Delta: US Air deal would hike fares

In a call with investors, Delta CEO Jerry Grinstein said US Airways is Delta's primary competitor on the East Coast, and a deal with it would be the one least likely to be approved because of the impact on fares.

"Combining the carriers necessarily reduces competition, which may sound good to a monopolist but a regulator would not like it all," he said.

US Airways quickly responded that it is not dropping its bid for Delta, despite the formal rejection by the Delta board.

"We remain a determined, disciplined bidder and are confident the offer we made presents the greatest value for all our stakeholders," said a statement by spokeswoman Valerie Wunder.

Delta said there are 2,000 routes where a combined US Airways and Delta would control 90 percent of the flights, which the company argues would prevent U.S. antitrust regulators from agreeing to the deal.

"Delta believes consumers have valid reason for concern, as pricing has gone up, not down, on approximately 6,600 US Airways routes following its merger with America West," said Delta's statement.

US Airways executives have insisted that fares did not rise after the former America West bought US Airways' assets out of bankruptcy in September 2005, arguing that cost savings from the combined operations allowed it to keep fares low.

But filings by US Airways Group (down $0.23 to $55.57, Charts) as well as the two predecessor carriers that combined in late September 2005, America West and US Airways Inc., suggest that the combined carrier has seen a rise in the revenue per passenger mile, a closely watched measure known as yield that approximates average fares.

US Airways Group's yield in the third quarter is up 10.4 percent compared to the average of the two predecessor carriers a year earlier. Over the first three quarters of 2006 the average yield is up 14 percent. Both are higher than the average gain in industrywide yields reported by the Air Transport Association, the industry trade group.

Grinstein rejected the idea of continuing talks with US Air, making some of its financial information available in order to see if US Air would be willing to raise its bid, while Delta management continued to move toward emerging from bankruptcy as an independent carrier.

"Remember this is a hostile proposal, not a solicited one," he said. "When you get into exchanging information with your largest competitor, you've got issues. The Justice Department has already indicated they did not want us to do so without some clearance from them."

S&P airline equity analyst Jim Corridore doesn't think the regulatory hurdles are as clear cut as presented by Delta management, but he agrees that in some smaller markets the merger would result in higher fares.

"I don't think that it's a regulatory non-starter, but there are significant hurdles that have to be cleared," he said. "I believe there is a case to be made that these hurdles can be overcome."

Tuesday's statement from Delta says that its financial adviser, the Blackstone Group, estimates that Delta will be worth about $9.4 billion to $12 billion when it emerges from bankruptcy.

US Air is offering $4 billion in cash and stock now worth about $4.4 billion to Delta creditors.

While Delta is not offering cash to creditors at this point of the discussions, Grinstein insisted that the Delta plan still is less risky for creditors since it doesn't face the regulatory hurdles that a merger with US Air would face, and it would allow Delta to emerge from bankruptcy sooner.

S&P's Corridore said he believes the U.S. Air offer is the better deal for Delta creditors. But he said he now doubts that the merger will take place.

"It will be very difficult for the deal to go forward in the face of the opposition from Delta management and directors," he said. "The Delta pilots are also a constituent that you have to convince, and US Air hasn't been able to do that."

But Joseph Capobianco, a Long Island, N.Y.-based merger & acquisition attorney, said he believes it's easier for a hostile bidder to convince creditors to accept a deal than it is to convince shareholders of a non-bankrupt company. So he thinks that US Air still has good chance to get Delta.

"I think US Airways will increase their offer," he said. "I don't think the fat lady has sung."

US Air's Wunder would not comment when asked about reports that the company was considering an increased bid.

Delta said it is on track to emerge from bankruptcy next spring but said that emergence would be delayed until 2008 if the merger went forward. The company filed its reorganization plan, which it said would result in a recovery for Delta's unsecured creditors of approximately 63 to 80 percent of their allowed claims through equity in the reorganized company.

Delta also argued a combined US Air-Delta would have $23 billion in total debt, compared with about $10 billion in total debt for a stand-alone Delta.

"In our industry, as all of us know, that [heavy debt] is a prescription for disaster," said Grinstein.

And Grinstein insisted the Delta contract with the Air Line Pilots Association prohibits the 10 percent cut in capacity at a combined Delta-US Air that the US Air executives plan to make as part of the merger.

"There are significant labor issues that can not be blinked away," he said. "The pilots have said that Delta is not for sale."

US Air's Wunder would not comment on the specifics of Delta's statement other than to repeat the prepared remark reiterating the bid.

The bid from US Air for Delta last month set off speculation that it could bring a round of mergers in the industry. Last week there were reports that United Airlines' parent UAL Corp. (Charts) was in preliminary talks with Continental Airlines (Charts) on a potential merger. And even smaller carriers could get involved, as AirTran (Charts) announced an unsolicited bid for Midwest Express (Charts).

Grinstein told investors that if some of the other deals come to pass, Delta may have to reassess its go-alone strategy. But he repeated that he believes an independent Delta is the best strategy, no matter what negotiations are taking place.

"They may be in conversation, but we haven't seen any fruit of that yet," he said. "What history has shown us about airline mergers is they're difficult to do."

If airline mergers fly, fares could follow