UAL, USAir in very advanced merger talks

CHICAGO - Moving quickly after being left at the altar by Continental Airlines, United Airlines stepped up talks with US Airways and was moving toward an agreement Monday on joining forces to create what could be the world’s largest carrier.

UAL Corp.-owned United and US Airways Group Inc. were in advanced talks and expected to be able to announce a deal within weeks, two people familiar with the negotiations told The Associated Press.

Representatives of both airlines declined to comment on what they called rumors about a deal, which drove up US Airway’s stock more than 20 percent and sent UAL’s down slightly.

A combined United-US Airways would jockey with the newly proposed Delta-Northwest for bragging rights as No. 1, dropping AMR Corp.’s American Airlines from first to third if both deals are approved.

Based on 2007 passenger traffic, United-US Airways would have a slight edge with 201.6 billion revenue passenger miles to 200.4 billion for Delta-Northwest. But the competition is too close to call in light of recent capacity cuts.

While a deal is not assured, the pairing became likelier after Continental stunned United on Sunday by ruling out any combination as an option following in-depth talks that had been expected to result in one by week’s end.

The two people familiar with the talks asked not to be named because of the sensitive nature of the discussions. The timing of any agreement remains hard to predict, and either side also could pursue an alliance or simply walk away, as Continental did.

United Chief Executive Glenn Tilton, long an outspoken advocate of the need to consolidate, said in a recording for employees that “the dynamics in the U.S. airline industry continue to change” with Continental’s announcement. “We continue to evaluate our options and will do what is right for United,” he said, not mentioning US Airways.

Chicago-based United and Tempe, Ariz.-based US Airways Group Inc. have been in preliminary talks for weeks. As the second- and seventh-largest U.S. airlines by traffic, both are under more competitive pressure to consolidate in the wake of the April 14 announcement of a proposed mega-carrier teaming Delta Air Lines Inc. with Northwest Airlines Corp.

Combined, the two have about 91,000 employees, 800-plus airplanes and annual revenues of $31.8 billion.

Other details of their talks were not immediately known, including what the name or headquarters location of the enlarged carrier would be. As a significantly larger airline, United typically would prevail in those decisions.

The airlines first agreed to team up eight years ago, but United called off the planned $4.3 billion acquisition in July 2001 after the Justice Department said it would sue to block it.

In contrast to a tie-up with Continental, whose route system was seen as highly complementary to United’s, US Airways offers some significant challenges as a partner and does not have the Atlantic routes United would like.

But analysts say there is enough overlap in their routes that United-US Airways should be easily able to cut capacity and get pricing power out of a deal. The combination also is seen as having a much stronger chance to be approved by federal regulators under the more corporation-friendly Bush administration than under a new president.

United’s hopes of pairing with Continental may have been dashed by the $537 million first-quarter loss it reported last Tuesday, which raised questions about its financial health. The concerns touched off a 35 percent drop in its stock which left Continental with a bigger market cap than United and changed the dynamics of a deal, according to insiders.

Frank Werner, an associate professor of finance at Fordham University who specializes in the airline industry, thinks United is “getting desperate” amid tough operating conditions after seeing other consolidation options vanish.

“They have a deteriorating balance sheet and fractious labor relations, and consolidation is under way” without them, he said. “United is looking for scale to bail them out of a very difficult situation, and I don’t think it’s going to work.”

Defending the company’s financial situations, Tilton told employees the results from the past year provide a solid foundation and reiterated confidence in United’s future. “We have generated significant free cash flow and have $2.9 billion in unrestricted cash,” he said. “We have a strong balance sheet and $3 billion in unencumbered assets that give us access to capital.”

Since US Airways dropped its hostile bid for Delta last year, that carrier has been mostly left out of merger speculation. Some industry observers have considered it a poor match for any other airline because of its weak international flight network.

US Airways’ reputation as a possible partner also was damaged because of its trouble with fully integrating operations almost three years after it combined with America West Airlines.

Frustrations among pilots over a joint contract have spilled over in recent months. Pilots have been fighting over who would get more seniority, and earlier this month a faction of East Coast pilots successfully ousted their union of 59 years and replaced it with another group.

Many of United’s approximately 7,000 pilots are particularly resistant to any deal with US Airways because of the labor issues. They also remain angry about concessions made during the company’s 2002-06 bankruptcy restructuring, coupled with Tilton’s total compensation of $41 million over the past two years.

“United has a financial sieve that leads directly into senior management’s pockets,” pilots’ union chief Steve Wallach said in a statement. “The time has come to plug these holes and invest this money into the future of this airline.”

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