Friday, April 18, 2008


One of the questions I have been asked a few times is why did CAL, NWA and DAL not do much after the merger announcement of the merger of DAL-NWA?

I have responded to individuals with a list of ideas, including that short term buyers "bought the rumor and sold the news". Of course, the other problem has been that the price of fuel soared on the same day and has not slowed down since.

As I have pointed out time and again, the price of airplane fuel is more of a perceived problem than a real problem. We must always remember that the higher the price of fuel, the greater the relative advantage of the bus, train and airplane. A fully loaded bus and a fully loaded plan each use substantially less gas per person than the same number of people driving individual cars. The price of fuel has now risen to such levels that it cost more fuel for two people to ride in the typical car than it does for them to fly on a plane.

Many of us have a very negative attitude about bus transportation. A major reason has been because our government has tried to force buses upon us. As a result, there are a huge number of buses riding around mostly empty. This does not say that buses are inefficient but that government is. With the significant increase in the price of fuel that has occurred over the past 5 years, bus ridership has become relatively much more attractive. Again, the relative cost, including the inconvenience of mass transportation, has fallen relative to the cost of private transportation. High fuel prices are not the reason to sell airline stocks.

I have not read the S&P report yet. I am confident that the reason to lighten up, includes the mistaken reason of higher fuel costs (in the short run this is certainly a problem for those who focus on short term earnings potential). I am also confident that another reason is because of the potential that CAL will feel compelled to pay too much for a merger partner and then have to deal with the integration hassles for the next two or three years.

CAL management has written the employees to say that the game has changed. The company feels compelled to bulk up to the approximate size of the new DAL. The most obvious candidate for purchase is UAUA but if the price is not right, there are other alternatives. CAL could even agree to sell out to AMR.

CAL has 2.5 Billion in unrestricted cash and it projects to have 2.9 Billion in unrestricted cash by the end of this quarter. This cash gives CAL the flexibility to make a lot of deals and it makes CAL an attractive target for other firms. Another firm could offer a 100% premium and get back more than half its investment immediately from this cash hoard.

Yes, the high price of fuel, with the resulting increase in ticket prices, will result in lower domestic demand because the number who decide to fly instead of to drive is not going to exceed the total number who simply decide to stay home (if the economy is as weak as is commonly believed). However, CAL, DAL, AMR and other managements have already planned to adjust. This year, CAL will reduce its domestic capacity by about 5% while continuing to increase its international capacity. The reduction of domestic capacity will make ticket price increases all the more likely to stick. The point continues to be that airlines are no longer willing to fly loss leaders. Airlines will always occasionally fly a few seats at prices only slightly above variable costs but they will adjust to insure that the average ticket is a profitable sale no matter what the price of fuel.