to review their strategies and determine if a structural change is needed in order to succeed in the long run. The airline industry has been struggling for several years, with the smaller, low cost airlines, left as the only profitable carriers.

As customers and competitors await the outcome, the question that remains is this deal an attempt to compete at the smaller carrier level or simply a desperate attempt at survival for US Airways?
By Jeff Fechalos and Paul Mountain


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