AMR, US Airways, and the Government Go to Counseling


Editors Note: This article previously incorrectly stated the London Philadelphia route was still up in the air for AMR & US Airways. This route has actually already been given up as part of a settlement with the EU. The incorrect section section has since been removed. The Motley Fool apologizes for and regrets this error.

AMR and US Airways are still waiting to merge. Photo credit: AMR.

Ever since the U.S. Department of Justice sued AMR and US Airways to prevent their planned merger, the two sides have dug in, vigorously defending their viewpoints.

Assistant U.S. Attorney General Bill Baer told reporters that nothing short of a full injunction against the merger could protect consumers. Meanwhile, AMR and US Airways have been working tirelessly to line up support for the merger among congressmen, state and local officials, chambers of commerce, and even their own employees.

Now, the two sides will go to "counseling." On Monday afternoon, AMR, US Airways, and the federal government stated in a court filing that they have agreed to work with a mediator to try to settle the case. The two sides are scheduled to go to trial in just four weeks, but this development significantly increases the likelihood that they will reach a settlement before then.

Risky business
While lawyers for both sides have each projected an air of confidence, going to trial would be a risky move for both sides. The DOJ has made a strong case that consolidation has been a contributing factor in recent fare increases, and that another merger would make it even easier for airlines to tacitly coordinate on pricing.

On the other hand, the pre-2008 airline landscape -- which featured frequent price wars -- was not healthy or sustainable. AMR and US Airways also have a solid case, as they can argue that the improved financial health of U.S. airlines is a good thing. Moreover, while consolidation may be leading to higher ticket prices, consumers still might be better off with three strong network carriers, rather than two strong ones and two weaker ones.

With both sides having reasonable arguments, it makes sense to settle the case if possible, rather than risk an all-or-nothing verdict. Indeed, AMR and US Airways executives have stated from day one that they would be open to a settlement. However, Monday's news was the first sign of progress in that direction.

What needs to happen
Much of the DOJ's complaint dealt with competition on one-stop connecting routes. Given the scale that a merged American and US Airways would have, it is inevitable that there will be hundreds of routes that lose a one-stop competitor in a merger. As a result, the DOJ will need to drop that complaint as part of a settlement.

The main issue that will need to be resolved in a settlement is market share in congested airports. Washington's Reagan National is the one airport where the combined carrier will definitely need to shrink in order to win DOJ approval. US Airways already holds a 55% share of the slots there, enough for more than 200 daily departures, while AMR holds a fair number of slots, too -- enough to support roughly 50 daily departures.

Since Reagan Airport is slot-controlled, other carriers cannot add flights there without buying or leasing slots, which rarely become available. The top two low-cost carriers in the country -- Southwest Airlines and JetBlue Airways -- have both expressed a keen interest in expanding there.

On Southwest's earnings call last week, CEO Gary Kelly stated that he expects the AMR-US Airways merger to eventually be approved, but only with slot divestitures. He noted that AMR and US Airways might have to give up slots at New York's LaGuardia Airport (where they have a much lower combined market share) as well as at Reagan Airport. Kelly said that Southwest was very interested in expanding at both airports.

JetBlue CEO Dave Barger has also been adamant that US Airways and AMR should have to give up slots at Reagan Airport if they merge. In fact, Barger has argued that no carrier should be allowed to have more than the 55% of slots that US Airways already holds. In other words, he wants the two carriers to give up all of American's current slots. JetBlue is also excited about the possibility of expanding at Reagan National Airport. In fact, back in 2011, the company paid $40 million for eight slot pairs there .

Let's make a deal
The decision by AMR, US Airways, and the DOJ to work with a mediator significantly increases the chances that they will settle the antitrust lawsuit. As is typically the case in litigation, a settlement makes sense for both sides, as it allows each side to get something it wants while avoiding the risk of an all-or-nothing verdict.

The exact parameters of a settlement are unclear, but the centerpiece will undoubtedly be a divestiture of slots at Reagan Airport. I expect that AMR and US Airways will ultimately agree to give up 20-30 slot pairs, or roughly half of AMR's current slot portfolio. These are small concessions to smooth the path of a merger that could deliver big long-term benefits to AMR and US Airways.

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