United Airlines Still Struggling With Merger, But Promising Signs Ahead

| About: United Continental (UAL)
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The future of United Airlines (NYSE:UAL) continues to ride on how soon it successfully manages the giant merger that made it the largest airline in North America, when it reschedules with Continental Airlines in 2010.

Clearly, UAL has not managed to integrate the two airline companies as fast as it hoped and expected. UAL's CEO, Jeffery A. Smisek, admitted as much after one of three costly computer failures in November 2012, meant delays for more than 250 UAL flights worldwide.

Apparently, one of the key elements of any airline's success or failure, its IT systems, is very hard to merge with another airline's. Different technologies in IT systems and different ways of doing things bedevil a smooth transition to a seamless and glitch-free IT system that will deliver as expected. Already in March, and again in August of 2012, UAL reservation system failures meant delays, stranded passengers and canceled flights. Both the mergers of Delta Airlines (DAL) and US Airways (LCC) suffered from similar teething problems in their booking systems at the beginning of their own mergers.

The costs of these mishaps, in short-run monetary terms and more importantly in long-run reputation terms, have been great. It is costly for UAL to reschedule flights for stranded passengers on other airlines. But the cost to UAL of being deemed a less than dependable carrier could be much greater. Especially for reschedules that have a greater propensity to change airlines to meet their business needs, delays and cancellations greatly increase the chances that they would switch to another carrier.

Operationally, UAL has been performing poorly, with a 28% rate of flights not reaching their destinations on time in Q3 of 2012. This has meant that UAL is considerably below the airline industry's average in timely flight arrivals, and it topped all the rest of the airlines combined, but not in a good way, when it logged more customer complaints than its competitors.

The idea behind mergers is to gain from the potential synergies of fusing two different companies into one. But while, in theory, there may be gains to such a fusion there are also all sorts of costs, so in the end mergers come down to whether or not the benefits outweigh the costs. In the case of UAL, so far, the costs have outweighed the benefits. While the more important costs are to its reputation as a dependable airline, there are also significant monetary costs. UAL had to shell out some $60 million in the third quarter for merger-related expenses including the painting of planes.

Then there is the problem of melding different cultures and dealing with new unions, or perhaps more accurately, bigger unions as they also merge in the new company. This has already cost UAL, with a provisional agreement with the pilots' union reached in Q3 2012 costing it $454 million, but it still is a challenge to reach deals with the rest of the unions, such as flight attendants and mechanics, because in a new company new contracts need to be signed that encompass both sets of employees formerly belonging to the two airlines that merged.

UAL's financial performance has been less than stellar after the merger. Q3 2012 has seen essentially zero net income and before that it reported losses on two of the previous four quarters. Its operating income hasn't been much better, with losses in Q1 2012 of $271 million and profits of $200 million in the most recent quarter.

Against these setbacks and continuing costs, monetary and otherwise, of UAL's merger, must be set the advantages of it. Most important of these is its size overall, having become the largest airline in North America. What that translates into is a huge network encompassing a dominant position in the continental U.S.'s North East via Newark's Liberty International Airport, a similar advantage from its Houston hub with regards to Latin America, and likewise with Asia from its San Francisco staging point. All in all, UAL reschedules 5,600 flights a day when its commuter partners are included, as well as secondary hubs such as Denver, Washington D.C. and Cleveland.

UAL has also taken the opportunity to upgrade its fleet significantly. It has ordered no less than 270 new planes, among them 50 Boeing 787s and 25 Airbus A350s. The Boeing 787 is Boeing's newest plane, appropriately christened the Dreamliner. According to those flying it in the most recent MegaDo, an event for flying fanatics sponsored by UAL, it has more space, better air quality, larger storage bins and even a better toilet than its competitors. The Airbus 350 deal was done before the merger and it was for the smaller A350-900 version. After the merger UAL is negotiating buying the A350-1000, the larger wide-bodied version, as a replacement for its older Boeing 747s to add to AUL's more than 700 odd plane fleet. Such a deal could apparently lead to buying Airbus' huge A-380 double-decker given the size and requirements of UAL's network.

Although UAL's stock price has dropped somewhat to around $22 on the basis of its latest woes from mid-year quotes of around $25, there hasn't been that much variability over the last year, having traded around a band between $17 and $25. It would seem the jury is still out about whether UAL's merger will pan out. But if recent airline mergers are anything to go by, UAL's prospects should be good. The two most recent precedents, Delta Airlines and US Airways mergers, are significant. They both suffered from similar problems after their own mergers but have now significantly increased their revenue and profits on the basis of much improved performance. Time is running out for UAL, but if it can emulate their performance soon the upside for its stock price should be considerable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This was article was prepared for Freedonia Freelance by one of our analysts.