Tags: Airlines

Air France-KLM Pins Hopes on Northwest Merger

By , Money Morning •

By Jennifer Yousfi
Managing Editor

Air France-KLM (AKH) is taking a unique interest in Delta Air Lines, Inc.'s (DAL) merger talks with Northwest Airlines Corp. (NWA) and UAL Corp.'s  (UAUA) United Airlines.

Air France-KLM, itself a product of a major airline merger, is one of Delta's primary European partners under the SkyTeam Airline Alliance.  Northwest is also a member of the alliance and has a long history of close ties with Air France-KLM. By contrast, United is part of the Star Alliance, which includes main European partner and Air France-KLM rival Deutsche Lufthansa AG (DLAKY). 

And that's why Air France-KLM is so interested in the outcome of a domestic U.S. carrier merger. Air France-KLM has been planning a joint transatlantic venture with Delta under the "open-skies" agreement for months now. It doesn't want to lose Delta as an alliance partner, and if it can strengthen its relationship with Northwest at the same time, even better.

In fact, Air France-KLM is so concerned about the outcome of these merger talks that it may even assist with funding a Delta bid for Northwest, Bloomberg News reports. 

High Oil Costs Fueling Mergers

With oil over $90 a barrel and no relief in sight, airlines are feeling the pinch just like the average consumer.

"Every penny increase in a gallon of jet fuel costs our industry $195 million annually, and while we operate more efficiently, we must be able to pass commodity costs on to customers, as other industries do," UAL spokeswoman Robin Urbanski said in defense of United Airlines' recent increase of its domestic fuel surcharge.

Higher costs make mergers seem like a good idea. Delta has been feeling the pressure from low-cost competitors like Southwest Airlines Co. (LUV) and just pushing the extra costs off onto consumers isn't the best strategy. Fuel is the biggest expense category for airlines and consolidating to capitalize on economies of scale seem to make sense. 

But not everyone is convinced that a merger will solve all of Delta's problems. 

"The question really is: how much more successful can a giant dinosaur be than two medium-size dinosaurs?" Peter Morris, chief economist of U.K.-based aerospace consultancy Ascend told MarketWatch.

The highly regulated domestic airline industry has many challenges beyond just high fuel costs. Airlines have a host of labor problems at every level from pilots to ground crews and management doesn't have a stellar track record for managing those troubles without letting it affect customer service. 

A Political Layover

The number of politicians with a vested interest makes merger talks more difficult.  While the U.S. government technically can't block a merger outright, it can certainly make things more difficult. 

With U.S. House of Representatives Transportation Committee Chairman James Oberstar hailing from Northwest's home state of Minnesota and the committee's aviation subcommittee chairman U.S. Rep. Jerry Costello coming from Illinois [United's headquarters], things are bound to get interesting. Plus, Georgia's congressmen are sure to be angling to ensure Delta will be maintaining a post-merger Atlanta hub.

If Air France-KLM helps to partially fund the merger, it will surely want a stake in the newly formed carrier. But U.S. government regulations limit a foreign firm's ownership of a domestic airline to less than 25%, as illustrated by Lufthansa's 19% purchase of JetBlue Airways Corp. (JBLU) just last month.

Airline industry regulations aren't the only type of U.S. government oversight Air France-KLM has to worry about.  CNNMoney reported that the European carrier is applying to de-list its shares from the New York Stock Exchange effective Feb. 7. The stated reason was that 95% of trading occurs on the Euronext Paris, but Money Morning guru Martin Hutchinson thinks there is more at play.

"Given the U.S. legal system, it's not surprising that foreign companies de-list, it's more surprising that they haven't all done so," he said.

The delisting of American Depositary Receipts (ADRs) by foreign companies is one of the worst consequences of the 2002 Sarbanes-Oxley Act. Section 404 of the Act is the most frequently cited problem, as it requires top managers to certify that the company's computerized control systems are sound and resistant to hacking and can often lead to hiring an expensive outside consultant to ensure the systems are up to code. 

Since U.S. institutional investors can still purchase shares listed in London or Paris, foreign CEOs don't see why they should go to the added expense, trouble and risk to list on the American exchanges.

Streamlining Costs

Air France-KLM's might be looking to cut costs because Delta isn't the only expensive merger on the European carrier's agenda. The French/Netherlands pairing has been eyeing troubled European rival Alitalia - Linee Aeree Italiane S.p A. and has pledged to invest $1.09 billion (750 million euros) if selected as the buyer for the Italian government's 49.9% share in the carrier.

While MarketWatch reports that the European airline had a sizeable $9.1 billion (6.2 billion euros) in cash reserves as of late September, it might not be enough to handle two major acquisitions at the same time.

Plus, while Air France-KLM has been selected as the preferred buyer of Alitalia, the deal is far from settled.  The Italian government was not pleased with Air France-KLM's offer for its both its stake and convertible bonds.  The carrier is also running into regional pressure over Milan's Malpensa airport.  In fact, the entire deal might be at risk if Air France-KLM does not eliminate planned route cuts from Malpensa, Forbes reported.

News and Related Story Links: