What The Airlines' Merger Defense Means for You: Part 2

What The Airlines' Merger Defense Means for You: Part 2

In August, the Department of Justice made a surprising move to file a lawsuit to block the proposed merger between US Airways and American Airlines parent company AMR . The airlines have promised to vigorously defend their merger and filed a response to the DOJ's complaint last week. This is the second part of a series examining the DOJ complaint and the airlines' response, and what it means for investors and consumers.

A numbers game
The craft of using numbers to one's advantage is key in business, and it is not lost on the DOJ or the airlines. Both documents cite various figures to illustrate their points, but one set of numbers looked particularly interesting.

First, let's examine the DOJ's perspective on the airline industry if the US Airways/AMR merger is allowed to go forward. The Department says in its complaint:

In 2005, there were nine major airlines. If this merger were approved, there would be only four. The three remaining legacy airlines and Southwest would account for over 80% of the domestic scheduled passenger service market, with the new American becoming the biggest airline in the world.

So four airlines would control a whopping 80% of the market. This sounds like a lot, but the airlines manage to provide a figure that shows they will have far less market control.

In the US Airways/AMR response, the airlines say:

Other low-cost carriers, including JetBlue, Spirit Airlines, Virgin America, Sun Country, and Allegiant, are expanding at dramatic rates. These carriers, together with Southwest and regional competitors Alaska Airlines and Hawaiian Airlines, now transport over 40% of all domestic passengers, and that share continues to grow.

US Airways and AMR make it appear that the market share of legacy carriers is less than 60%. How can the market share of the major carriers be both less than 60%, and more than 80%? Both sides are technically right, having picked statistics that favor their own argument. Let's look further into it.

Selective data
The phrases "now transport over 40% of all domestic passengers" and "would account for over 80% of the domestic scheduled passenger market" sound so similar, it would be tough for many people to distinguish between the two.

The airline argument's statistic, based around the percentage of domestic passengers, is measured by how many passengers each carrier has as a percentage of the total number of passengers using airlines. (So, 1 out of 4 passengers means 25% of all passengers.)

The DOJ's statistic centers around a different measure of airline market share. The Department uses the percentage of available seat miles (ASMs) to generate its "over 80%" figure.

Available seat miles is calculated by taking the number of seats per plane, and multiplying it by the number of miles those seats are flown. (It does not matter whether the seat is filled.) This may sound like a more difficult calculation than percentage of total passengers, but ASMs is a fairly standard industry calculation. In fact, it's the top measurement in the airline business listed on American Airlines' website.

I would agree that ASMs is a better measure of market share, since it is the standard for capacity and the most frequently cited figure when airlines talk to their investors. Before you think that I'm just picking on US Airways and AMR, however, the DOJ gave itself a bit of leeway with its figures as well.

The other big airline
You may have noticed that US Airways and AMR exclude Southwest Airlines from the category of large airlines, while the DOJ combines Southwest with the legacy carriers to get its figure. According to the Bureau of Transportation Statistics, Southwest had a market share of 15.2% for the period of June 2012 to May 2013, based on domestic revenue passenger miles -- a measurement similar to ASMs, but only counting paying passengers. Clearly, the inclusion or exclusion of Southwest can have a major impact.

Although Southwest could now be considered a major airline, its operating style is decidedly different than that of the legacy carriers. The legacy carriers operate on a hub-and-spoke system, while Southwest offers point-to-point flights. Southwest acts as a discount airline and has free checked bags, while legacy carriers are full-service and charge for every extra they can. Southwest also operates many of its flights from less-popular airports to save on airport fees.

Through a different airline business model, Southwest has built one of the most stable airlines ever, as it approaches four decades of straight profitability. As a result, the merger's effects on Southwest are likely to be less than the effect on the legacy carriers.

Because of the sharp contrast between the legacy carriers and Southwest in both pricing and operations, I believe that the inclusion of Southwest with the other legacy carriers greatly overstates the power the legacy carriers would have post-merger.

Coming in for a landing
Both sides of this lawsuit have picked out numbers that favor their side -- which is only natural. After all, both sides want to win. I see available seat miles (ASMs) as the most appropriate measurement of airline market share, since it's the figure executives take before their investors. But I also would exclude Southwest from the category of legacy-style airlines.

By removing Southwest from the ASMs calculation, we get roughly 65% of the market share controlled by the legacy airlines post-merger. In other words, the truth is about halfway between the figures provided by the airlines, and those from the Department of Justice.

In the next part of this series, we'll look at the fare price disputes and route control arguments given by the DOJ and the airlines. We'll see why they matter to each side, and what they could mean for a merged airline.

If you're curious...
Much of the information used in this article comes form the legal documents filed by US Airways/AMR and the DOJ. For investors who want to do further research on this topic, here are links to those documents.

Department of Justice complaint

US Airways/AMR response

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The article What The Airlines' Merger Defense Means for You: Part 2 originally appeared on Fool.com.

Alexander MacLennan owns shares of Air Canada, AMR, Delta Air Lines, and Gol Linhas. He is also long the following options: $22 January 2015 Delta calls, $25 January 2015 Delta calls, $30 January 2015 Delta calls, $17 January 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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