Closed-door Newark slot deal has the airline industry buzzing

By Michael Fabey

Getting the government’s approval for an airline merger is proving to be easier than winning its blessing for a swap of takeoff and landing slots at busy domestic airports.

That’s the lesson that many in the aviation industry say they took away from the Justice Department’s decision last week to approve the United-Continental merger, which promises to create the world’s largest airline, with an estimated combined revenue of about $25 billion, through an all-stock deal worth $3.17 billion.

The Obama Justice Department, which vowed to be a tougher sell than its predecessor when it came to mergers, took less than two-thirds the time to review and approve the United-Continental merger than it took the Bush Justice Department to give its nod to the Delta acquisition of Northwest.

United and Continental still have some cleanup work to do. Both have stockholder meetings scheduled in mid-September to approve the merger, and both are talking with states attorneys general who are still reviewing the merger.

But what really has the industry buzzing is the single condition imposed by the DOJ and how the airlines responded: The government demanded that the merger partners give up slots at Newark Liberty Airport, and the two airlines did just that by turning the slots over to Southwest in a closed-door deal.

Federal antitrust regulators said Continental and United needed to divest themselves of some of their slots at Newark Liberty because it was the one airport where the carriers truly overlapped, and the loss of competition resulting from the merger could cause serious harm.

Newark is a slot-controlled airport, limited to 83 arrivals and departures per hour during peak flying time, and slots there are as precious as gold to the airlines.

Continental and United responded by detailing plans in late August to lease 36 slots to Southwest. The move created a major opportunity for Southwest but also sparked debate in the aviation community.

While the United-Continental merger promises to reshape the airline landscape, the slot-lease agreement will not only alter the competitive makeup of the New York market, it could affect other slot deals throughout the country and even the way airlines look at how they should approach slot deals and future airline mergers.

No one is publicly questioning the value of Southwest entering Newark. The low-cost carrier currently has only 16 slots at LaGuardia. Its only other New York-area service is out of Islip MacArthur Airport on Long Island. Many predict airfares will drop by about a fifth once the carrier gets up and running at Newark in March.

But what has many people scratching their heads is the fact that the DOJ’s acceptance of the slot-leasing plan at Newark appears to contradict its earlier decision regarding a proposed slot deal at New York LaGuardia and Washington Reagan National.

In the latter deal, the DOJ recommended that the Transportation Department require Delta and US Airways to divest some of their slots through a blind auction, instead of selling them to any airline it wanted to, as a condition of federal approval for the two airlines to swap slots at LaGuardia and Reagan.

In that case, the government argued that allowing the two airlines to decide who got their divested slots amounted to letting them pick their competition.

Paradoxically, Southwest earlier this year argued in a DOT filing that an auction was the only way to handle a slot divestiture. Eventually, the DOT did demand such an auction, a decision that Delta and US Airways are contesting in the courts.

Industry analysts and bloggers said the different approaches contradict each other and could easily open the door for Delta and US Airways to win their current appeal.

There’s also some question about how Continental picked Southwest for its Newark slot leases.

"Obviously, there were some backroom deals going on here, and Continental and United chose their poison," observed industry blogger Cranky Flier.

Continental and Southwest, he noted, are not strangers: "They’ve been competing with each other for years. The devil youEWR-CoUnitedSlots know is better than the devil you don’t."

Henry Harteveldt, who worked at Continental in marketing and planning in the late 1980s and is now vice president and principal analyst for airline and travel research at Forrester Research, said, "The two have done deals before."

Both carriers are based in Texas, he pointed out, "where backdoor deal-making is an art form."

Others say the government’s actions will force the airlines to look more to mergers than to slot exchanges to enhance the efficiency of their networks.

"Maybe this suggests that the better path for US Airways is to get bought (as they’ve been saying for some time anyway)," the Cranky Flier wrote. "Then it won’t need to get an FAA waiver to give its LaGuardia slots to another airline. It’ll be that other airline, so the FAA won’t get to ruin the party."

Helane Becker, an analyst with the Dahlman Rose investment firm, is among the industry observers who believe the Continental-Southwest slot deal gives Delta and US Airways ammunition in their court appeal.

That might not necessarily be the case, others contended.

"Every transaction is different," said Kevin Mitchell, chairman of the Business Travel Coalition.

Continental executives and Justice Department officials said the merger proposal’s slot divestiture plan is a much different animal than the swap proposed by Delta and US Airways.

In fact, declared one senior DOJ official, the two deals are "apples and oranges."

In reviewing mergers, the official said, the department focuses on specific competitive criteria in determining if the proposed combination would be in the public’s interest.

"The proposed merger would combine the airlines’ largely complementary networks, which would result in overlap on a limited number of routes where United and Continental offer competing nonstop service," the Justice Department asserted in a statement. "The largest such routes are between United’s hub airports and Continental’s hub at Newark Airport, where Continental has a high share of service and where there is limited availability of slots, making entry by other airlines particularly difficult."

The transfer of slots and other assets at Newark to Southwest, "a low-cost carrier that currently has only limited service in the New York metropolitan area and no Newark service, resolves the department’s principal competition concerns and will likely significantly benefit consumers on overlap routes as well as on many other routes," the statement said.

The slot permanently conveys to Southwest all of Continental’s rights in the assets, Justice noted.

The senior DOJ official also pointed out that while the Southwest deal was not achieved by auction, Continental and United negotiated with several airlines before reaching an agreement with Southwest.

Continental confirmed it had negotiated with other competitors.

Still, many question just how much competition is being saved with the slot deal. The 36 slots are the same number now operated by United, and the DOJ official agreed that the deal trades United’s service for Southwest’s.

But, the official said, that would still be a plus for passengers because of Southwest's low-cost model.

Besides, as the Cranky Flier noted, "The feds do seem to love Southwest these days."

JamesOBERSTARRep. James Oberstar (D-Minn.), the chairman of the House Transportation Committee, said the Justice review was too narrow, and he termed the department’s decision "regrettable."

"While I am disappointed with the ruling, I understand that the [Justice] Department believed it had little choice," Oberstar said.

The DOJ, he said, "concluded that it had to base its decision on a very narrow set of criteria to determine whether the merger would violate existing federal antitrust laws. When Continental announced a deal to transfer slots and other assets at Newark to Southwest, the potential antitrust violation was removed, and Justice believed that it had no grounds on which to object to the merger."

This case, Oberstar said, demonstrates why the DOT should have more say over merger approvals.

Despite the concerns of Oberstar and others, there is still a general industry feeling that any deal that gets Southwest into Newark is a good one and is a small price to pay for Continental and United to get their merger approved.

"This is good for competition," Mitchell said, "and good for consumers of all stripes."

This report appeared in the Sept. 6 issue of Travel Weekly.

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