MIAMI — Earlier today, the US Department of Justice (DOJ), along with six state attorney generals and the District of Columbia filed an antitrust suit challenging the proposed merger between US Airways Group Inc. and American Airlines parent AMR Corp.

The lawsuit to block the merger was filed in the US District Court for the District of Columbia, and was filed by the DOJ’s Antitrust Division in conjunction with the attorneys general of Texas (home of AMR’s headquarters), Arizona (home of US Airways’ headquarters), Florida, the District of Columbia, Pennsylvania, Tennessee, and Virginia.

The lawsuit marks the first time the Department of Justice has sued to stop an airline merger since the proposed merger between US Airways and United was blocked in 2000. Earlier this decade, the DOJ approved large mergers between America West and US Airways, between Northwest Airlines and Delta Air Lines, between United Airlines and Continental Airlines, and between AirTran Airways and Southwest Airlines.

In the case of the United-Continental merger, the merger was approved after the merged airline agreed to divest 18 slot pairs at slot controlled Newark Liberty International Airport to rival Southwest Airlines.

In its press release announcing the suit, the DOJ states its belief “that the merger, which would result in the creation of the world’s largest airline, would substantially lessen competition for commercial air travel in local markets throughout the United States and result in passengers paying higher airfares and receiving less service.” Beginning in late July, US Airways and American held meetings with the DOJ where they offered antitrust concessions to the DOJ in an effort to win approval for the merger.

The merger already won European Union antitrust approval after the carrier agreed to lease out a pair of slots used on Philadelphia-London Heathrow services – a route where the new American Airlines would hold a monopoly in conjunction with joint venture partner British Airways. However, the new American’s proposed concessions clearly did not match the DOJ’s expectations, leading the DOJ to file suit.

Much of the concern from the DOJ (and from its federal government counterpart the Government Accountability Office [GAO]) surrounds the combined carrier’s slot holdings at Washington’s Reagan National Airport, where the new American would hold a 69% share of take-off and landing slots, a 49% market share, and a monopoly on 63% of the nonstop routes from the airport.

Current US Airways and future American Airlines CEO Doug Parker appeared to accept the need for some slot divestitures at Reagan at US Airways Annual General Meeting (AGM) in Phoenix in mid-July, however he warned that small cities would be the first cities to lose service in that scenario. He further questioned whether US Airways should even have to divest slots at all, saying:

There is no such standard in antitrust law that says airlines can’t have that size of departures from any given airport.

It is Airchive’s view that the primary driver behind the lawsuit is in fact the Washington Reagan operation, the potential post-merger scale in the market, and the threat to reduce service to small cities by Doug Parker. We feel that the DOJ wishes in part to use this lawsuit as a bargaining chip to win deeper concessions from US Airways and American before the merger is approved, rather than use it to block the merger outright. However, the merger could still be blocked (as the DOJ has done before), though it would be surprising given the precedent set in the past decade.

Airchive feels that American and US Airways could reach a deal with the DOJ that allows them to continue on with the merger, only with a divestiture of a significant proportion of the new slots added at Reagan (keep in mind that United was forced to divest its entire slot holdings at Newark to win approval to merge with Continental) as well as a specific and enforceable commitment to maintain service to small cities from Reagan. Other considerations, including slot divestitures at other slot controlled airports, and/or traffic rights to restricted destinations such as Brazil could be part of a concession deal as well.

However, the DOJ has taken a very angry and firm tone, not only in its press release and filing, but also in a conference call it held earlier today. Assistant Attorney General Bill Baer stated during the call, “We [the DOJ] simply cannot approve a merger that would result in U.S. consumers paying higher fares, higher fees and receiving less service.” He adds, “The lawsuit we filed today to block this deal gives consumers the best possible chance for continued competition in an important industry that they have come to rely upon.”

Airchive feels that the there is significant risk that the merger may fall apart – given that the DOJ did not first file to block any of the other “mega-mergers” it approved earlier this decade. However, it is possible that the DOJ is just trying to buy itself more time to review the merger as on August 15th, a hearing is set for US bankruptcy judge Sean Lane to confirm or deny American’s re-organization plan (including the bankruptcy). Still, it is our view that the merger is now at risk. Correspondingly, shares of both AMR and US Airways are down heavily in today’s trading.

We think the DOJ is wrong to sue to block the merger between US Airways and American. While there is some concern over rising fares and decreasing competition due to the merger, these concerns existed for every other merger that the DOJ approved earlier this century, including US Airways – America West, Delta-Northwest, United-Continental, and especially AirTran-Southwest.

Where was the DOT when all of these mergers went through, capacity was cut, and fares went up? There was a time for the “sky-is-falling” argument with regards to airline mergers, but that time was in 2010, before United-Continental was approved. Now that the DOT has set the precedent that such mergers will be approved with slot concessions at slot restricted airports, it can hardly just back away from the deal.

Moreover, much of the rationale behind the lawsuit is based on spurious analysis and weak understanding of the airline industry. To select just a few of the offending quotes from the conference call:

“They will pay more for less service because the remaining three legacy carriers – United, Delta and the new American – will have very little incentive to compete on price.”

This is somewhat true but not entirely – they will have less incentive to compete on price, but in today’s day and age, when purchase decisions for leisure travelers (the majority of US air travel) are made first on the basis of price, airlines will still have no choice but to compete on price. However, the level at which that price rests will go up some, moderated by the pricing behavior of ULCCs like Frontier and Spirit.

“This Indeed, as our complaint shows, the management of US Airways, which will run the new airline, sees consolidation as a vehicle to reduce competition between the airlines and raise fees and fares.”

This is a view held by most of the industry, not just Doug Parker.

“If the merger goes forward, consumers can also expect to pay higher fees for things like checked bags, flight changes, more legroom and frequent flyer benefits.”

Ancillary fees will increase in coming years irrespective of whether this merger goes through – that’s just the evolutionary track that the industry is on today. Un-bundling of airline products is now the norm in the US airline industry.

“US Airways charges an average of $40.  If the merger is allowed, US Airways is planning to take this frequent flyer benefit away and make American’s frequent flyers pay redemption fees.  By eliminating this competitive distinction between American and US Airways, the new airline generates an additional $120 million in revenue.  But you pay the price.”

Given the evolution of many frequent flyer programs towards revenue based status models, it was only a matter of time before American started charging for redemptions as well. Moreover, that estimate in additional fees is overstated because US Airways (and likely post-merger American) frequent flyer program members with elite status don’t have to pay the fee. Such redemptions are a significant proportion of the overall number of redemptions.

“Consumers will also pay more on routes where US Airways and American today offer competing nonstop service.  We know from prior mergers that elimination of head-to-head competition on nonstop routes results in substantial price increases for consumers.

Expect similar fare increases if this merger is allowed.  For example, US Airways and American offer competing nonstop service between Charlotte, North Carolina and Dallas-Ft. Worth.  Consumers will likely pay more than $3 million more per year for travel on that route alone.”

This is true and that route is a reasonable example. However, the number of such routes affected by American-US Airways is less than that of the other three recent mergers. Heck, Southwest-AirTran overlapped at each carrier’s second largest hub (Baltimore-Washington) and even that didn’t preclude DOJ approval.

“You don’t need to go far from this very city to see another worrisome effect from the proposed merger.  Across the Potomac River, the merged airline would dominate Washington Reagan National Airport, by controlling 69 percent of the take-off and landing slots at DCA.

And, it would have a monopoly on 63 percent of the nonstop routes out of Reagan National.

By allowing one airline to control that many slots, the merger will prevent other airlines, including low-fare carriers like JetBlue and Southwest from competing at Reagan National.

It would face little or NO competition.

Indeed, this would get worse.  Recently JetBlue started service from Reagan National to Boston, competing with US Airways, and fares dropped by more than 30 percent saving consumers about $50 million a year.

Similarly, consumers saved about $14 million in lower fares between Tampa and Reagan National after JetBlue started competing against US Airways.  But – and this is important – half of JetBlue’s slots at Reagan National are leased from American.  If this deal is allowed, new American can terminate that lease and JetBlue’s ability to compete will be severely diminished.  Consumers will pay the price.

Blocking the merger will preserve current competition and service at Reagan National airport, including flights that US Airways currently offers to large and small communities around the country.”

The DOJ sure is devoting a lot of space to Reagan here in the conference call. This is where the DOJ’s argument is strongest, at least with regards to increased fares. That being said, here is a counterpoint. How much will the loss of nonstop access to small cities from Reagan if there are slot concessions adversely affect consumers?

Moreover, the DOT continues to rely on outdated categorization of JetBlue and Southwest as LCCs. Both carriers are now hybrid network carriers with lower costs than the legacies; the true LCCs are ULCCs like Allegiant, Spirit, and Frontier. It is somewhat ironic that the same issue that tanked the United-US Airways tie up in 2000 (Washington Reagan), threatens to derail another merger 13 years later.

“Just this January, American’s management presented plans that would increase the destinations and frequency of its flights in the U.S., allowing it to compete independently and vigorously with plans to grow.”

However, critically, American has stated that even in its standalone plan, it expects capacity growth to remain low or even flat. What matters in terms of fares is not destinations nor frequencies but capacity – increased capacity leads to decreased fares and vice versa.

Turning to the press release, there are a couple of more cases of poor analysis and bad understanding of airline business fundamentals.

“The department also said that the merger will make coordination easier among the legacy carriers.   Although low-cost carriers such as Southwest and JetBlue offer consumers many benefits, they fly to fewer locations and are unlikely to be able to constrain the coordinated behavior among those carriers.”

Perhaps not. But when combined with ULCCs Allegiant, Spirit, and Frontier, plus potential new entrants and niche players like Vision Air, other carriers can do a reasonable job of containment.

“The department said the merger will allow US Airways’ management to abandon these aggressive growth plans and continue the industry’s current trend toward higher prices and less service.”

US Airways doesn’t have “aggressive” growth plans moving forward, or really any growth plans at all on an overall capacity basis. In each of the past 4-5 quarters, US Airways has been pretty consistent in giving forward capacity guidance of low growth or flat growth in capacity.

“American and US Airways compete directly on more than a thousand routes where one or both offer connecting service, representing tens of billions of dollars in annual revenues.”

The DOJ here appears to be referencing a GAO study on the competitive effects of the merger. That study, as I pointed out in an analysis, is highly flawed. Most importantly, its study of the effects of the merger on competition relies on the bait and switch tactic of analyzing airport pairs instead of city pairs (read the analysis for a more thorough explanation), which overstates the competitive impacts and loss of competition.

Sum Up:

The merger is certainly not a panacea for consumers by any means. Fares will likely go up to some degree, and capacity will fall as US Airways’ costs rise to match those of American, thereby rendering parts of US Airways’ current network unsustainable for the new American. But that being said, the merger can hardly be blocked outright given the precedent that has been set.

It all comes back to that quote from Baer on the conference call; “We [the DOJ] simply cannot approve a merger that would result in U.S. consumers paying higher fares, higher fees and receiving less service.” Where was that language five years ago during Delta-Northwest, three years ago during United-Continental, or two-years ago during AirTran-Southwest?

That being said, the analysis and rationale behind the DOJ’s lawsuit is heavily flawed; filled more with bluster than with hard facts and analysis. Looking forward, American and US Airways have vowed to fight the lawsuit vigorously.

American Airlines CEO Tom Horton said in a letter to employees this morning that the lawsuit “will likely take a few months” to move through the courts. “Since the DOJ has formed a contrary view [to the merger], the matter will now be settled by the courts,” Horton said in the same letter. “In the meantime, American and US Airways will continue to operate as independent companies and competitors. All recent leadership announcements for the new merged American will be on hold until such time as the merger receives final clearance.”

At the very least, this lawsuit delays plans to close the merger by the end of the third quarter. The upcoming bankruptcy hearing on the 15th of August will make for interesting watching. Given the DOJ’s actions, it remains to be seen whether Mr. Lane will stay on script, or modify his decision based on the DOJ’s actions.

Philosophically, the tone of the DOJ lawsuit treats profits in the airline industry almost like a taboo, or a dirty word. All of the changes in fares/fees are couched only as “costs” to the consumer, not simultaneously as financial benefits to the company, its employees, and its shareholders. Moreover, the analysis fails to account for the positive economic impact of having a third competitor with a truly global and nationwide network and reach. American and US Airways will be able to finally offer a product that truly competes with the networks of Delta and United thanks to the merger – in this case the merger actually expands competition for a significant subset of travelers.

Still, it remains to be seen what will happen in the coming weeks. Either way, a merger that had just yesterday appeared to be a foregone conclusion is now very much in doubt.

Read Tom Horton’s letter to American employees below as well as a letter from US Airways CEO Doug Parker

Letter from Tom Horton

 Dear American Team,

Today we learned the Antitrust Division of the U.S. Department of Justice (DOJ) will opposeour pending merger with US Airways. I wanted to quickly let you know the implications of this decision and to explain what’s next.

As you probably know, this merger in the context of a restructuring, has been a very complex undertaking. It has formed the basis for an unusually successful restructuring, with very positive outcomes for our people, our customers, our owners and the communities we serve. But, it was also subject to a number of approvals including US Airways shareholders, AMR creditors, the Court, and the United States and European Union regulatory authorities. The US Airways and AMR financial stakeholders have voted overwhelmingly in support of the merger and the EU approved the merger. We always expected U.S. regulatory approval to be the final hurdle to clear.

We and our counterparts at US Airways have been working with the DOJ staff for months to ensure that they had an informed view of the merger. We have maintained that the merger is complementary (only 12 overlapping routes), that it provides significant customer benefits and that it enhances competition in the airline industry.

Since the DOJ has formed a contrary view, the matter will now be settled by the courts. The DOJ has filed a lawsuit in federal district court to enjoin the proposed merger. We and US Airways will vigorously defend our position. While we do not yet know how long the court process will run, it will likely take a few months.

In the meantime, American and US Airways will continue to operate as independent companies and competitors. All recent leadership announcements for the new merged American will be on hold until such time as the merger receives final clearance.

Throughout this restructuring, the people of American have stayed focused on caring for our customers day in and day out. And the results speak for themselves. American is again strong, profitable and competitive as evidenced by our record-setting second quarter results. As we work through the court process to clear our merger, let’s keep building the momentum of the new American.

Thanks for all you do.

Letter from Doug Parker

Dear friend,

As US Airways continues to pursue a potential merger, I want to keep you updated as developments occur.

The DOJ has unfortunately just announced that it intends to try and block our proposed merger with American Airlines. I am extremely
disappointed in this action and believe the DOJ is wrong in its assessment and we will fight them. I remain confident that by combining American and US Airways we are enhancing competition, providing better service to our customers and improving the industry as a whole.

We are mounting a vigorous and strong defense against the DOJ’s case in order to bring our airlines and talented team members together as the new American Airlines.

I am certain that our proposed merger is the best path forward for both airlines, all of our stakeholders and the communities that each airline serves. In fact, the unions at both carriers support a merger of American Airlines and US Airways because they know that they will
benefit from working for a stronger, more competitive airline that is better positioned to grow and thrive in today’s industry.

The new American will be a premier global carrier that is positioned to meet our customers’ needs better than any other airline, while also
competing more effectively and profitably in the global marketplace.

In light of today’s announcement, the companies no longer expect the merger to close during the third quarter of 2013. However, we are
hopeful that the litigation will be successfully concluded and we will close the merger before year end.

I appreciate your support and will keep you posted on any developments, but in the meantime, it is business as usual at US Airways. Please
contact our Washington, D.C. representatives should you have any questions about this matter.


Doug Parker

Chairman and CEO

US Airways