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United, Continental now eye partnership

United Airlines and Continental Airlines each signaled interest in industry consolidation Tuesday, with the two increasingly seen as a potential pair.
/ Source: The Associated Press

United Airlines and Continental Airlines each signaled interest in industry consolidation Tuesday, with the two increasingly seen as a potential pair that would leapfrog the newly proposed Delta-Northwest team as the world's largest carrier.

While the two airlines were publicly mum about their preferences for a partner, it was clear the Delta-Northwest agreement had broken the logjam on industry consolidation and breathed new urgency into talks between United and Continental on how they could combine. Other tie-ups also are possible.

Wall Street analysts and other airline experts see another attempted pairing of large U.S. airlines as almost inevitable but indicated the industry's future under two mega-carriers would remain volatile amid record fuel prices and economic weakness.

"It's a dangerous time to be making mergers when you're heavily dependent on exogenous variables over which you have no control," said John Pincavage, a Westport, Conn.-based financial adviser to airlines. "Make the wrong moves and you could be building a bigger Titanic."

Marrying UAL Corp.'s United to Continental Airlines Inc. would create a company with a combined $35 billion in revenues and nearly 100,000 employees. Between them they would have eight U.S. hubs and an impressive domestic and worldwide network.

But Wall Street was skeptical about such a pairing. United shares fell $1.29, or 5.5 percent, to close Tuesday at $22.32, while Continental's declined $1.53, or 7 percent, to $20.36.

Letting their two big competitors combine without a challenge would bump them down to the third- and fifth-largest U.S. airlines, respectively, and pose a threat to their business on numerous domestic and international routes. AMR Corp.'s American Airlines, currently No. 1, also would slip but appears to have fewer consolidation options, according to industry experts.

"Certainly this puts a lot of pressure on them," Darryl Jenkins, a Virginia-based consultant to numerous airlines, said of United and Continental. "This airline (Delta-Northwest) is big enough that it's going to take away accounts from smaller airlines."

Teaming up would enable them to top the size and scope of a combined Delta Air Lines Inc. and Northwest Airlines Corp., with its $32 billion in revenue and 87,000 employees.

In a statement to employees, Continental's CEO Larry Kellner and President Jeff Smisek said the Houston-based airline's preference has been to remain independent, "as long as the competitive landscape remained the same." However, the executives noted, "the landscape is changing."

"We will review our strategic alternatives and make sure we remain a strong long-term competitor," they said.

United CEO Glenn Tilton reportedly approached Continental at least as far back as 2006 but was rebuffed. More recently, the two sides have held exploratory talks and their pilots' unions also have been involved.

The airlines agreed tentatively earlier this year that Kellner would run a combined Continental-United as chief executive and Tilton would be chairman, according to a person familiar with the negotiations who asked not to be named because of not being authorized to talk publicly. Other details remain to be worked out.

Tilton issued his own statement to employees Tuesday in which he called consolidation "one of the changes necessary" for the industry to achieve sustained profitability.

"As the industry evolves, we will take the actions we need to strengthen our global competitiveness, and we will participate in consolidation when and if it is the right choice and provides the right benefits for employees, customers and shareholders," he said. The airline declined to comment on specifics.

Gaining approval from the two airlines' unions won't be easy _ especially at Chicago-based United, where employees are angry over what they see as excessive pay for senior managers following their own heavy cuts while the airline was in bankruptcy, from which it emerged in 2006.

"Mr. Tilton can no longer hide behind the robes of a bankruptcy judge to get what he wants from labor," the leaders of United's unions coalition said in a statement.

Michael Roach, an airline consultant in the San Francisco area, said United-Continental is not only the next logical step in the big domestic carriers' game of musical chairs but "about all that's left" because of added challenges that American and US Airways would face in efforts to consolidate.

"They fit together fine from a route structure point of view," he said. "If merger is the flavor of the month, why not?"

American and United are seen as unable to join forces because federal regulators wouldn't approve such a dominant combination of the Nos. 1 and 2.

American could still make a bid for Northwest, according to Ray Neidl of Calyon Securities, because it has no other way to stop a domino effect that would leave it the nation's No. 3 airline.

Standard & Poor's analyst Philip Baggaley said there's a slight chance that Continental could combine with American but that would pose more antitrust hurdles because they have more overlapping routes than Continental and United.

No prospective combination's prospects were helped by crude oil prices rising more than $2 Tuesday to $113.79. Efforts to strengthen bottom lines by consolidating and cutting back could be torpedoed if that level doesn't drop.

"No matter how much capacity is taken out, unless oil prices come down or stabilize at least it's going to continue to be difficult for the airlines financially," said Matthew Jacob, an airline analyst at New York-based Majestic Research.