“I don't know of anyone who had seen this coming,” says George Hamlin, president of Hamlin Transportation Consulting, although some argue the carriers must have suspected trouble by the nature of the questions from the Justice Department.
The planned merger was supported by all of the constituents in the industry and even American's large competitors—Delta and United—were officially in favor of it for the same reasons that Justice is now opposing it: The industry argued that the combination would help with continued capacity discipline leading to sustainable “pricing power” (higher fares).
“They [Justice] got this wrong . . . very wrong,” says Rich Parker, partner at Washington law firm O'Melveny & Myers and a noted antitrust specialist. “We intend to have our day in court, and look forward to it.”
The defense strategy, according to three leading antitrust lawyers employed by the airlines, will center on proving how the merger will create benefits for consumers via cost synergies that will, in part, be passed to passengers. The defense also will show that the “new American” will increase services and create a competitive network for corporate travelers (including on connecting services) that currently have to rely on United and Delta. Parker, along with Dechert partner Paul Denis and Jones Day's Joe Sims, says the airlines' defense also will dispel the department's claim that U.S. airlines collude to set ticket prices, and notes that the burden of proof is on the regulator, not them, to show the merger is anti-competitive. “No one should assume the merger is over,” Sims, who represents American, insists.
Levine points out that “the incremental network benefits to the public of this transaction are minimal and the costs to the public of the difference between a three-firm network oligopoly in which all the participants have aligned incentives and a four-firm oligopoly that leaves them misaligned and hence willing to defect from the tacit joint monopoly equilibrium are considerable.”
He quips that “[US Airways CEO Doug] Parker and his crew and the Wall Street guys have been telling us for a year at least that a tighter oligopoly will perfect the industry's “pricing power.” I don't know why we shouldn't believe them!” And: “I understand why tightening the oligopoly should be good for shareholders, managers and organized labor, but I don't understand why anyone should believe that it will be good for the public.”
While the deal is not dead and its fate now lies in the hands of U.S. District Court in Washington, a significant delay beyond the planned third-quarter closing is all but unavoidable. Last week's American Bankruptcy Court hearing in New York became almost a side note in the new process. Judge Sean Lane said he had “lingering doubts” about whether it was appropriate to confirm the plan under the circumstances. And the industry now has reason to review the various scenarios that would result if the merger is ultimately blocked. The conclusions are not comforting, many argue, but here's the thing: The U.S. airline industry has managed to greatly improve its finances. In the second quarter, Delta, US Airways, United, American and Southwest Airlines earned a combined $1.9 billion profit, up from $1.4 billion a year earlier. And most insiders believe that all four legacy carriers will continue to be viable in the future. “Call off the funeral,” says Levine.
Looking at the situation from a global perspective, the U.S. would be the only major market in which four big legacies compete. Low-cost carrier Southwest is another major factor. Latin America has consolidated around three operators, as have Europe, China, the Middle East and Africa (see table). There are also three global alliances. If the Justice Department has its way, the U.S. will be the exception.
“We believe this represents a seminal negative event for the U.S. airline industry and significantly jeopardizes industry capacity discipline,” Jamie Baker, airline analyst at JP Morgan says. “A potential independent [American] will significantly diminish longer-term investor confidence in the sector.” In Baker's view, Justice has “significantly altered its usual M&A analysis to introduce connecting markets and baggage fees into its calculus. As such, it is difficult for us to imagine how both parties could offer any meaningful regulatory appeasement.”