Investors Point At Rising Oil Prices

Airlines are rumored to be talking about mergers, but while the music is playing no one has taken a step forward to the dance floor yet. A hedge fund with large stakes in United Airlines parent UAL Corp. and Delta Air Lines Inc., who has a healthy interest in spurring a deal between the two, went public this week with its plan for combining the nation's No. 2 and No. 3 carriers, stating that rising oil prices and competition necessitate combining the two, according to the Chicago Tribune.

"It's a matter of getting the chaperon out there, getting it started," said a person close to the hedge fund, Pardus Capital Management LP.

Apparently backroom talks with the carriers' management teams dead-ended. Pardus decided to publicize its concerns about the industry's long-term viability and its case for a merger in a letter to Delta's top three officials. It sent a similar directive to United executives, the Tribune reported.

"Pardus is trying to kick them in the butt, to say, 'Let's get going. Let's not wait for oil to get any higher," said Gordon Bethune, the blunt former Continental chief executive who has been consulting with the funds' principals for nearly a month. Merger rumors have wafted around the industry for a year.

Most airline CEOs, during their most recent earnings calls, agreed that consolidation was needed. However, many analysts and observers remain skeptical of any mergers materializing from the latest industry events. United and Delta were quick to declare that while they are open to mergers, they are not negotiating. The reasons are many, mergers would give unions an opportunity to reopen contracts at a time when workers are dissatisfied with management and want wage increases, thus diminishing any savings from a business marriage.

"I think it's a bad time right now," said Roger King, airline analyst with CreditSights Inc. "It would have to be a consensual merger, and labor's not going to consent." Also the complexity of merging two airlines with networks that stretch around the world: melding disparate computer system, fleets, management teams and global marketing alliances are corporate challenges difficult to attain.

"You can sell any deal from a power point," said airline consultant Robert Mann, president of R.W. Mann & Co. "It's rather more difficult to make it work in practice." Analysts are pointing at the need for a restructuring of the airline industry if oil prices remain high. Every dollar increase in oil costs major airlines as much as $335 million annually, according to AirlineForecasts, a Virginia-based market research firm.

"Pardus is trying to bring some awareness of the growing dissatisfaction with shareholders in the status quo," Bethune told the Tribune on Wednesday.

"The status quo is no longer sustainable: Why not this and why not now?" Bethune, who advised Delta's creditor committee on US Airways' hostile overture earlier this year, indicated he had no part in merger talks, and had no interest in leading a company if a merger occurred.

"I'm not going to run anything anytime soon," he said. Bethune agrees with an analysis, commissioned by Pardus, which found United and Delta, if combined, would generate $585 million after taxes in combined earnings. Nearly $169 million would come from revenue generated by the global network that the deal would create, say experts familiar with Pardus' analysis. Additional revenue could be gained by more efficient hub use, and switching to larger narrow-body jets.

A scenario sketched out by Pardus wouldn't involve major job cuts or closing any hubs, according to Tribune sources. Investors are skeptical about mergers that involve labor cuts, which could sour a deal.

"Unless you did a substantial capacity cut, there's really no reason to do this deal," Mann said.

"The economics can't work. And when economics don't work, the first that happens is cuts." Pardus also envisions a stake by employees, and estimates a figure of five percent that would be worth $1.2 billion by 2012. There is no certainty that labor unions would buy it and that United's pilots won't approve deals negotiated by management.

While many obstacles meet the concept of consolidation, only blunders along the way could derail mergers, say experts.

"You never know," said Bethune. "It certainly should happen unless the idea is defeated by ineptness."

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