Mega-mergers on horizon as US airlines blaze a trail in the skies

Date: 15/02/01

By Bruce Barnard

THE wave of consolidation sweeping through the US airline industry is sure to trigger copycat deals in Europe, paving the way for the first transatlantic mega-merger.

And that will pose a tough challenge for trust-busters in the new

Bush administration and competition regulators in Brussels who are putting the finishing touches to proposals to liberalise air travel in the EU and across the Atlantic.

A transatlantic merger may not be imminent thanks to the web of outdated regulations - notably limits on foreign ownership in the US - preventing carriers from mounting the large cross-border takeovers that have reshaped most other sectors, including the sensitive defence industry. But the situation in Europe and the US is extremely fluid and governments will face increasing pressure to align regulations with market realities.

The US Justice Department is likely to approve, with restrictions, the €4.3-billion United Airlines-US Airways merger and American Airlines' €4-billion combined purchase of Trans World Airlines and 20% of US Airways' assets. As a result, United and American will soon be flying 50% of US air travellers.

Brussels regulators soon could be facing complicated competition investigations because Europe's leading carriers will have to grow through cross-border takeovers in order to compete with the emerging US super-airlines and to become equal alliance partners.

So far, European airlines have failed to pull off successful mega-mergers to rival those in the US, largely because Europe's supposedly single air-transport market is still very fragmented and carriers bring political and historical baggage to the negotiating table.

KLM and Alitalia came closest with a revenue and profit-sharing joint venture that ran for six months before it collapsed in acrimony and lawsuits last April. An even more ambitious merger between KLM and British Airways (BA) that would have created the world's largest airline, ranked by revenue, was almost in the bag before it too crumbled at the last minute in September.

SAirGroup, the parent of Swissair, broke a taboo by buying 49.5% of Sabena, the first cross-border acquisition of a large slice of a European flag carrier, but it has paid a heavy price for the abysmal performance of the Belgian airline. The company's chief executive, Philippe Bruggisser, resigned two weeks ago, prompting a review of all its holdings in airlines in France, Italy, Austria and Poland.

These three pioneering deals faced much more regulatory scrutiny and political interference than similar transactions in the US. The KLM/Alitalia deal was nodded through within days of being notified to European Commission competition officials, but was then caught in a blazing row over Milan's new Malpensa airport between Brussels, Rome and half a dozen European carriers. It was eventually torpedoed by delays in privatising the Italian carrier.

The planned all-European merger of BA and KLM faced more regulatory heat from Washington than Brussels. The Commission was expected to order the two carriers to give up some of their London/Amsterdam slots and require KLM to sell Buzz, its low-cost carrier-based at London Stansted. Washington, by contrast, threatened to scrap KLM's unrestricted rights to the US market under a 1992 US-Netherlands aviation agreement if it was taken over by BA before Britain agreed to an "open skies" accord with the US.

SAirGroup had to await a 'yes' vote in a Swiss referendum on closer trade links with the EU before it could sign an agreement to lift its stake in Sabena to 85% - a commitment that has turned into a nightmare as Sabena struggles to stave off bankruptcy.

The regulators will be busy again soon as Europe's airlines embark on a new round of consolidation. They have little choice if they wish to remain sizeable players in a rapidly globalising industry. KLM says it can only survive another three years without a merger.

Alitalia and KLM are now talking about renewing negotiations as Air France also makes overtures to the Italian carrier. Swissair has abandoned its 'go it alone' strategy and is speaking with the major global alliances including Star and oneworld. And BA and American Airlines are in discussions about deepening their partnership. It is getting progressively easier for Europe's airlines to merge and swap shares as governments cut their political and financial links with the industry, though it is still more difficult to agree deals on this side of the Atlantic than in the US.

The French government has just appointed bankers to advise it on reducing the state's current 56% holding in Air France to below the critical 50% level. Spain recently announced it will float the state's 53.9% holding in Iberia in April. And the appointment of a new chief executive at Alitalia last week is expected to put the carrier's privatisation back on track.

European airlines know they must merge to meet the challenge from across the Atlantic and don't want governments to put obstacles in their way. State control no longer offers protection against market forces as the Commission will not permit further bail-outs of failing carriers after approving over €15 billion in handouts to national flag airlines to prepare them for deregulation.

The consolidation on both sides of the Atlantic, coupled with the move by leading Asian carriers to buy into the western industry led by Singapore Airlines' acquisition of a 49% stake in Britain's Virgin Atlantic, is bringing forward the day of the first global merger.

Airlines hype the benefits of global alliances, supported by share swaps and minority holdings in smaller member carriers, but executives acknowledge they are a second best option to the full-scale cross-border mergers that are impossible in the current regulatory regimes.

During merger negotiations with KLM, BA was ready to walk away from its oneworld alliance and team up with Northwest Airlines, the Dutch carrier's partner. BA and KLM had unhappy experiences as minority shareholders in US Airways and Northwest respectively, but both would jump at a chance of a transatlantic merger.

That could come a lot sooner than many in the industry thought possible before US carriers embarked on their consolidation endgame.

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