AA To Take TWA, Parts Of US Airways - 2001-01-15

<B>AA To Take TWA, Parts Of US Airways</B>

By David Jonas

The longest-standing brand name in commercial aviation effectively was erased last week in airline industry consolidation developments that include a joint initiative by the most bitter rivals. American Airlines' bid for Trans World Airlines and parts of US Airways still must be approved, but it already is complicating matters for buyers wary of a negotiating environment with fewer major players.

Not content to sit back and watch United Airlines consume US Airways unanswered, American last week agreed to acquire "virtually all the assets" of TWA and certain assets from US Airways, including a portion of DC Air. If approved by all necessary parties, the transactions not only would significantly strengthen American, but also would increase the likelihood of approval for United's proposal to acquire US Airways. The end results would be two imposing carriers each controlling a quarter of the country's market share, redrawn battle lines between themselves and other competitors, and less leverage for buyers in many markets.

Financially troubled TWA on the surface appeared an unlikely acquisition target. It had struggled for years to make a profit and acknowledged a "steadily deteriorating financial condition." But American sees tremendous value in taking over the 75-year-old carrier at the modest price of $500 million plus the assumption of aircraft leases.

For starters, TWA's fleet and route network, combined with certain pieces of US Airways, would bump American into the mega carrier category redefined last May when United announced its intention to assimilate US Airways.

Specifically, AA would get TWA's St. Louis hub, giving it a trio of strong bases in the country's mid-section and greatly improved coast-to-coast opportunities. St. Louis also would relieve congestion in AA's Chicago and Dallas/Ft. Worth hubs.

"While TWA has been chronically unprofitable, St. Louis is a well-situated classic fortress hub and American is short a domestic hub relative to its primary network competitors in a partially consolidated environment," said UBS Warburg analyst Sam Buttrick.

American also would assume control of TWA's remaining international routes, as well as a growing San Juan, Puerto Rico, operation. American already has a sizable presence in San Juan.

Furthermore, TWA's excess maintenance capabilities in New York, Los Angeles, Kansas City and St. Louis would help AA with the integration, especially at a time when mechanics in the industry are in short supply.

Because TWA is in such a dire financial state, regulators likely will not try to block the deal, though AA chief Don Carty expects a review to last several months.

Following TWA's third and presumably final bankruptcy declaration made last week in federal court, AA announced it would commit $200 million in debtor-in-possession financing to keep TWA in the skies during the transition. "Without our acquisition, there was grave risk TWA would have been forced to cease operations this week or next," Carty said. "When you get to the competitive issues, it almost becomes irrelevant. Either way, one competitor will go away."

Both TWA and American, however, acknowledged that "higher and better offers as a result of a bidding process" could surface and scuttle American's takeover, including a move by former TWA chairman Carl Icahn. But American has built in protections, including a break-up fee, a minimum topping bid clause and the right to match any bids exceeding that minimum.

Late last week, a federal bankruptcy court allowed TWA to begin using American financing to keep operating, denying Icahn's inital objections. The court on Jan. 27 will hold a final debtor-in-possession hearing.

American and TWA already share codes as part of an American Eagle-Trans World Connection partnership. Meanwhile, AA next week plans to fold TWA flights into its frequent flyer program. "That will help to quickly increase the attractiveness of TWA's system and drive new traffic," Carty said.

In an interesting spin, American also has agreed to purchase assets from US Airways that would strengthen its East Coast presence while making the United-US Airways merger more palatable to federal regulators. Those assets--roughly about 20 percent of US Airways and priced at $1.5 billion all told--would include a total of 86 jets; 36 slots at New York LaGuardia; gates in Atlanta, Boston, LaGuardia, Newark, Philadelphia and Reagan Washington National; and half of the US Airways Shuttle. To preserve competition on hub-to-hub routes that otherwise would be dominated by a combined United/US Airways entity, American also agreed to offer service for a minimum of 10 years on key city pairs: Philadelphia to Los Angeles, San Jose and Denver, Charlotte-Chicago, and Washington National-Pittsburgh.

"When it became clear to us that United and US Airways would likely have to sell some assets to complete their proposed merger, we moved very quickly to identify desirable assets so that we could keep them out of the hands of our other major competitors," Carty said. "Those assets will make us more competitive with United/US Airways and other major competitors."

In a bizarre twist of fate, American and United--harsh rivals that have been left out of the lucrative Northeast shuttle market--plan to jointly operate the existing US Airways Shuttle against Delta Air Lines. The 20-year joint initiative calls for each carrier to operate half of the daily flights with their own planes. Tickets will be completely interchangeable and frequent flyers can choose to accrue mileage in either program, regardless of the operating carrier for any given shuttle flight.

With American's offer to take the US Airways assets, Buttrick raised the probability of approval for United/US Airways from less than 40 percent to nearly 70 percent. "Clearly, reducing United's position in key Northeastern cities has been a focus of ours, and it seems regulators," Buttrick said. "Therefore, this transaction is a significant step forward in addressing regulatory concerns."

The U.S. Department of Justice must analyze the new American proposals ahead of the scheduled April 2 decision-day on the United/US Airways deal. That deadline already was pushed back as the two carriers and regulators agreed to extend the review period.

Meanwhile, the European Commission on Friday approved the United/US Airways merger proposal as it relates to transatlantic competition.

In a separate transaction, but one also contingent on approval of United/US Airways, DC Air chairman and CEO Robert Johnson agreed to sell to American 49 percent of the Reagan Washington National-based startup. American will pay $82 million and provide DC Air with 11 Fokker-100 jets. DC Air also will join American's frequent flyer program.

United said American brings to DC Air "a substantial network and operating expertise that will allow it to provide strong competition with United Airlines," while AA said DC Air will give it sustainable presence for a new hub in Washington.

Despite DOJ's review extension and prior to AA's announcements, US Airways launched Potomac Air at Reagan Washington National, its fourth wholly owned subsidiary. If the merger is approved, Potomac Air would transition into DC Air.

All told, American's three transactions amount to $5 billion in capital, of which only $1.8 billion is in cash.

"And we have that," Carty said. "We still will be in a comfortable position from a balance sheet point of view."

Big questions remain as to what the other major carriers will do to stay competitive. There could be counteroffers for both TWA and the US Airways assets or additional M&A activity. All eyes now are on Delta, which thus far has been the odd carrier out.

Many industry insiders are betting on a Delta-Continental link, but it would be difficult for Delta to convince both Continental, which is doing well and clearly wants control of its own destiny, and Northwest, which still has a say in certain Continental matters following a settlement in an earlier antitrust case (BTN, Nov. 13, 2000).

Said an agency source, "If all this goes through, we'll eventually go down to three major carriers, no doubt about it. The government is just trying to make sure everything will be spread out evenly among those three."

The short-term and long-term ramifications for corporate clients won't fully be understood until these transactions are completed and airlines' full route structures are known. But massive contract restructuring would be in order and the conventional thinking is fewer competitors would mean less competition and difficult pricing negotiations.

"The demise of US Airways is an important factor in terms of competition and pricing," said John Heilner, a consultant with Management Alternatives/MSIG in Princeton, N.J. "They were aggressive enough in their discounting to be interesting to most companies."

For buyers in St. Louis specifically, there is no question that tougher days are ahead. TWA was renowned for offering extremely attractive contracts to its corporate clients simply because it needed the business. While American certainly wants all that business, it doesn't need it as badly.

In fact, Carty said that higher fares in some cases are "conceivable" because TWA had been forced to sell below cost to survive.

"Consumers should not expect those uneconomic fares every day," he said.