December 12, 2008 / 11:00 PM / 11 years ago

DEALTALK-U.S. airline merger talks could resume in '09

(For more Reuters DEALTALKS, click [DEALTALK/])

By Kyle Peterson and Jui Chakravorty Das

CHICAGO/NEW YORK, Dec 12 (Reuters) - As several European airlines talk about merging to create big global networks even as fuel prices ebb, the question on a lot of minds is: will merger talks in the U.S. airline industry take off again?

The answer is likely to be “yes” in an industry that clearly has excess capacity, is adding surcharges despite a retreat in gas prices, and is facing international competitors likely to consolidate significantly in the coming year.

“As we are in a recession that is becoming worse, there is going to be an impact on air travel,” said Bruce Zirinsky, a bankruptcy attorney at Cadwalader Wickersham & Taft. “There is already shrinking demand and if that continues, it is fair to say we will see more consolidation.”

For some of the world’s biggest airlines, it is a question of clout. The carrier with the strongest international route system often wins the biggest chunk of the lucrative corporate travel market.

International business travelers — those that pay top dollar for flights — are an increasingly valuable market for airlines.

“Some, like (American Airlines parent) AMR Corp AMR.N, face the prospect of going from the No. 1 to the No. 3 network in the U.S., with the loss of interest by high-paying corporate accounts that goes with that,” said airline consultant Robert Mann.

American lost its status as the world’s largest airline this year when Delta Air Lines (DAL.N) bought Northwest Airlines to take the top slot. Additional pressure on American comes from a strategic alliance announced this year by UAL Corp’s UAUA.O United Airlines and Continental Airlines (CAL.N).

Across the oceans, a wave of merger talks is taking place. British Airways BAY.L is in talks with Australia’s Qantas Airways (QAN.AX) about a merger while also having a set of parallel talks with Spain’s Iberia IBLA.MC. A tie-up of those three airlines would create the world’s largest carrier.

Virgin Atlantic [VA.UL], which is interested in buying British carrier bmi, said this week it is in talks with the airline’s majority owner, Germany’s Lufthansa (LHAG.DE).

Ryanair Holdings (RYA.I) has made a bid for Aer Lingus Group AERL.I. Lufthansa has agreed to buy Austrian Airlines.

Efforts to increase cash flow and decrease capacity will likely force U.S. carriers back to the discussion table in 2009, but limited access to credit markets to finance deals might keep mergers from happening.

“Following a year of operating weakness characterized by extreme volatility in jet fuel costs and a steady erosion of air travel demand in a deepening recession, U.S. airlines face another year of intense cash flow uncertainty in 2009,” Fitch Ratings analyst Bill Warlick said.

“Attention has now shifted to the management of an increasingly precarious supply-demand relationship that will force airlines to once again monitor scheduled capacity plans closely,” he added.

FOREIGN OWNERSHIP

U.S. law currently restricts foreign ownership of U.S. airlines to 25 percent or less of voting stock.

Even though political opposition to foreign control of U.S. carriers remains strong, many industry experts and analysts expect some easing of restrictions in 2009.

The first phase of the international agreement called “open skies” took effect in March and replaced restrictive treaties dating to World War Two. It allows EU and U.S. airlines to serve any route between the European Union and the United States for the first time.

But EU states have threatened to scrap the deal if Washington does not agree by 2010 to a second phase allowing foreign airlines to buy more voting rights in U.S. carriers and permitting them to run domestic services.

“I think you will see a reduction in foreign ownership restrictions that will allow for greater co-operation between U.S. and foreign carriers and help sustain competitiveness,” Zirinsky said. “It could open up the doors for mergers of U.S. and foreign airlines.”

IF NOT NOW, WHEN?

Murmurs of consolidation have long been background noise in the U.S. airline industry. Serious talks between any two major carriers tend to spur discussions between other potential partners that do not want to be left out of a merger wave.

Industry-watchers now expect interest in consolidation to increase in 2009 after the transition to a new presidential administration and new Department of Justice leadership.

Leading consolidation advocates like US Airways LCC.N Chief Executive Doug Parker and UAL CEO Glenn Tilton have said repeatedly the airline industry is too big and fragmented.

“This is a global network business with big economies of scale, yet no airline has even a 25 percent share of ... total revenues,” Parker said on a webcast this month.

“And we have six airlines with shares of about 10 percent or more. So it’s highly fragmented,” he said.

US Airways was formed in 2005 from the merger with America West Airlines. The carrier later made a failed bid for Delta.

“The industry is still too fragmented,” Parker said. “We have made some strides here and indeed some pretty important strides over this last cycle. But more is needed.”

For more M&A news and our DealZone blog, visit here Reporting by Kyle Peterson and Jui Chakravorty Das, editing by Matthew Lewis

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