Airline mergers may not take off

NEW YORK (CNNMoney.com) -- Along with packed airplanes and millions of holiday travelers, the skies next week will be filled with talk that a round of airline mergers could soon reshape the industry and reduce the choices available to fliers.

With jet fuel prices soaring and airline stocks plunging, proponents of mergers are casting as nearly inevitable combinations that would create three mega-carriers carrying more than 70 percent of the nation's air traffic.

Even as Delta Air Lines denied reports of merger talks with United Airlines Wednesday, Delta CEO Richard Anderson climbed on board the idea that a merger could be the answer for the nation's third-largest carrier.

"Delta believes that the right consolidation transaction could generate significant value for our shareholders and employees and that strategic options should be evaluated," Anderson said in a statement.

Anderson's comment came after one of his major shareholders, hedge fund Pardus Capital Management, proposed that Delta (Charts, Fortune 500) buy United Airlines parent UAL Corp. (Charts, Fortune 500), in which Pardus also owns a large stake.

"We believe it is imperative that you seek to enter into a merger transaction with another carrier given the rapid rise in fuel prices and the increased risk to the business as a stand alone entity," said Pardus wrote in a letter to Anderson.

But huge hurdles stand in the way of airline mergers. Other than industry executives and some investors, airline combinations aren't terribly popular. Mergers can bring operational problems, staff cuts and higher fares, while drawing heat from such important constituencies as business travelers, airline unions and the general public.

The potential backlash against mergers has left those who want to see deals looking for a way to sell the idea. What they have focused on is rising cost of jet fuel, which has jumped 24 percent since Labor Day.

"With oil at over $90 a barrel, this analysis takes on a heightened importance as we factor those prices into our long-term planning process," said Anderson.

But other experts say jet fuel prices are more an excuse than a valid reason for mergers that some carriers were pushing even before the price spike. They point out that it will take years for any carrier to see any savings from synergies or improved revenues from a combined route structure.

"There's no immediate relief from fuel prices from consolidation," said Joe Schwieterman, a transportation professor at DePaul University.

He said advocates of mergers are focusing on fuel prices because they have depressed the value of airline stock, which would get a lift from a round of mergers.

"Shareholders are looking for some big strategic moves since the outlook for profits now seems so poor with these fuel prices," Schwieterman said. "That's why I think momentum is building for consolidation."

The Amex Airline Index has fallen by more than third since it hit a three-plus year high in mid-January. But it has rallied 9 percent this week on lower oil prices and the talk of a possible round of mergers.

Even some experts who believe that mergers would be good for airline profits say current financial problems in the industry could delay, rather than hasten, a round of mergers.

"I still do not believe anything will develop this year, but the pressure will increase," said Ray Neidl, airline analyst with Calyon Securities.

Neidl says a host of factors could make it difficult to pull off an airline merger in the near-term. He cites the depressed share price of carriers such as Delta, US Airways Group (Charts, Fortune 500), or American Airlines parent AMR Corp. (Charts, Fortune 500), which he would expect to be a buyer, and problems in the credit markets that would make it difficult to raise cash to do deals.

Industry consultant Mike Boyd said the merger talk is driven by the fact that airline management is conducting what he called scenario planning.

"Every airline CEO has got to be considering scenarios because United is in play," said Boyd. "Also they'd like to bring capacity down to charge more for what's left. But the Delta management has the highest level of expertise in the business. They're not going to make a mistake and jump into something that doesn't match up very well."

And even Neidl, who sees advantages to industry consolidation, says any benefits for the carriers' stocks might be short-lived.

"At this time we would be cautious buyers of network carriers based on fundamentals and aggressive buyers when the time comes for possible consolidation, perhaps as early as next year," he wrote in a recent note. "We would advise to buy on news of consolidation and sell upon action being taken, since engineering airline mergers has proven to be difficult in the past."

Schwieterman argues that if and when fuel prices retreat, carriers will be in relatively good shape because downsizing and labor cost savings they have won in recent years in bankruptcy courts have allowed them to post profits.

"The airlines have finally got their house in order, so one wonders if this is the time to roll the dice on something like this," Schwieterman said. "It will take years for approval. There's going to be upward pressure on pay to keep all the unions on board. They're making money at the moment even with astronomical fuel prices. This will throw a lot of key variables up in the air."

Mergers might make more sense next year, however, assuming fuel prices decline, Schwieterman said. He said the combinations could then be done with an eye toward long-term strategic changes, rather than an emergency move to boost depressed share price.