FORTUNE — The Department of Justice rolled over big time in its bid to block the merging of US Airways (LCC) and American Airlines. The shoddy “settlement” inked with the two airlines Tuesday fails to address much of the government’s previous grave concerns regarding further consolidation in the airline industry and will do little to prevent the “New American” from raising fares and slashing air service down the road. While that may be great news for airline investors, it comes at the expense of the flying public.
“Why mince words? ‘A win for the airlines’ is how we view the negotiated settlement announced intraday Tuesday,” Jamie Baker, the airline analyst at J.P. Morgan, said in a note to clients yesterday. That pretty much sums up the view across the market, which sent shares of both airlines soaring after the surprise announcement. The government’s crusade to halt further consolidation in the airline industry had apparently ended as abruptly as it began.
How could this happen? One second the government says the merger would be the most anti-competitive move in airline history, and the next it’s signing a settlement document allowing it to go through. The truth of the matter was the government’s case was always shaky, despite it being well-intentioned. After all, the DOJ allowed consolidation in the airline industry to go on for years with little to no opposition. Its sudden change of heart was seen as hypocritical, reducing its credibility on this issue.
Yet the government (shockingly) contends it actually won a big victory for the consumer. While it is allowing the merger to go through, the settlement calls for the New American to give up landing rights and gates at a number of major airports to so-called low-cost carriers, like Southwest (LUV), JetBlue (JBLU), Virgin America, and Frontier (RJET). It also forces the airline to maintain air service at “historical levels,” at its hubs. The government contends that this settlement promises “to impede the industry’s evolution toward a tighter oligopoly,” and that it “will deliver benefits to consumers that could not be obtained by enjoining [blocking] the merger.”
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Really? Let’s take a closer look at what the government actually got in this settlement and what, if any, advantages they could bring to consumers. First, the agreement calls for the combined airlines to give up two gates at five “key airports:” Miami International (MIA), Boston Logan (BOS), Chicago O’Hare (ORD), Los Angeles International (LAX), and Dallas Love Field (DAL). The government’s thinking here is that in relinquishing these gates, low-cost carriers would be able to gain greater access to these big airports, thus increasing competition.
But save for Love Field, there doesn’t appear to be a “gate shortage,” preventing low-cost carriers from flying in to these airports. Southwest, for example, doesn’t fly into O’Hare, not because it can’t get a gate at the massive airport, but because it maintains a hub at Chicago’s other airport, Midway. Pretty much any airline that wants to fly into these big airports can do so, meaning that this concession won’t really help the competitive environment. It won’t even limit the number of flights the New American will be able to operate out of the airports as the gates they are using aren’t running at capacity. Indeed, Tom Horton, American’s chief executive, told reporters yesterday that he expects the gate divestitures to have almost no impact on flight operations.
As for Love Field, it is a special and complicated case. With the expiration of the Wright Amendment next year, the airport will only be allowed to operate with 20 gates. Of those 20 gates, Southwest would get 16, while United and American would get two each. By forcing American to divest two gates, the government is effectively banning it from flying into Love, which it believes would be good for competition in the Dallas market.
But American has showed little interest in doing anything with its two gates at Love. It doesn’t even use the ones it currently has; rather, it leases them to archrival Delta Air Lines (DAL). That’s because a few miles to the northwest of Love Field is Dallas/Ft. Worth International (DFW), which is American’s largest and most important hub. Flying to Love Field makes little sense for American as it can’t connect passengers on to other destinations.
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Clearly, the government’s “great gate giveaway program” is a dud. The competitive dynamic at the impacted airports will almost certainly remain the same, and it is unlikely to have any adverse impact on the New American’s combined flight schedule. But this is just part of the settlement.
The government is also forcing the airlines to give up some of their coveted takeoff and landing “slots” at New York’s LaGuardia (LGA) airport and Washington’s Reagan International (DCA). Both are the close “in town” airports serving their respective metropolises, and both have capacity controls, meaning that airlines must obtain a prescribed number of “slots” in order to run flights in and out of the respective airports. The hope here is that it will prevent the New American from using its size to push up prices, especially at DCA where it would have a combined 69% of the slots.
The forced slot divestitures out of LGA means that the combined airline will have to reduce its total number of daily departures from 175 to 163. That impacts just 12 daily departures, equating to less than 7% of the combined airline’s daily departures — hardly earth-shattering.
The government had a bit more luck over at DCA. There, the airline will need to reduce its combined daily departures from 294 to 250. This decreases the number of daily departures the New American will be allowed to fly by 44, about 15% of the combined airline’s daily departures. The move essentially gives all of the old American’s slots to other carriers and allows the New American to retain just those slots previously held by US Airways.
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It is hard to know how these slot divestitures will end up impacting the bottom line of the New American as neither airline reports its revenue by airport. But chances are the airline will elect to simply eject its lowest performing routes as well as those routes where there was overlap between the two carriers. This should help minimize the negative impact on the combined airline’s revenue as a result of the forced cuts.
So will passengers at DCA get any relief from the government’s actions? Don’t count on it. Many of American’s slots will probably go to JetBlue, which has been trying to crack the DCA market for years but has been held back due to a lack of slots. While JetBlue is seen as a low-cost carrier, it isn’t a charity. It will charge as much as it can get away with just like any other airline. For example, a last minute round-trip flight from DCA to Boston Logan’s airport tomorrow costs $538, whether you travel on United (UAL), US Airways (LCC), or JetBlue. This dynamic is unlikely to change as long as there remains capacity constraints at the airport.
The last part of the settlement is a big one. The new American agreed to maintain “historical levels of service” at every one of the combined airline’s eight hub airports for three years and maintain air service to a smattering of small airports for the next five. This is unusual — normally the government forces airlines to give up routes, not maintain them. This was to satisfy the various state Attorneys General who joined the DOJ’s case as they feared the New American would be tempted to reduce or shift service away from some towns and hubs inside their states.
While management at both airlines have said repeatedly that they would not cut or shift service from any of their hubs, that is really hard to believe. It would be almost impossible for the airline to achieve the annual $550 million in cost synergies it promised investors without “rationalizing” the combined network. Why should the New American continue to fly to Rio de Janeiro out of US Airways’s hub in Charlotte when it can now shift that coveted route to one of American’s hubs at either New York’s JFK or Miami International where there would be far more local demand for such a flight?
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While this agreement may seem like a win for those consumers located in vulnerable hub cities like Charlotte, Phoenix, and Philadelphia, the truth is that it will probably just delay, not prevent, an aeronautic gutting at the hands of US Airways chief executive Doug Parker, who will be taking the reins over at the New American. Parker has experience crushing hubs — just ask the people of Pittsburgh. After three years those hubs will be marked for “rationalization,” and there will be nothing the government or any state Attorney General can do about it.
In fact, it may be much shorter than three years. The settlement allows the New American to break its promise to maintain service levels at its hubs and cancel those flights to smaller cities if it feels that there has been a material adverse change, “in demand, the competitive environment, or New American’s cost to comply.” This so-called MAC clause is extremely vague and can be triggered at the sole discretion of management. So say oil prices go above $100 a barrel — that could possibly be a trigger as it impacts the “cost to comply.” Say Southwest starts a new route to Phoenix — that could constitute a change in the “competitive environment” of the entire hub.
Forcing the New American to maintain an inefficient route network and keep all its hubs open will be very costly. In addition, the combined airline will have a labor bill that will be at least $500 million more than what it was when the two airlines were separate companies. It will also have to pay at least $1.2 billion in “merger-related costs” over the next three years. The New American is also planning to massively upgrade its fleet, which will see leasing costs jump.
Clearly, this merger is going to cost a lot of money. That means higher fares — period.