Delta shares closed off 12.6% Tuesday and lost another 5% at midday Wednesday, while Northwest was off 8.4% and 6%. The selloff caught some industry watchers by surprise, given the sentiment on Wall Street that airline consolidation is necessary for a stable industry. But the drop is unlikely to do much to dissuade companies, including United Airlines parent UAL Corp., a long-time advocate of dealmaking that has reportedly had recent discussions with rivals including Continental Airlines Inc. and US Airways Group Inc.
Indeed, the stock reaction seems to have more to do with the specifics contained within Delta's announcement than it does overall feelings about airline mergers. J.P. Morgan Chase & Co. analyst Jamie Baker in a report said "investors aggressively voiced their disappointment for a deal thought to underdeliver on synergies and capacity cuts." Specifically, Delta's proposed $1 billion in planned synergies is biased toward revenue enhancements, a product of the combined airline's plan not to close any domestic hub operations. By comparison an analysis done last fall by activist hedge fund Pardus Capital Management LP estimated a Delta-Northwest combination would generate $1.5 billion in synergies "resulting primarily from network rationalization in combining the smallest hubs" of Cincinnati and Memphis, the fund said in a letter to Delta management.
Wall Street seems to recognize that revenue synergies tend to be far less of a guarantee than cost cuts. Baker notes that "one airline's revenue synergy is another airline's lost share," to be competed away over time and subject to fickle consumer tastes. Should United merge with Continental, that combination could be well-positioned to retain some of the flyers the new Delta hopes to take and could even steal some of its own.
The good news for investors is that the new Delta is almost certainly underpromising on cost cuts, and for good reason. Its proposal to create the world's largest airline is in for a long summer of congressional hearings, regulatory scrutiny and labor bargaining. There is little reason for the company at this point to announce broad schedule reductions or job cuts sure to fire up opposition to the merger.
Longer-term fuel prices and other fundamentals will determine the amount of flying a merged Delta will do out of Memphis and Cincinnati as well as its other hubs, and the airline is likely to cut unprofitable routes. Still, the stock declines surely are not what Delta CEO Richard Anderson had hoped for as he prepped for a deal announcement. - Lou Whiteman
See TheDeal.com story on Delta's planned acquisition of Northwest
See Dealscape post on Wall Street reaction to the deal
Airline managers considering their options in the wake of Delta Air Lines Inc.'s $3.6 billion acquisition of Northwest Airlines Corp. are sure to take note of the pounding that shares of both companies have taken in the days since the deal was announced.
