PILARSKI SAYS… The myth about mergers
PILARSKI SAYS…
The myth about mergers
Adam Pilarski, Senior Vice President at Avitas, continues his quest to discover why airlines merge.
As featured in Airfinance Journal Column PILARSKI SAYS
The recently proposed merger between American and US Airways would create the world’s largest airline. The incoming leader of the new entity, Doug Parker, announced unequivocally: “It will be better for customers, certainly better for the employees of the two airlines and better for the communities we serve.” Missing from this is only a claim that it will promote world peace, eliminate infectious diseases and reduce worldwide poverty. So how can anybody in their right mind be against such a wonderful union? Let us start with the obvious. American has been one of the world’s largest airlines for years now, so why does it need to get bigger? The carrier entered bankruptcy when it was number two in the world while dozens of much smaller airlines were profitable, including other US airlines. Does it need to grow bigger by means of a complicated acquisition to become profitable? This merger is quite unusual. For one, rare in bankruptcies, existing shareholders are being offered some financial recovery to the tune of $400 million. It also has the strong support of the unions. The genesis of the merger is the acquisition of US Airways by the much smaller (circa half the traffic level) America West in 2005, which assumed control but kept the name of its conquest. Same now, the smaller US Airways, again about half the size in traffic terms, acquires the bigger entity but keeps its name. What is the verdict regarding the success of the original America West/US Airways merger, and why did it happen? Really, it is too early to talk about success. From a passenger point of view it has not been a stellar performance because the airlines are still not really functionally integrated. Supporters of the merger argue that US Airways has been profitable in the past few years, which they directly attribute to the 2005 merger. This is a partially correct assertion. Yes, from 2005 US Airways has had net losses only in 2008 and 2009 and operating losses only in 2008. However, the same pattern applies to the whole US airline industry. In other words, the general environment caused the positive numbers, which were enjoyed by other airlines and were not merely the result of the 2005 merger. Let us look at historical market shares. United’s share of the US passenger market was 20.9% in 1994. That share dropped to 12.2% by 2011 showing a long-term secular decline. At the same time Continental increased its market share from 7.3% to 10.1%, hence a merger prevented United from eventually disappearing. It looks like United desperately wanted to keep its previous market share. Note that the total share of United today is very similar to the 1994 level (20.9% versus 21.8%). The history of Delta shows a market share of 16.9% in 1993 (12% for Northwest), down to 13% and 8.8% the year of the merger of 2008 and down to a combined 20.6% now. A similar picture emerges when looking at the America West/US Airways merger. In 1991 US Airways had a much bigger market share with 7.7% versus 2.9% for America West. By the time of the merger in 2005 the acquiring airline slightly increased its share to 3.1%, while the acquired one was down to 5.2%, and at present that combined share (8.3%) declined slightly to 7.6%. How about American? A similar picture emerges. Its market share was 20.3% in 1992, down to 16.3% by 2001, up with the acquisition of TWA in 2002 to 19% and now down to 15.3%. Even with the US Airways merger the new American will barely be bigger in terms of traffic market share than it was two decades ago. It looks to me like both management teams have pursued increased market share when facing continuous declines. What do these market share numbers tell us? Simply that large US legacy carriers have inefficient business models and eventually wither away. Pan Am, Eastern, et al, did not disappear because they were puny airlines. They were too big, and experienced diseconomies rather than economies of scale. The remaining legacy carriers continue shrinking. Instead of adopting better business models they survive temporarily by merging with other large entities to temporarily regain market share. They are losing market share to low-cost carriers and to regional carriers. The merger lifts the market share of the combined entity, but raises many more questions than it answers. I do not see an easy integration and cannot see any cost reductions. Labour problems seem to loom on the horizon. The competitors of American both in the US and around the world should not fear the new behemoth.