Slicing Up The Sky

By John Greenwald

What's in it for us?

Frequent flyers pondered that question in the wake of an audacious, $5 billion five-carrier buyout proposal launched last week by American Airlines. Consumers were clearly skeptical of any scheme that would enable American and archrival United to control fully half of U.S. air travel. If the deal goes through, "the world is going to be divided up among just a few airline companies," says Bruce Edwards, a California doctor who was forced to return home via Miami last week after United canceled his flight from Ecuador to San Francisco, citing weather conditions. "It's not going to be very consumer friendly."

American's proposal--a double loop with 1 1/2 twists--brings an ignoble end to storied Trans World Airlines, delivers US Airways into the arms of United and eliminates 15% of the competition in the marketplace. If the deal is approved, American, the No. 2 airline after United, will pay $500 million in cash and assume $3 billion in plane leases to acquire TWA, the No. 8 carrier, which landed in bankruptcy court last week for the third time in a decade.

The maneuvering would allow American to pull even in size with United and acquire the size and scale it deems necessary to do battle in a rapidly consolidating industry. United plans to grow by first shrinking a little. American would pay $1.2 billion to United for about 20% of the assets of US Airways, the No. 6 carrier, which United was trying to acquire before federal regulators delayed that $4.3 billion deal. By unloading assets, United figures to win antitrust approval for the merger. American would also shell out $82 million for a 49% stake in DC Air, a Washington-based start-up that Robert Johnson, founder of Black Entertainment Television, is carving out of US Airways.

When the music stops, American would command 24% of the U.S. market and would add valuable East Coast routes to its flight map. The airline, already dominant in such markets as Dallas and Miami, would become a force at New York City's John F. Kennedy Airport, where it would pick up 17 gates and 84 takeoff and landing slots. United would also increase its presence in the populous Northeast and would raise its U.S. market share to 25%. And in a unique agreement, United and American would jointly operate the lucrative Boston-New York- Washington shuttle that US Airways now runs, in competition with Delta.

TWA, once owned by Howard Hughes and a pioneer of flying's early reputation for glamour and luxury, would disappear into American. But most of TWA's 20,000 employees, the majority of whom work out of the carrier's home base in St. Louis, Mo., would be retained. TWA is history in any event. The company was down to its last $20 million before the bankruptcy court allowed American to provide new financing.

Simple logic says the mergers will jack up ticket prices. American and TWA compete head to head on Caribbean routes, for instance, yet TWA has long relied on hefty discounts to fill its seats. American, on the other hand, has long employed "yield management"--software that continuously analyzes and adjusts ticket prices to maximize revenue per seat. Donald Carty, chief executive of American, calls TWA's broad discounts a "failing business model." American does not think it prudent to give money away. Says Carty: "Consumers should never expect those [prices] every day."

That may seem hard to swallow, given how consumers feel about the service they're getting. Asked in a TIME/CNN poll last week whether airline mergers will result in better or worse service for flyers, 55% of those surveyed said worse, vs. 31% who saw an upside. Over the past five years, quality of service has deteriorated even as fares have been rising. Last year was particularly miserable. Delta and United have been poleaxed by labor disputes with the pilots' union that have caused thousands of flight cancellations. And relations between American's management and its labor groups have been notoriously bad for years. These guys need to pass through metal detectors before they get into a room together.

The animosity broke out again last week when American's 23,500 flight attendants, who have been without a contract for more than two years, agreed to take a strike vote later this month. If the members approve a walkout--and you can count on it--the strike could begin in late February. That's just when American's six-year contract with its 30,000 mechanics and ground-crew workers runs out. Says John Ward, president of the Association of Professional Flight Attendants: "It is ironic that American can find more than $5 billion for these various assets but can't invest in its best assets, its employees." In a post-merger era, a walkout at American could instantly ground one-fourth of U.S. air travel.

American's consolidation plans would provide consumers with some benefits. The deals would lessen airport congestion and reduce flight delays because American could route passengers through TWA's former St. Louis hub rather than through crowded Chicago or Dallas. Some jetliners now take off with many empty seats--tying up scarce runway and air-traffic space--because carriers tend to jam competing flights into the same popular time slots. Fewer carriers would mean fewer overlapping flights. Passengers could also get service to more cities on the same carrier, a benefit for those who want to concentrate their frequent-flyer miles.

All sides agree that the consolidations would force rival carriers to bulk up fast or join the endangered list. The most vulnerable major competitors would include No. 3 Delta, whose 18% share of the market would suddenly make it seem like a second-tier competitor to United and American. "Delta would be severely wounded if it just sat back and did nothing," says Brian Harris, who follows airlines for the Salomon Smith Barney investment firm. That could prompt Delta to make a play for No. 4 Northwest or No. 5 Continental. Either deal would give the top three carriers control of nearly 85 out of every 100 U.S. airline seats.

Which is precisely the scenario that critics of airline consolidation are eager to avoid. Says Representative Louise Slaughter, a New York Democrat: "It would be a travesty for the new Administration to let this go forward." Maybe, but few expect the Bush Administration to find the thrust reverser for this one. The President-elect hails from American's home state (CEO Carty was a big Bush contributor), and John Ashcroft, Bush's nominee for Attorney General, comes from TWA's. Says Holly Hegeman, an aviation analyst and publisher of the website planebusiness.com "I really don't think we would have seen this type of move if the Democrats had kept the White House."

The change in Administrations hasn't stopped some politicians, including Republican John McCain, chairman of the Senate Commerce Committee, who strongly opposes United's takeover of US Airways, from mounting a bipartisan effort to halt the deals. Democrat Byron Dorgan of North Dakota last week urged the Justice Department to "do its job and promote competition in the airline industry, not preside over its demise."

The Justice Department's merger review could come at an awkward time for American, which is preparing to defend itself in a major predatory-pricing trial. American is battling a 1999 Justice complaint accusing it of driving smaller rivals out of its Dallas-Fort Worth hub by illegally slashing ticket prices and saturating the market with new fights.

There is one surprise awaiting the industry. This week lame-duck Transportation Secretary Rodney Slater is expected to issue long-anticipated and controversial "competition guidelines," which the big airlines have tried for years to fend off. The document will give detailed definitions of what constitutes predatory behavior and unfair methods of competition. The guidelines will, for the first time since deregulation, allow the DOT wide latitude in looking into the subtle ways competition can be affected. For instance, if a large airline threatens vendors who offer their services to start-up airlines, the new rules would let the DOT move quickly to make the offender halt these practices.

Such rulemaking could limit the majors' ability to run off low-price rivals. Says a former DOT official: "I don't think it's a coincidence that Slater is pushing this out the door days after American Airlines just got bigger."

American's bold proposal could bring airline deregulation to its logical--if unforeseen--conclusion. More than 50 new carriers have taken wing since deregulation's dawn in 1978, but only a few, like Midwest Express, have survived. And at least one, America West, is the subject of takeover talk. The rest have either been scrapped, like older carriers Braniff and Eastern, or swallowed up.

Today "the whole industry is on the brink of consolidation," says Kevin Murphy, an airline analyst for Morgan Stanley Dean Witter. "Clearly we're going to go from six major carriers to three, and that will be the story of 2001." If that forecast proves accurate, weary travelers had better enjoy today's service, because the prospects for improvement aren't getting any better.

--Reported by Sally B. Donnelly and Mark Thompson/Washington and Cathy Booth Thomas/Dallas

With reporting by Sally B. Donnelly and Mark Thompson/Washington and Cathy Booth Thomas/Dallas, Missy Adams