Scenarios: United Air at center of potential merger hookups

NEW YORK/WASHINGTON Thu Apr 15, 2010 6:29pm EDT

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NEW YORK/WASHINGTON (Reuters) - United Airlines is now in separate merger talks with Continental Airlines Inc CAL.N and US Airways Group Inc LCC.N for the second time in two years as carriers feel pressure to further cut capacity, build revenue and accelerate the industry's recovery.

Word of potential consolidation, confirmed by a source familiar with the matter [nN15247749], has pushed the shares of U.S. airlines higher.

Many Wall Street analysts have responded positively to the prospect of a deal, especially between United, a unit of UAL Corp UAUA.O and Continental.

"Consolidation prospects would be a significant positive for the industry and, in our view, serve to enhance what is already a compelling stand-alone case for the equities," said Barclays Capital analyst Gary Chase.

Here is how the industry may shape up should one or two mergers materialize.

UNITED/CONTINENTAL

Analysts and other industry experts agree a Continental/United pairing makes the most strategic sense and would have the best chance of clearing labor and antitrust hurdles.

The two have a common pilot unions and less route overlap than United/US Airways. They are also partners in the Star alliance, which has been lucrative.

A Continental/United merger would create an airline larger than Delta Air Lines Inc (DAL.N), which bought Northwest Airlines in 2008 to become the world's biggest carrier.

Such a combination would have a combined annual revenue of $28.9 billion, based on 2009 figures. Delta last year generated $28.1 billion.

"I think it's the path of least resistance from a labor perspective, from a regulatory review perspective and from a political perspective, frankly too," said Stifel Nicolaus analyst Hunter Keay, who said Continental could bid for United in a note to clients this week.

"Continental had far too much to lose by not pursuing a United merger."

Continental has big hubs in Houston, Newark, New Jersey, and Cleveland, and smaller service in Los Angeles. United is strong in Washington, Chicago, Denver, Los Angeles and San Francisco.

Continental walked away from merger discussions in 2008 due to concerns about United's finances. Analysts say United has since bolstered its balance sheet and is in much better shape.

Continental pulled in $12.6 billion in revenue last year. No. 2 American Airlines, a unit of AMR Corp AMR.N, drew in nearly $20 billion.

Should United and Continental merger, US Airways could consider teaming with AMR, whose network could "suddenly become somewhat marginalized," Keay said in a note this week.

UNITED/US AIRWAYS

A merger between United and US Airways would create the No. 3 airline in the world, according to Gimme Credit analyst Vicki Bryan.

Analysts have said this is a less favorable scenario due to potential labor problems and more route overlap than a United/Continental deal. But insiders say the airlines would still benefit from less capacity, which enables them to raise fares.

"It would cement Delta in its position," Bryan said. "It could stymie the marketing position of the remaining U.S. airlines."

The merger would likely face more regulatory scrutiny than a United/Continental proposal because of overlap in Washington, where US Airways has a major hub. US Airways also has operations in Los Angeles and Phoenix, which could raise competition questions in a United deal, experts said.

Opposition by United pilots to a merger with US Airways and discord among pilots at US Airways over seniority following the carrier's merger with America West Airlines in 2005 are red flags cited by some industry experts.

Keay projected a merger between United and US Airways had a 15 percent chance of working out.

A tie-up with Continental and American Airlines is a distant possibility should United and US Airways merge, but the two carriers have significant overlap in many markets that might be "potentially dilutive," Bryan said.

NO DEAL

Absent a merger, individual U.S. airlines are expected to move to strengthen their balance sheets.

North American loss estimates have been pared to $2 billion, with passenger demand up and revenues growing in an improving economy, according to the International Air Transport Association.

One worry, however, is fuel prices, which have been on the rise and are expected to average $81 this year, compared with $62 in 2009.

Analyst Helane Becker, a Jesup & Lamont managing director, believes the major carriers would continue to grow internationally and through their alliances if left on their own.

"The big international airlines are going to do better than the smaller domestic airlines. Airlines like Continental, Delta, United and American -- those guys will do fine," Becker said.

Consultant Mike Boyd said major carriers do not have to merge to thrive.

"Does it make the entity more efficient, a savior to the system? No," Boyd said of consolidation.

He said Continental and American are both strong as stand-alone carriers, especially American with its robust South American business and its plans to build up its transatlantic service.

United has a good route network, but would have to shift its primary focus away from becoming smaller to growing in a smart way so it could be an attractive merger partner, Boyd said.

"They can survive," he added.

US Airways, however, could struggle without an international partner, Becker said.

Boyd said US Airways "has some challenges" in integrating pilots groups from its 2005 merger with America West Airlines.

"The asset they have is probably the most visionary management in the industry," Boyd added.

(Reporting by John Crawley in Washington, Deepa Seetharaman in New York and Karen Jacobs in Atlanta; editing by Andre Grenon)

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