Flying Among the Merger Clouds

By George Russell

For Frank Lorenzo, chairman of Houston-based Texas Air, triumph was savored in poker-faced silence. For Donald Burr, Lorenzo's onetime protege and chairman of ailing, once revolutionary People Express, it was time to put the best possible face on defeat. The two fierce rivals and captains of cheap U.S. air travel sat at opposite ends of a table last week in Manhattan's St. Regis- Sheraton hotel to announce what many had expected: the long, tortuous People Express saga had ended with the airline's tentative sale to rapidly expanding Texas Air. The price: a bargain $125 million. At the same time, Texas Air will buy People's grounded subsidiary, Frontier Airlines, for $176 million. The complex deals, which come in the wake of several other big airline mergers, could mark a turning point for the low-fare carriers and indeed for the entire industry. The swift consolidation in the skies also raises the prospect of reduced choices and higher prices for consumers.

Within days, the intense Lorenzo celebrated a second coup. The U.S. Department of Transportation announced that it would give tentative approval to Texas Air's $600 million purchase of Eastern Air Lines, an agreement first struck last February. Piled atop the planned acquisition of People Express and Frontier, the Eastern deal confirms that Texas Air is about to become the country's No. 1 passenger airline, with 20.1% of the domestic market, passing former leader United (15.7%).

By its rapid maneuvers, Texas Air has emerged as the high flyer in the country's fierce merger wars. On Oct. 1 Northwest Airlines formally merges its flight schedule with Republic's, creating what will be the fifth largest U.S. airline, with 9.4% of the market. Trans World Airlines, which gained DOT % approval early this month for its $250 million purchase of Ozark Air, will soon be the sixth-place carrier (8.1%). Two weeks ago Delta Air Lines announced a bid to take over the fourth-place spot (11.9%) in the passenger race with an $860 million play for Western. Warns Lee Howard, an economist with the Washington consulting firm Airline Economics: "We see a tight oligopoly emerging in the airline industry, with perhaps a half-dozen major carriers controlling 90% of U.S. travel."

Oligopoly of sorts may already exist. If the latest buyouts take place as planned, eight airlines will control more than 87% of the U.S. passenger market (see chart). The rush of new entries into the passenger business that began with airline deregulation in 1978 has long since peaked: from a high of 123 certified passenger carriers in 1984, the field has now shrunk to 96. Enthusiasm for new airline ventures among financial backers has dropped dramatically. Says Geoff Crowley, a senior vice president of Presidential Airways, a year-old low-fare carrier based in Washington: "We wouldn't be able to get started now. Wall Street is casting too questioning an eye on new airlines." David Hinson, chairman of Chicago-based Midway Airlines, cites another barrier. Says he: "All the infrastructure, like airport gates, has been consumed by the big boys."

As the majors expand their operations, the number of alternative carriers in many cities is shrinking. As a result of the Northwest-Republic merger, some 80% of all commercial passenger service in Minneapolis-St. Paul will now belong to a single carrier. In Detroit, that figure is 60%. After the Ozark- TWA deal, St. Louis will be dominated by a single carrier, while in Denver, United and Texas Air's subsidiary Continental will divide a market formerly shared with Frontier. In Pittsburgh, nearly 80% of flights are USAir's; in Charlotte, N.C., roughly the same proportion belong to Piedmont.

Where large airlines have not taken over regional carriers outright, they have often entered into more subtle arrangements aimed at funneling as much local traffic as possible into major hubs. United, for example, has an agreement with Air Wisconsin that incorporates the regional airline's passengers in United's more sophisticated, computerized booking system for travel agents. Delta has similar links with Atlantic Southeast Airlines, American with American Eagle. Says an airline lobbyist in Washington: "For the regionals, it's an advantage to be linked to the computer codes of the majors." As a result, large carriers have an increasing say in the pricing and marketing plans of regional carriers.

The big question, though, is how much airline consolidation will affect the cheap fares originally unleashed by People Express after the no-frills discounter's 1981 launch. Many of those bargains were still available last week. Budget passengers could fly from Los Angeles to San Francisco for as little as $39, or from New York to Los Angeles for $99. Boston to Houston could still be bought for $119, and Chicago to Miami for $89. Says Matthew Scocozza, Assistant Secretary of Transportation for Policy and International Affairs: "You can find flights for $39 to $169 in just about any market."

But there are already small traces of change in the jet stream. At last week's St. Regis press conference announcing the People Express buyout, Chairman Burr declared bravely that "we intend to continue to bring our form of headstrong, headlong competition to the fat cats, the big guys out there." Then Burr announced fare increases of up to 9.5% for his gasping airline. Texas Air's current flagship airline, Continental, recently shuffled its low- price fare structure for flights out of Denver, reducing more than 20 price options to a mere half a dozen. John Huggins, head of Boston-based Woodside Management, one of the country's largest corporate travel agencies, predicts that other major airlines will begin to hike their rates within the next four to six months, at least for business customers.

The fact is that past fare wars have been one of the chief causes of the recent Darwinian merger wave. Says Economist Alfred Kahn of Cornell University, who is widely viewed as the father of airline deregulation: "Instability is the price we pay for competition." Indeed, some 150 airlines have filed for bankruptcy or ceased operation since 1978, as the industry has lurched from occasional feast to occasional famine. The low point for deregulated airlines came in 1982, when the industry suffered an $800 million operating loss. The best unregulated year was 1984, when industry-wide profits hit $2.3 billion. But last year airline earnings dipped 39%, to $1.4 billion, meaning that on average, carriers had profit margins of only 2%. The first half of 1986 has once again been a bloodbath, with losses of $765 million. Says Kahn: "Some diminution of intense price cutting is probably necessary and healthy." Agrees Dan Smith, an executive with the Dallas-based International Airline Passengers Association: "Even consumers realize that airlines have to make a buck."

Many of the conditions that fostered the rise of the discount carriers no longer prevail. Right after deregulation, the major airlines were at a serious disadvantage: during the time they were protected by the Government from competition, they had become high-cost, unionized operations. In the previous 40 years, the old Civil Aeronautics Board had received 79 applications from companies that wanted to become long-distance, interstate airlines; not one was approved. When competition was opened up in 1978, the fleet of new carriers generally employed relatively cheap nonunion labor and used smaller crews on their aircraft than established airlines did. Some upstarts, like People Express, championed pared-to-the-bone competition, in which low ticket prices took the place of almost all amenities.

But the bigger airlines slowly fought back. United, American, Piedmont and others have set up two-tier hiring, with lower pay scales for new employees. On some planes, the three-person flight crews of yore have been reduced to two. Established airlines have been able to offer frequent-flyer programs and the convenience of powerful computerized reservation systems to woo back customers. The counterrevolution has to a large extent worked. Says George James, president of Washington's Airline Economics: "There is far less motivation for going into the industry now that the big companies can compete well."

Even so, consolidation does not make it inevitable that the benefits of deregulation will disappear. Says Harvard Economist John Meyer, an expert on airline deregulation: "This may not mean the end of low fares, just the end of $99 transcontinental fares." The Department of Transportation's Scocozza argues that "as long as there is head-to-head competition in the marketplace, we should not be concerned." For every airline merger, Scocozza adds, "I see a smaller carrier taking its place." Houston-based TranStar, for example, is now offering a $79 fare between Miami and Los Angeles. As far as overall customer choices are concerned, Al Becker, a spokesman for American Airlines, argues that today "most people can get to more places more frequently than at any time in the past."

The best guarantee that competition will persist, though, is that across the whole industry, too many airline seats are chasing too few passengers. John Pincavage, an analyst with the Paine Webber brokerage, notes that while fratricidal giveaways among the airlines may soon subside, "you'll now see fares that are properly related to the amount of unused capacity." Says he: "Unless we have a strong economy and increased passenger loads, we're going to see some fierce price competition."

All of that added up to a considerable challenge for the reigning airline merger king, Frank Lorenzo, as he surveyed his prospective Texas Air empire. He undoubtedly took personal satisfaction in his newly expanded holdings, particularly in his triumph over People Express Chairman Burr. Burr was once Lorenzo's subordinate at Texas Air's predecessor company, Texas International Airlines. The two men were virtually inseparable until Burr founded People Express; Lorenzo was said to be deeply embittered by that, believing strongly that the notion of a no-frills discount airline was originally his. Last week, as Burr insisted that the sale of People Express would allow it to "carry on," Lorenzo merely stated that Burr's baby would be folded into one of Texas Air's subsidiaries.

As he swallows People Express, though, Lorenzo must worry about indigestion. Before the deal is finally consummated, it must be approved by the Department of Transportation. Eventually, some such favorable ruling is considered probable. In the meantime, Lorenzo is pressing People Express bondholders to accept a 33% cut in interest payments on their debt as well as leaning on bank lenders to renegotiate an October deadline for the repayment of $32 million in People Express obligations.

Even then, Texas Air would be saddled with some $3.2 billion in additional debt from the People Express, Frontier and Eastern acquisitions. Those dollops of red ink will bring Texas Air's debt total to $4.5 billion. Can Lorenzo, for all his financial acumen, handle that load? Or is the merged airline itself a possible future casualty of the skies? "Texas Air is very strong," Lorenzo asserts. "We have $600 million in cash and no near-term obligations." Texas Air Spokesman Bruce Hicks is a bit more cautious. The company's best chance for survival in the tough climate of airline consolidation, he says, is to be "as profitable as possible." Exactly how that will eventually translate into the company's fare schedule is still anybody's guess.

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With reporting by Patricia Delaney/Washington and Thomas McCarroll/ New York