3 Things You May Not Know about the US Airways-American Airlines Merger Lawsuit

On Tuesday, August 13, the Department of Justice, six states, and the District of Columbia filed suit to block the planned $11 billion merger of US Airways and American Airlines. This surprise government attack on the merger follows three successful approved major airline industry mergers during the past five years: Delta-Northwest (closed in 2009), United-Continental (closed in 2010), and Southwest-AirTran (closed in 2011).

The government seems to view the American-US Airways merger differently, as the often bizarre complaint against it indicates. While a number of commentators have weighed in raising good points, here are three DOJ claims that deserve attention:

1. US Airways’ “Exceptional” Profitability: The Department of Justice et al. claim “US Airways is performing exceptionally well. In 2012, it enjoyed record profits.” (p. 8) This is an interesting take on the actual financial data. While second quarter 2012 operating margins were indeed record-setting at 10.3 percent, US Airways’ 2012 annual operating margin was just 5.3 percent. While this was greater than the top-10 carrier average of 3.7 percent, recently merged legacy carrier Delta reported an annual operating margin of 7.3 percent, with JetBlue, SkyWest, and Alaska all reporting annual margins exceeding 7 percent. US Airways was right in the middle of the Big 10.

   Further undermining the Justice Department’s “exceptional” profits claim is this multi-year chart which shows US Airways’ pre-tax profit margins from 2008-2012 (based on US Air’s income statements):

   US Air’s oh-so-“exceptional” recent performance.

   It should be clear to everyone US Airways hardly has an “exceptional” history with profits. Cherry-picking data does not tell the full story. Low single-digit margins — pitiful compared to most other industries — are considered healthy for airlines, but many are routinely in the red. The DOJ’s characterization of US Airways’ “exceptional” performance is the business analogue of making sure everyone gets a token trophy.

2. We Should Simultaneously Trust and Distrust Airline Executives: The DOJ relies heavily on American and US Air executives’ public claims to matter-of-factly determine that a standalone American will be able to thrive and compete globally (p. 9). One thought that apparently never crossed the DOJ attorneys’ minds is that American executives would never tell their shareholders they will be condemned to financial purgatory without a merger and that US Airways executives would never tell their shareholders they are going to purchase a debt-laden collector of aircraft fossils (a fair way to describe American’s $8.2 billion negative shareholder equity and continued heavy reliance on McDonnell Douglas MD-80s).

   Such ignorance and gullibility might be excusable (these are government lawyers, after all) if the DOJ didn’t also spill a good amount of ink calling into question the reliability of executives’ claims, such as here: “By making claims about benefits that are at odds with their prior statements on the likely effects of this merger, that is precisely what the merging parties’ executives are doing here—saying what they believe needs to be said to pass antitrust scrutiny.” (p. 7) The DOJ is talking out of both sides of its mouth, telling us to completely trust the veracity of airline executives’ statements one moment and saying they’re lying bastards in the next.

3. DOJ’s Hatred of “Capacity Discipline” Ignores Consumer Benefits: In discussing the 2005 merger of AmericaWest and US Airways, the complaint portrays the deal as bad for consumers (pp. 23-24). Many commentators have focused on reduced competition leading to increased fares on specific routes rather than effects across the network and the travelers who use it. Such a myopic view is wholly inappropriate, assuming the goal of competition policy is to ultimately improve consumer welfare. A May 2013 study of the 2005 merger published by the Centre for European Economic Research (Zentrum für Europäische Wirtschaftsforschung), one of the world’s leading economic research institutes, concluded:
   

   With respect to the overall consumer welfare effects of the merger, our estimation results on the surface suggest that the merger might have been anticompetitive as it led to substantial price increases in two route categories and to price decreases in only one category. However, taking the number of passengers traveling in the respective categories into account revealed that only about 10 percent of the overall number of passengers in the two year period following the merger travelled in markets which experienced a price increase post-merger. For the majority of passengers, however, the merger either led to substantial price reductions (47 percent) or had no significant effect on average prices (43 percent).

   The DOJ’s analysis here is similarly colored by sloppy assumptions based on undergrad textbook understandings of competition policy and industrial organization. When airlines are able to take advantage of economies of scale, scope, and density to develop more robust networks, consumers generally win. This is a large part why the 15 mergers and acquisitions over the past 15 years have occurred while inflation-adjusted average fares fell by approximately 15 percent (15-15-15).

   Saying that any amount of reduced capacity when an airline is rationalizing its operations is inherently bad has the approximate intellectual depth of Big is Bad, which many regulators honestly and incorrectly believe. Ultimately, the impact on consumers is an empirical question — meaning this cannot be answered a priori by government lawyers, most of whom lack the knowledge to conduct any sort of meaningful economic analysis in the first place.

Beyond these three, a number of other issues bear repeating. American filed for Chapter 11 bankruptcy protection in 2011. Heavily indebted, its plan to emerge from bankruptcy rested largely on the merger going through and offering the weary giant some much-needed liquidity. On Thursday, August 15, instead of the scheduled bankruptcy hearing being the effective end to American’s reorganization, the judge asked parties to submit briefs detailing the effect of the DOJ’s lawsuit on the reorganization plan.

In addition, organized labor is strongly in favor of the merger. This is because unions recognize that two less-competitive air carriers are more likely to furlough workers, cut benefits, and possibly fail and face liquidation than a new American Airlines that is able to effectively compete with global network carriers Delta and United. Critical allies of President Obama and the Democratic Party, the administration risks the wrath of the labor movement if they fail to approve the merger.

The inclusion of the state attorneys general is interesting, especially when you consider their party affiliations (four Republicans, two Democrats) and political ambitions. Texas Attorney General Greg Abbott is running for governor next year while Ken Cuccinelli in Virginia is locked in a bitter gubernatorial race with former Democratic National Committee head Terry McAuliffe. Cuccinelli is supported by Tea Party activists and many regard him as a friend of free markets and limited government. However, politics often leads to unprincipled horse-trading. Virginia’s current Republican governor, Bob McDonnell, made similar big government and anti-market concessions to pass an awful transportation package — earning the ire of fiscal conservatives and effectively ending his near-term political career.

Cuccinelli most likely has a parochial interest in trying to prevent a combined American Airlines from holding 69 percent of the takeoff and landing slots at Reagan National Airport in D.C.’s northern Virginia suburbs. However, the complaints about reduced competitiveness from the anti-market legal class were not shared by 106 members of the House of Representatives (53 Democrats and 53 Republicans), who in June wrote a letter to the Departments of Justice and Transportation urging the agencies not to force American and US Airways to divest slots. Their objection was twofold: first, members enjoy convenient flights offered from Reagan National to smaller hometown airports that would likely be unprofitable for airlines with smaller market shares; and second, having an airline pull out of a market in their congressional district would likely enrage their constituents.

But worst of all is Cuccinelli’s pandering to the Obama administration. Did he ever consider the possibility that the reason DOJ sought support from mostly Republican attorneys general is because the administration was attempting to preemptively defuse the narrative that blocking this merger is typical of President Obama’s opposition to free markets? While the president happily derails another positive, voluntary transaction (remember when the DOJ killed the $39 billion merger between AT&T and T-Mobile?), he can lean back and say, “Even the Tea Party attorney general in Virginia agrees with me.” Once again, we see that politicians are far more comfortable with free market rhetoric than actually promoting free markets.

It is too early to tell what will ultimately come of the proposed American Airlines and US Airways merger. The companies have vowed to vigorously fight the DOJ. But antitrust battles are incredibly expensive and both airlines may simply be unable to effectively take on an army of Washington bureaucrats.