Leeham News has a short blog entry referencing this article about Southwest and its Airtran merger and integration.  It is difficult to figure out where to begin in trashing this story.  But let’s take a shot at it:

1. Southwest Airlines will remain a single aircraft type using the 737 in the various variants it has today and in which it plans to have in the 737MAX.  The 717 has been offloaded to Delta and will be gone in a fairly short period of time.
2. Airtran is not based around the 717 solely.  It, too, uses the 737-700 which is also a significant part of the Airtran fleet.
3. Airtran is a hub and spoke operation but it’s major hub is Atlanta only with significant focus cities (a la SWA) elsewhere.
4. Airtran does not operate just primarily into major hub airports.  It has had a significant number of flights into cities that are smaller than the typical SWA destination that it made profitable using the 717.
5. As SWA takes over Airtran routes, it’s adapting them to SWA’s point to point model.
6. SWA has huge focus cities which kind of resemble hubs.
7. Atlanta was the only airport that SWA could fly into in that area.  There was no smaller, inner city airport.
8. SWA has been operating into and out of major hub airports already.  Notice its operations, for instance, into La Guardia and Newark airports.  It’s operated out of LAX for a long, long time.  Phoenix as well.  Same for Denver.  It’s figured out the “how to operate at a major airport” problem for a long time.
9. Airtran does present Latin American opportunities but also Caribbean opportunities and SWA has already announced plans for Puerto Rico as a first step.
10. It completely misses the point that Airtran, as a subsidiary operating entity gives SWA the chance to accelerate international flights via the Airtran reservations system.

I’m sure people see my point.  This isn’t SWA’s first rodeo and for sure it knows how to deal with a variety of destinations and airports.  What it completely ignores is SWA’s already high and rising labor costs which is an area of concern.  The creators of that “report” would know this if, you know, they had listened to Gary Kelly’s concerns expressed at a variety of quarterly earnings calls.

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With the AA Pilot Contract ratified by the Allied Pilots Association, speculation as to what’s next has gone into full overdrive.  Some think American Airlines will make a case for its stand-alone bankruptcy exit plan and some think this clears the last hurdle for a merger with US Airways.

American Airlines has asked that the court set a hearing to approve the contract more quickly than the customary 21 days.  I suspect that request is more about checking the box quickly than anything.  With this contract settled, American Airlines is done with the big challenges of reorganization in its mind.

Is it done?  Frankly, we’ve seen them address costs in a very aggressive manner and not just in the area of labor.  AA’s fleet has been slashed of aircraft and leases on other aircraft have been renegotiated.  Costs have been addressed more than adequately.

But where is the revenue plan?  It remains the cornerstone market strategy of old.  Routes haven’t been radically altered and hubs haven’t been re-tooled and new markets haven’t been explored.  Bankruptcy reorganization gives AA time to work on this area too and it appears there has been no real interest in putting in the same effort here as what has been done to costs.

My concern is that American Airlines has achieved another 10 year holding action.  Time will tell but this reorganization feels like the company has puts its hopes into the cost cutting basket without truly addressing the need to grow revenue and, frankly, repair relations with employees.

I sit amazed that the company hasn’t acknowledged its challenges going forward with respect to employee morale.  Were I an analyst, I would be worried about this companies exit from bankruptcy not because the employees would intentionally sink the ship but because a service company such as an airline is extremely dependent upon its employees providing a positive experience.

American Airlines seems to think it’s still the dominant player in all its markets and that people don’t have choice.  That’s just not true.  Los Angeles and New York City are extremely competitive marketplaces and areas where other airlines have been much more aggressive than AA to date.  Chicago is a very, very competitive market with United Airlines and Southwest Airlines eating at American’s constituency every day.  Miami / Fort Lauderdale has a tremendous amount of LCC competition and airlines are flying to South America from other gateway cities and competing just fine with AA.  Dallas / Fort Worth has increasing competition at DFW airport and the prospect of a fairly unlimited Southwest Airlines in 2014.

The differentiating difference for an airline over the next 3 ot 5 years in the SuperLegacy category is going to be service and its those employees who have been roughed up badly who will be delivering it.  What’s being done to sooth those wounds and what’s being done to incentivize a positive experience for passenger?  A plan for this would be a good thing.

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Two respected analysts (William Swelbar and Aaron Gellman) in the airline industry have come out swinging at the AMR – US Airways merger in small but significant ways.  Each questions the value of such a merger to American Airlines in terms of synergies.

Synergies of a merger are important and should be talked about with respect to a merger in this industry but they aren’t everything about a merger.  They are, in short, the talking point that the world understands.

In the case of American Airlines and US Airways, many scoff because of US Airways exceptionally weak position in international markets.  That’s where the sexy and fairly profitable flying is today.  But the day to day bread and butter of a US airline remains in the domestic markets.

The domestic synergies between the two airlines amount to a savings in costs with respect to a combined infrastructure to serve such an airline (less labor needed to serve the two combined entities, less overhead since one reservations system is used, etc.) and they amount to opportunities generated with a larger network.  Curiously, no one ever seems to talk much about how US Airways has two hubs that slot into areas of the country where AA is at its weakest.

Not only are those areas where AA is at its weakest (the West Coast and Southeast), but they are where US Airways actually performs really well.  That ain’t nothing.

Furthermore, despite AA’s Corners Strategy, American Airlines is now far from a dominant Northeast airline in New York City or Washington D.C.  US Airways plays very well there.  They have their shuttle operation and excellent position in Washington DC.  While US Airways gave up market share in NYC to Delta in exchange for its position in Washington DC, if you combine US Airways operations in NYC with AA’s, it started to look good and respectable again.  That ain’t nothing either.

Swelbar talks about the labor conflicts at such a merged entity.  I would like to make an observation:  A conflict free merger with respect to labor is bar far the exception to the norm.  Delta and Northwest got it and that’s nice.  Southwest and Airtran are doing OK but that was a different situation really.  ContiUnited hasn’t had it so good.  Few airlines ever did have it very good with labor in a merger.  It’s a fact of life.  So, how, then, is it much of a disadvantage? US Airways has actually proved that a profitable airline can be run despite unions biting at each other left and right.  If anything, its been an advantage for US Airways.

But there is a benefit to such a merger and particularly so to American Airlines that gets ignored by both these academic analysts:  US Airways management takes over.  It is pretty much agreed that the American Airlines management and board of directors is dysfunctional and even in this merger they have not taken full advantage of the opportunity to come out the other side a lean, competitive company.  With the roadmaps for doing so set in the examples of Delta, Northwest, US Airways,  America West and United Airlines, you would think that there had been more slash and burn than there has been.

Finally, there is room for more consolidation and the ugly truth is that both these airlines need each other.  There is nobody else left to work with and there is, perhaps, just one opportunity to pull this off and save both airlines.  They need each other and the sad fact is that they need each other equally but for different reasons.  That’s OK but it’s time to acknowledge the elephant in the corner.

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Terry Maxon, who I respect immensely in the business of airline reporting, has a story in the Dallas Morning News saying that sources close to the potential merger between American Airlines and US Airways say an official offer is imminent.

All parties involved were supposed to meet last week in New York City but that meeting was delayed after Hurricane Sandy.

The radio silence since October 31st, the date the non-disclosure agreement between the two airlines was to expire, has made me curious.  The NDA was extended for more time between the two parties.

It’s hard to read the tea leaves on this one and at this point.  American Airlines and its executive team isn’t in the worst position possible although their position hasn’t improved measurably either.  My expectation was that the AA team would stall for more time.

To make this deal attractive, US Airways will have to make an offer that creditors find hard to refuse.  The expected valuation of the company upon bankruptcy exit is likely to be $6 Billion or more.

The combined revenues of each company would be approximately $36 Billion and that exceeds that of Delta and United Airlines.  The synergies that would result have the potential to offer profitability that might approach that of Delta and that isn’t trivial.

The creditors have to balance what their holdings would be worth with a stand-alone exit and what the prospects of AA are as a stand-alone company against what value might be created over the same time combined with US Airways.  Creditors aren’t going to sell their holdings as soon as the markets open upon bankruptcy exit.   My guess is that the time frame they’ll consider is somewhere between 3 and 5 years.

If I’m a creditor, I’m interested in the executive team that can create the most value over that time period.  Based on that, US Airways as a merger partner looks very attractive based on their performance with a sub-par network.  I would not be concerned about the ability of the US Airways team to integrate or operate the new airline as this team has proven that it can run an airline and that it knows American Airlines.  And it really does know American Airlines.

This is the part where pilots would have been very wise to have taken the deal they were offered this past summer.  With a 13.5% equity stake in the new airline, they would have been in a stronger position to profit.  I wonder if the creditors would be as excited about such a large stake in the airline given to the pilots with a US Airways merger involved.

We may hear something soon but we won’t hear it today, in my opinion.  I would look for an announcement next Monday or Tuesday at the earliest as I suspect all voices will need to be heard for the next few days.

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Virgin America has a net loss of $671 million.  It’s a great airline and certainly the one that everyone said they wanted but . . . it ain’t making money.

And it should be by now.  Virgin America never quite seems to close the revenue gap despite promises that that will happen.  Yes, they have succeeded on many routes and, yes, they are popular with the business traveler who has tried them but . . .

Virgin America doesn’t offer the business traveler what he wants:  Frequent flier miles that go someplace they want to go.

The true business flyer already can access great service and comfortable seats.  They get upgraded on the legacy airlines and sniff at the lowly economy fliers who trudge past them.  They don’t *need* more service.  It’s a nice to have when it comes to Virgin America for these travelers but not a must have.

What the legacy airlines have that Virgin doesn’t is frequent flier miles that give these people the chance to fly their family to great destinations for vacation.  Virgin America doesn’t.  Unless you want to go from San Francisco to New York City.  Not many do.

As much as I want to support Virgin America as a contender, there comes a time when such an airline needs to go away.  I believe that time might be arriving since they have no (announced) plan to improve revenues and profits.  Their advantage is evaporating quickly against legacy airlines and despite their low costs, they can’t even beat Alaska Airlines.

Who should buy them?  You know, a great businessman such as David Neeleman could put JetBlue, Virgin America and Frontier together and create a national airline.  I’m just pointing out the opportunities here since each airline uses the same aircraft type (Virgin and Frontier use the CFM powered version while JetBlue uses the IAE powered version) and which would suddenly have focus cities that cover the East Coast, West Coast and even part of the Midwest.

It’s not a foolish idea.  There are synergies there that would serve all three airlines.  Each has some valuable slots at slot controlled airports. And a 3 way combination isn’t entirely unprecedented in this industry either.

Use JetBlue’s reservations and IT infrastructure.  Use Virgin America’s A320 orders for expansion and use Frontier’s assets to build a real Midwest operation.

But it would take a very visionary airline industry leader.  Someone who has started successful airlines and who is brave enough to take advantage of opportunities and who knows how to compete with major legacy airlines.  Someone who, you know, is driven and leads well.  A guy who speaks both English and Portuguese.

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Over the last 40 years, a lot of criticism has been made of Southwest at various times and Southwest has managed to prove people wrong about its decisions over and over again.  For instance, analysts are just screaming for Southwest to put baggage fees into place and Southwest just as adamantly refuses to do so.

I’m a fan of Southwest for many reasons.  First and foremost for their track record in delivering annuals  profits.  They work hard to do this and should be admired and appreciated for it.  The truth is, I think their stock gets short shrift over and over again on this point alone.  It’s as if everyone has been waiting 40 years to pounce on a failure of theirs.

I think they’ve been very smart to keep baggage fees out of their system.  It’s a key discriminator at this point and by now they have enough hard fact to back up this decision.  People need to give this a rest.

They are starting to take flack for their fare prices going up and up but I don’t think that this is deserved.  Southwest is as good at revenue management as anyone else and better than most.  And even though it hits me in the pocketbook, fares *should* go up some.

They take hits for their high(er) labor costs now.  Yes, their labor is paid very, very well.  Their labor also delivers very, very well.  Yes, their pilots earn exceptional salaries but they also work like mad to earn it.  This is a group that actually fights to take on more flights rather than fewer each month.  When the company needs operational efficiency, they deliver in a variety of forms.  Peace and efficiency from a labor group is a vastly underrated value in my opinion.  j

They do have hubs although they are referred to as focus cities.  They aren’t traditional hubs and Southwest works a hub like no one else.  They deliver more people through their gate space than is generally imagined possible.  They skillfully schedule flights through these hubs to not only make connections possible but also to offer many, many one-stop, no plane change flights between some rather unusual city pairs.  And do it so well that they can deliver a total travel time that meets (and sometimes exceeds) the performance of non-stop flights on other airlines.

But I am unimpressed with two aspects of Southwest Airlines.

I’ve said it before and I’ll say it again:  Where the hell is an upgraded IT system?  An airline of the size and scope that SWA is should not be using a relic reservations system that has Braniff International’s original COWBOY system at its core.  It was a great move on SWA’s part to buy it and incorporate it in the 1980’s.  That was truly a smart way to go.  It was fine that they kept building on top of it all through the 90’s and even in the early 2000’s.

It’s appalling that Southwest hasn’t fixed this glaring problem in the last 5 years.  The airline has changed and the airline industry has changed.  Southwest hasn’t changed its IT systems to meet those challenges well.  It’s long overdue.  My greatest fear is that they are working on this internally, too. Building a strong, world class reservations system for an airline of its size is no trivial task and should have been outsourced to someone who had a system on the shelf.   Given the state of reservations systems in general, it defies my imagination why SWA wouldn’t have bought into one of the strong legacy systems and moved on with other tasks.  SABRE or SHARES could have done the job and done it at a fair price.

I also don’t like the feelings I get with SWA’s merger integration.  I don’t get a sense of urgency on SWA’s part to get this done.  Certainly not when SWA is predicting that merger integration won’t be complete until 2015.  The minimum time it would be for that is 27 months from now.  It’s likely to take as much as 36 more months and only if the airline manages to get the Airtran system talking to the SWA system.

I have an ugly feeling that SWA is going to use the Airtran reservations system as its “international” reservations system, too.

I think the merger integration has distracted the airline from looking at growth opportunities elsewhere.  Yes, the airline grew with the addition of Airtran.  It’s now contracting considerably and it bothers me that we don’t see Southwest making any growth moves at present.  More than anything, I get a sense that SWA is creeping into conservatism just because the entire industry is as well.

Where is the next big purchase of slots at Newark or La Guardia or Washington National?

What preparations are being made to exploit Dallas Love Field in 2014 when the Wright Amendment goes away?

We saw a move in Houston to create an opportunity for international destinations in Central America and then. . . everything went silent.

I honestly think SWA needs more help in their merger integration.  In particular so that they can get their creative executives back to work on developing more growth and more profits.

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I believe the non-disclosure agreement that US Airways enjoys with American Airlines expires at the end of this month.  Am I the only one looking forward to that media storm?

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US Airways has, again, reported record net income for its 3rd quarter and, once again, has made a better argument for a merger than any of the posturing that goes on in the press.

This is an executive team that continues to deal with contentious crew issues, a still separated flight system and yet has managed to fix major customer issues and operate an on-time, profitable airline. Believe me when I say that that isn’t happening simply because they have some low(ish) labor costs.

Costs are *not* the only key item for profitable, successful airlines.  You have to attract people to your business and keep them there.  That’s about service and US Airways is a whole lot better airline today for the money than it ever was before.

The executive team manages to outperform many airlines on earnings vs revenues  and does it from sub-standard hubs.  US Airways has all of the handicaps, none of the advantages and earned $192 million on revenues of $3.5 billion.  American Airlines managed to lose money on revenues of $7 billion and that’s with their costs artificially depressed at this point due to bankruptcy.

Hey AA?  Do you like apples?

Yes?

How do you like those apples?

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US Airways pilots feel there is nothing in the way of negotiating a new combined contract with US Airways after a ruling made last week that essentially said that the airline and union may do so but there is no cover from a lawsuit necessarily.  A ruling that I feel probably lacked the clarity all were hoping for but which was  a correct ruling.  You can’t give legal cover to people from lawsuits like that.  You don’t know the nature of the lawsuit until it happens.

I agree that US Airways pilots are in desperate need of a new contract.  It’s been 7 years now and it’s time for a successful airline such as US Airways have a truly combined operation.  This is true for US Airways flight attendants as well.

But primary fault in this delay is largely due to the pilots.  Neither group (US Airways and American West pilots are the two groups) could agree on seniority integration and after an arbitration ruling, the US Airways (original) group broke away from ALPA (who represented both groups)  and by sheer numbers formed a new union.  The two sides have been at war in a courtroom since.

And US Airways doesn’t know who the legitimate combined union is really since there has been no ruling on the fight itself.

Successful airline merger seniority integrations that have taken place since the US Airways merger were based on relative seniority.  This meant that for seniority purposes only, the two lists were merged in a manner that more or less preserved each parties seniority position in the new company.

It’s our view that this is both reasonable and right as a method for combining pilot groups (or other labor groups).

Sadly, US Airways (original) pilots want date of hire as the defining measure for seniority integration.  This would lead to a large group of US Airways (original) pilots sitting at the top of the food chain and blocking promotion for years for the younger America West group.  Not very fair and particularly so when you consider this:
It was US Airways (original) that was bankrupt (again) and about to sink to the ocean floor.  Not America West.   America West was health and in possession of an excellent management team who ultimately proved to be more than capable of not just running a combined operation but improving operations tremendously while consistently earning profits.

Yes, I think that US Airways pilots deserve a contract.

I also think the two groups should shake hands, adopt the original arbitration ruling and immediately go to the negotiating table for a new contract with unity.   That’s what moves this process forward.

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I found this MarketWatch Top Ten brands to disappear in 2013 and it lists American Airlines first.  The story cites that American was a leader but became a “mid-size” carrier after the unions of Delta/Northwest and United/Continental.

Uh, no, it won’t disappear in 2013.  Disappearing implies either liquidation or a merger where the brand disappears in favor of another.  That won’t happen.  American will either exit bankruptcy as a stand-alone and survive, exit bankruptcy and merge with another carrier or merge with another carrier and then exit bankruptcy.  In any of those situations, the brand is almost certainly going to remain American Airlines.

I will concede that the brand is taking a lot of hits this month and is likely to get hit a bit more over the next few months.  That, alone, won’t undo the brand.  It is highly recognizable and the fact that so many are upset at AA right now indicates that there is still ample opportunity to fix these problems and win people back.

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US Airways has signed American Airlines Non-Disclosure Agreement and plans to engage in reviewing sensitive American Airlines information with AA in order to make a better determination if a merger can be done and, if so, how it should be done.

Expect both airlines to go pretty radio silent on this issue for many weeks now.  It takes time to review data and it takes time to do an analysis on that data.  US Airways has until December, more or less, to formulate a plan and have it ready for presentation.

If we hear of anything from AA about this process, especially from Tom Horton, expect this to become a much more ugly fight.

AA goes into this with the public thinking that it is already improving its situation with respect to reported profits for the past 2 months.  Those reported profits aren’t “real”.  Bankruptcy has allowed AA to stop paying many creditors and to reduce payments to others.  Its operating costs are artificially low presently and combine that with the summer season and you get what appears to be “profit”.  It’s a nice publicity announcement and can certainly go a long way towards confusing public perception but analysts know better.

Also of interest is the fact that AA has revealed it has signed NDAs with other parties as well.  These may not be airlines and, in fact, they may be investment companies interested in participating in a stand-alone exit where the equity they would hold is quite likely to see a considerable gain in the first year.

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JetBlue CEO David Barger says that not only have they not received a non-disclosure agreement from American Airlines nor any contact regarding a merger, JetBlue does not want to merge with American Airlines.

Under any circumstances.  Barger says that JetBlue sees its future as a successful independent and not bringing any value to the table in a merger with an airline such as American.

I agree.  Purchase of JetBlue is an asset purchase, primarily, where American Airlines would suddenly be free to try to operate JetBlue routes with a cost structure exceptionally higher than JetBlue’s.  Even after a successful, stand-alone bankruptcy exit, AA is unlikely to be able to operate at the same cost level of JetBlue or even close to it.  So how does it win with JetBlue routes?

I like JetBlue still but I do think the airline has stagnated considerably since the departure of David Neeleman.  In fact, I think that JetBlue has missed opportunities just preceeding and after American Airlines’ bankruptcy filing.  Opportunities that I think Neeleman would have gambled on and won.  That said, the airline is profitable, successful and operating in its niche acceptably.  Barger isn’t wrong about not adding value to an airline such as AA.

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Bankruptcy Judge Sean Lane did not impose Section 1113 terms per American Airlines’ request on pilots yesterday but don’t think that that was a win for the pilots.  Judge Lane found two small areas where he disagreed with need.  The first was unlimited codeshares and the second was an overly large number of furloughs.

American Airlines will revise its proposed terms and hand them back to the court in days and something will be decided.  The pilots can crow victory for labor all they want, this wasn’t a win for them on any level.  American Airlines is going to get fundamentally what they want and the judge signaled that, so far, he sees nothing out of line with the forming business plan despite the specious arguments made by pilots that it was unsustainable.

The business plan isn’t pie in the sky.  I honestly don’t think they have made a strong business case for a long term view either.  The continued focus on costs ignores the revenue problem which, despite AA PR, remains pretty bad.  Costs are much easier to quantify and therefore generally remain in focus during bankruptcy.  Revenue is based on a plan and projections that fundamentally rely on business conditions that are assumed and the ability to execute the plan.

My reservations about American Airlines are based on two fundamental observations.  First, the executive team in place today is in no way fundamentally different than the one in place for the past decade.  Over that past decade, the executive team has not shown itself capable of executing a plan to success.  As a result, the company has lost more than $10 Billion over 10 years.  That is not a company proving itself.

Second, business conditions in the industry are too volatile for making sound projections.  Delta Airlines exited bankruptcy with a business plan based on $80 / barrel oil prices.  Within months they were faced with $130 / barrel oil prices.  The airline industry is subject to strong influences from a variety sources that are entirely outside of the airline industry’s control.  The sum of American Airlines’ plan for revenues is “the other guys are doing this and we therefore think that with reduced costs, we can do that or better.”

The problem with that is you only know how the other guys are doing today, not how they’ll be doing tomorrow.  The other guys have other issues to cope with that aren’t always the same issues that AA is presented with.  Delta fixed many of its issues with a merger and built an unparalleled network as a result.  Then they doubled down and did a deal to capture the NYC market.  United did its merger in the reality that to compete with Delta, it needed scale and it remains to be seen that the ContiUnited merger is a true success.  There is evidence that they’ll succeed, we can’t declare it a success quite yet.

My problem with American is that, so far, the business plan seems to ignore weaknesses that are inherent in the system today.  In part, the Cornerstone Strategy relies upon capturing market share in very competitive markets.  Anyone who follows this industry knows that in light of the capacity restraints that airlines have shown, American Airlines has been the least effective in this and hasn’t shown much restraint.  Furthermore, to gain that market share means getting it on price (which sets off an industry war on fares) or on service.  American Airlines continues to do virtually nothing to improve service and demonstrate that it has a handle on service issues and can get its employees to assist in raising the customer experience level.

I think American Airlines needs a team that can execute a revenue and service plan.  That team sits at US Airways, not American Airlines.

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American Airlines CEO Tom Horton told the Financial Times that an American Airlines merger partner could be decided within weeks.   In the Financial Times story, Horton also reiterates his claims of being a consolidation advocate before it was cool to be one as well as that he suggested a US Airways / AA merger before Doug Parker did.

Want to know what I notice?  US Airways and Doug Parker have gone radio silent.  They have been largely radio silent for a few weeks now.  Despite Horton’s Weird PR Trip, Parker & Company are nowhere to be seen.

And that does not mean that US Airways is having second thoughts.  It’s not the snake you hear that bites you.  It’s the snake that you don’t hear and don’t see that gets you.

I also note that Tom Horton is sounding very shrill these days.

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Terry Maxon at the Dallas Morning News has THIS blog entry on why we might have not heard much from the APA on a US Airways merger lately.  The short version is that the APA board issued orders that APA President David Bates not speak about this after his appearance with Doug Parker in Washington earlier last month.  Color me unsurprised.

The Allied Pilots Association Board is very dysfunctional.  It’s comprised of Captains elected from pilot bases who each are sure they know one hell of a lot more about an airline than any other person.  As a result, they run their union a little bit like the Mafia runs New York.   They’re unified but only to a point and damn anyone who gets in the way of their opinions.

This means that unions officers such as the president, vice-president, etc really don’t get much power to execute in their offices.  I think we now know why David Bates was asked to resign:  He had already upset the board who wants its opinions to be public, not his.

No good deed goes  unpunished and David Bates was punished.

This also speaks a lot on why the APA voted down its last offer:  there was one set of voices advocating for the contract and entire board arguing against it in the background.  No pilot wants to piss off his local union representative either.

What does it all mean?  Simply this:  Expect much more dysfunctional behavior on the part of the APA in the coming months.  Do not be surprised if they appear to back away from US Airways as the APA board is going to want to be in charge of such a merger when it comes to the various pilots unions and it will want to use its power in endorsing a merger to get satisfactory terms.  To do that, it first has to go silent on Doug Parker.

The problem is . . . by voting down that contract, Parker can’t use them nearly as much as he could have.  He now has to work with other unions and bondholders and other members of the unsecured creditors committee.  By allowing ego to get in the way of strategy, the APA has nearly completely removed its voice from the process.

But, hey, they sure smacked David Bates and Tom Horton around, didn’t they? (insert sarcastic tone)

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As was inevitable, there are now public interest groups decrying a merger between US Airways and American Airlines as anti-competitive and bad for the consumer.  No surprise.

Industry consolidation has been good for airline profits and we definitely have seen airlines move towards a more sustainable business model as a result.  I would, however, credit capacity restraint for as much improvement in airline profits as anything else.  Frankly, all of the major airlines in the United States (with the exception of AA) have impressed me with their discipline in the marketplace.  It isn’t a discipline ever seen before and after 4 years, I think we’ve seen a transition to a truly different way of operating airlines.

That new model for operating as an airline includes looking at routes in the right manner, for once.  They are now being treated as “businesses” and evaluated individually for profitability.  In the old model, it was about market share at any cost.  The problem with market share at any cost is that it required unfettered, almost violent, competition between airlines on routes and found routes being operated at a substantial loss for years.  That has largely stopped now and I applaud the airlines for showing enough discipline over the last 4 years to make that stick.

Airlines also now seem to recognize that defending market share at any cost is a bad model as well.  Curiously, the one airline that seems to have continued to trouble itself with defending routes is American Airlines.  Until bankruptcy, the airline has “punished” intruders on its “turf” over and over again with high frequency, high capacity and extremely low fares to push out that intruder.

Finally, I think airlines have actually realized that providing a reasonable service experience is important again.  It’s not the service model of the 1970s or 1980s, no.  However, it also isn’t the embodiment of the idea that all a customer ever wants is a rock bottom price.  If price was truly the only key to winning on a route, Spirit Airlines and Allegiant would be exploding with growth never seen before.  They aren’t.  In fact, what we have seen is that broader offerings of service levels attract more revenue per seat and that’s what airlines need.

US Airways has, in many ways, been a leader in executing change to meet the new industry model.  It has figured out how to drive incremental revenue in ways that exceed most any other airline.  At the same time, they have steadily improved customer experiences across their lines both on and off the airplane.  They are now an airline that can be depended upon to deliver passengers to their destinations reliably and with their luggage.  Am I the only one to notice that US Airways is about the only legacy airline to not experience a major public embarrassment over customer treatment in recent times?

American Airlines is actually the antithesis of US Airways and has shown a strong reluctance to acknowledge the industry changes.  They’ve pursued market share, they’ve defended routes at all costs, they’ve been more price driven than any other legacy airline and many LCC airlines.  They have not upgraded or improved their cabin experiences in any significant way since the 1980s.   Their website drives customers away or at least angers customers.  Their aircraft are old, inefficient, and painful to fly.

The SuperLegacies, United and Delta, have done quite a bit to improve everything across the board and one thing that AA hasn’t done:  evaluated routes for profitability on  a regular basis.  Furthermore, UA and Delta now see opportunity on routes that have traditionally been owned by American Airlines.  They’ve even overwhelmed cities where American Airlines was once a major presence and a dominant player (NYC, Wash D.C., Chicago, Los Angeles).

SuperLegacies are now evaluating competitors routes and going after those routes which are yielding major revenue.  Delta and United both are targeting both AA and US Airways as well as holding their own against airlines such as JetBlue and Southwest Airlines.

Yes, American Airlines and US Airways need each other.  American’s operations need US Airways executives who know how to methodically fix operations in a lean manner.  US Airways needs American’s hubs and routes to build much better network yield.  Yes, US Airways can exist quite nicely as a stand-alone airline.  It cannot expect to rise to the scale of the SuperLegacies and compete both domestically and internationally over the long term without a merger.

A combined US Airways / AA company nominally looks like the biggest airline in the world once complete.  That won’t necessarily be true.  There will be consolidation and rationalization between the two airlines  but the entity will be a member of the SuperLegacy group and it will have the potential to compete in the market on a level playing field.  That’s all they can ask for.

3 SuperLegacy airlines, Southwest (who doesn’t quite fit into any category now), and a smaller stable of LCC carriers looks about right for the modern competitive landscape.  At this point, I actually think we will see increased competition over the long term among the Big 4 and that will be good for the consumer.  We will not, however, see that increased competition until there is a Big 4 and until those airlines have time to settle their operations in the new competitive landscape.  If the US Airways / AA merger were consummated by the end of 2013, I would expect a rational and highly competitive marketplace to be fully emerged by 2017/2018.

If there is an area where I see reduced competition in the US, it’s among the LCC carriers (and doesn’t include SWA).   I think the narrowed gap in costs and differences in revenue models between the LCC carriers and SuperLegacies removes the best business argument for an LCC carrier.  It will be a struggle for those carriers in the future and we do need them.  On the other hand, if a relatively new LCC carrier with rock bottom costs can’t compete against SuperLegacies, the market place has done its job.

So, no, I do not think the proposed US Airways / American Airlines merger is wrong.

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Now that the APA has thrown its temper tantrum, let’s take a guess at where things go for American Airlines for a while.   I think that the APFA will see their membership vote no to their contract because, at the end of the day, having a similar temper tantrum will feel more satisfying.  This won’t matter because I think the bankruptcy court is going to give AA exactly what it wants:  imposed terms on both the APA and APFA.

It’s possible the court will wait for the APFA vote and the judge has shown previous interest in seeing rational agreements happen but . . . the APA vote is a signal to the court and judges are able to be emotional as well.  I think AA gets terms imposed and I think Tom Horton gets to chuckle at the unions.  He provoked them and got what he wants.

(Update:  The court did delay its ruling on the APFA contract.  I expect the APFA will also turn down its last offer.)

US Airways and Doug Parker now have a much more difficult uphill battle to pursue a merger.  The pilots just damaged his credibility badly and markets will take notice.  He won’t have influence through the unions because they are giving up a voice at the table as creditors.  They’ve lost some credibility in the PR wars going on and Tom Horton wins this round.  It isn’t good.

A merger still is quite possible and still the most sensible thing to do.  In some ways, it’s even smarter to do it in bankruptcy as opposed to after AA’s exit.  There are decisions that can be made that are easier to execute in bankruptcy as opposed to out of bankruptcy.  Creditors (future shareholders) are more willing to accept those decisions in bankruptcy than outside of it.   A merged company before bankruptcy exit probably sees a little less shareholder value at the exit but probably sees much more value created for shareholders after 3 to 5 years.  If (potential) shareholders are willing to see the long term, this deal makes sense.

But Doug Parker & company now have to go to work hard on bondholders and influential members of the unsecured creditors committee.  They have to present a sterling and realistic business case.  All their ducks need to be lined up perfectly and even with that, one more thing has to happen:

The current AA executive team has to make a mistake.  It doesn’t have to be a very big one but it needs to be enough to cause some to question their ability to deliver on a stand-alone plan.   Another quarterly loss could do it.  Possibly declining revenues might as well.  Delta and United could do US Airways a favor and engage in predatory behavior against AA in its cornerstone markets and that would certainly do it.

A US Airways / AA merger makes huge sense when it comes to competing with UA and Delta.  Those two have proven that their scale is helping them in ways that AA can’t experience.  It is crystal clear that both airlines need each other in the future.

And if you don’t think this fight is about who runs the company, you are kidding yourself.  It really does boil down to that and, in a way, you want that kind of discussion to happen.  Doug Parker is seen as having “failed” at 3 attempts to merge with Delta, UA and Continental.  I would argue that he didn’t “fail” but that marriages with those airlines were a bit less optimal than they would have been with AA.  The real truth is that if anyone is the “ugly chick” in the airline world for the past 5 years, it’s been AA, not US Airways.

After all, it’s AA that has lost $10 Billion in 10 years, not US Airways.  It’s AA that has refused to address its costs and revenues, not US Airways.   It is AA who has an atrocious relationship with its unions, not US Airways.  US Airways’ union problems are a product of the unions, not management.  And the circumstances under which those problems occurred can’t happen again because of new federal laws.

I’ll point out that US Airways not only didn’t like AA for a merger partner for 6 years, it went to the very best prospects over and over again.  That wasn’t dumb, that was smart.  They didn’t lose because they were bad ideas, they lost those merger attempts because their counterparts wanted to remain in charge at those airlines.

You see, those executives didn’t fear US Airways.  They feared Doug Parker and the reason they fear Doug Parker and his team is that they are aggressive, smart and overperform.  There is firm, consistent evidence of that.  Parker & company can make quite a few other executive teams look stupid and no one wants to look stupid.

So, I think Parker will go radio silent for the next few weeks, await some outcomes in bankruptcy court and spend their time quietly working with bondholders and lenders to firm their business case for creditors and shareholders.  Tom Horton isn’t dumb but if I had to choose between him and Doug Parker to run a modern airline against the likes of Jeff Smisek and Richard Anderson, I’d choose Parker.  Parker is aggressive, hungry and willing to think outside the box when it comes to an airline.  Horton hasn’t shown any inclination at adopting new behaviors in light of a changed industry.

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American Airlines, as a part of its commitment to investigate merger partners during their bankruptcy, has sent out its Non-Disclosure Agreement to all parties interested and confirms that US Airways is one of those parties.  The NDA was crafted by American Airlines and, supposedly, in consultation with creditors.

It’s the last part that has me wondering if US Airways CEO Doug Parker knew something about the NDA coming his way before it showed up.  Parker seemed to qualify what he thought US Airways support would be for the AA bankruptcy process based on what US Airways perceived the merger process to be at AA.  Parker indicated that he thought the NDA would be an indicator of just how “real” and fair AA would approach a merger.

And the fact that he was spinning that NDA 2 weeks ago makes me think that some parties on the unsecured creditors committee leaked details of that NDA to US Airways.  Details that might indicate that the merger process at AA is window dressing rather than real.

I suspect that there might be some kind of gag written into that NDA that prohibits anyone from talking about AA in any way.  and I’m not certain that that is going to fly with US Airways or anyone else for that matter.

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A number of people have found a disconnect in the idea that American Airlines unions would encourage their membership to vote for the recently negotiated terms as a result of bankruptcy court mediation.  Particularly so after signing agreements with US Airways in support of a merger.

The answer is that it is a calculated bet on the part of the unions.  The terms are better than the term sheets offered by AA to the court for imposing upon the unions.  They increase AA’s costs although the terms are less than what is being offered by US Airways.  This boxes in AA when it comes to making its case for a stand-alone exit strategy.  Once those costs are fixed by a vote, US Airways can better those terms and advance its own business case.

This is why AA and Tom Horton are working so furiously to push away US Airways.  It is putting pressure on them to make a better and better business case and that means they have to find an argument for the revenue side of their business.  Unfortunately, that argument is increasingly not a very compelling one.

Bondholders have formed an ad hoc committee to try to gain more leverage in the bankruptcy process and US Airways CEO is reportedly directly negotiating with bondholders and offering a better deal.

The walls are closing in on AA management.  To succeed in a stand-alone strategy, they must:

• Make a cost savings argument that supports a viable business plan going forward.  Their costs are now being forced upon them by unions and US Airways which doesn’t make creditors feel like the management has control of the situation.
• Make a revenue argument based on the Corners Strategy.  This argument is becoming more and more difficult to make since American Airlines still cannot point to revenue improvements that impress anyone.  No financial analyst feels confident about AA’s revenue strategy and many are expressing that lack of confidence very publicly.  US Airways, on the other hand, is able to point to its own revenue strategies and their unequivocal success:   US Airways is earning signficant profits and growing its revenue very successfully despite the inherent weaknesses of its own network.  This shows that US Airways management knows how to run an airline today and puts pressure on AA executives again.
• AA must convince its creditors that their fortunes are better in a stand-alone strategy than a merger.  The argument here is that an exit from bankruptcy will result in those creditors owning shares of a company that is thought to be worth about $6 Billion upon exit.  Unfortunately, US Airways is forcing cuts into that pie for creditors outside the company by maneuvering AA into offering pilots a very, very significant portion of that pie.

And that’s why the fight is on.  We’ve seem a significant ramp up in PR activities by both airlines and already AA appears to be lashing out wildly in hopes of gaining maneuvering room.  Doug Parker and US Airways is applying pressure both externally and internally and has maneuvering room as a function of their financial results.

I expect this fight to get increasingly dirty.  AA’s disadvantage in this fight is that AA unions aren’t particularly fond of their executive management and just aren’t interested in supporting them.  The DFW area has not, so far, really put forth any strong movement to keep American Airlines a stand-alone company.  Why should they?  US Airways made the guarantee that the merged airlines would retain both the name and headquarters location in the DFW area.

American has lost public support in its Corners Strategy markets of Chicago where it has to contend with the fact that both United and Southwest Airlines are competing with it.  The New York market is being dominated by Delta and United Airlines.  There is no groundswell of public support for American’s current management.

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Tom Horton is now going even farther than claiming credit for the idea of an AA/US Airways merger.  In addition to all of that, Tom Horton is also bashing US Airways as the airline who needs a merger more desperately than American Airlines.  It is his contention that US Airways is desperate, has always been desperate and that he’ll be in charge of any merger decisions at American Airlines.

This is getting personal real fast.

US Airways isn’t wrong when it contends that its a viable airline without a merger.  They’ve proved that over and over again over the past 4 years. They earn money, they earn a lot of profit relative to their revenues and they do it consistently.  American Airlines hasn’t earned profits, hasn’t even mitigated their losses very well relative to their revenues and has lost roughly $11 Billion over the past decade.

US Airways has been pretty smart in seeking merger partners.  Even if it hasn’t been able to engage in one since the America West / US Airways merger, it has pushed industry consolidation very hard.  Over and over again, US Airways has been the catalyst for mergers.  And each merger has benefited US Airways with industry consolidation.

The thing that I find arrogant (again) is Tom Horton’s statements about who’ll be in charge of deciding mergers at American Airlines.  Increasingly, his public comments remind me of a certain Secretary of State for Ronald Reagan in 1981.   It’s notable that that man was ultimately asked to leave government.

I’m also finding the political intrigue going on at AA to be distressing.  Instead of engaging in a real merger examination process, the executive leadership and its attorneys are running around trying to find ways to derail that examination while publicly appearing to embrace it.  Not good.  It begs the question:  What are you so damn afraid of if you think you are so damn good at your jobs.

Members of the UCC and the bankruptcy court judge should consider having a frank discussion with the executive leadership to level set expectations and, perhaps, indicate that egos needed to get put away for now.

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