Merger generates giant air network

Jeff Smisek says that the airline sector is in a much stronger position than three years ago. Photo / Bloomberg

United Continental's airline network map looks like an atlas attacked by a crayon-wielding 2-year-old.

With 371 destinations and 5811 daily departures, United can lay claim to being the world's biggest airline.

Jeff Smisek is chief executive of United Continental Holdings - the holding company for United Airlines and Continental Airlines which in October agreed to merge.

"We've built this giant network and we can go now to corporations and we can pretty much offer any destination in the world on United alone and if we don't take you there then Star Alliance carriers will take you there," Smisek says.

"And if between United and Star Alliance we don't take you there," he says, leaning forward and speaking in a tone of mock concern: "You shouldn't go there."

The two airlines will operate as separate companies until the Federal Aviation Administration approves a single operating certificate allowing them to operate as a single carrier, which is expected by the end of 2011.

"Of course we provide tremendous opportunities for leisure customers as well but we're principally focused on building a network for the business customer."

The merger was expected to generate US$1-1.2 billion a year ($1.3-$1.5 billion) with US$800-$900 million of additional revenue and US$200-$300 million of cost savings.

The airlines had been looking at a merger in 2008 but had decided against it because the timing was terrible with the start of recession, fuel prices rocketing, capital markets cratering, both airlines losing money and issues with liquidity, Smisek says.

Continental and United in 2009 lost US$282 million and US$651 million respectively as revenue plummeted by 17.4 per cent and 19.1 per cent.

"Now fast forward to April and May of 2010. All the underlying reasons for marriage were still there and the timing was great because instead of having headwinds we had tail winds coming out of recession, capital markets coming back, more liquidity, both carriers making money, all the things you would want."

The airline environment is improving and business travel is coming back slowly, Smisek says.

"If you look at it by geography Asia is doing extremely well, the trans-atlantic market is doing surprisingly well given all the things you read about ... the Latin-American market is doing well and the US domestic market is recovering."

The International Air Transport Association (IATA) last month raised its industry net profit outlook for 2010 to US$15.1 billion, up from the previously forecast US$8.9 billion.

The net profit forecast for 2011 was also raised from US$5.3 billion to US$9.1 billion but IATA warned that the industry was fragile and sitting on a knife edge.

IATA director-general and chief executive Giovanni Bisignani says any shock could stunt the recovery.

United's Smisek says governments are reacting appropriately to the recession and as a result there is a nascent recovery, certainly from a US perspective.

"I don't see any signs at all of a decrease in demand ... what we're seeing is a steady increase, how long that occurs I don't know."

Fuel prices have risen by about 15 per cent since the start of the year and although Smisek is not happy with the direction the price has not swung wildly.

"What hurts us as an industry and hurts us at United is when you have extremely volatility in oil price because you can't chase the price up ... and so you end up suffering huge losses with highly volatile fuel prices."

The industry has an interest in improving the environment by reducing the fuel burn, including the use of modern aircraft, technology and investigation of biofuels.

Biofuels are currently not economically viable, Smisek says.

"They have to be produced in volumes sufficient that we can use them and they have to be at a price that makes rational economic sense," he says.

"That may be the future for the airline business but it isn't the future in my time running United because that's more a 20 and 30 and 40 year [horizon].

"What we need is investments in not only the technology in enhanced efficient engines and airframes ... but also our government to invest in the air traffic control system."

The US system needed updating.

"We have the very finest 1950s ground-based radar technology and we need to modernise it."

The US needed more "required navigational performance" type technology, which provided a GPS assisted precise approach to a runway and had estimated savings of up to 10 per cent of the fuel burn of airlines in the US, he says.

"Not only is it safer, it is also more efficient and you can actually bring more aircraft into any given amount of airspace and you can save considerable amounts of fuel."

Smisek was among about 24 airline chief executives from the Star Alliance network in Queenstown last month for the organisation's annual meeting.

Bernard Gustin, chief executive of Brussels Airlines, says the environment in Europe is getting better.

"We had the little bad luck of the volcano in Europe which didn't help but the year is much better than in 2009," Gustin says.

"However, it remains challenging because it still is very fragmented, you have very heavy competition, sometimes a little bit unfair when you look at the subsidies that some carriers can receive ... it's legal but it's unfair," he says.

"Now we need to see what's going to happen in 2011, I'm personally quite cautious and we still need to see how economy recovers."

Gustin wants to avoid an industry rollercoaster of recovery and collapse.

"If economy continues to recover I think it will be an OK year but I hope we are not in a W [business pattern] kind of scenario rather than a V-scenario where you go back up," he said.

Air New Zealand chief executive Rob Fyfe says history suggests that when economies start to recover airlines get over enthusiastic and throw too much capacity into the market, creating another bubble that bursts.

"We'd all like to hope that wasn't going to be the case but history tends to be a pretty good predictor of future behaviour so we'll wait and see," Fyfe says.

Fyfe says airline alliances are becoming increasingly important and merger activity is accelerating.

"I expect we'll see more and more of these mergers to compete with the very large, emerging dominant carriers ... so scale is important in this industry, you either achieve it through alliances or you achieve it through mergers and takeovers."

Mergers did not really suit Air New Zealand, which has individual competitors and potential partners on each route but no other carrier sitting naturally on top of its network.

"More quite lateral alliances will be key for the growth and expansion of our network for sure."

The Australian Competition and Consumer Commission this month approved for three years an alliance between Air New Zealand and Virgin Blue, which Fyfe in May said had $20 million to $30 million of benefit a year to NZX-listed airline, mostly from increased revenue from carrying more passengers.

The industry is in quite good shape, Fyfe says.

"The industry seems to be recovering faster than what a number of economies are. Forecasts for 2011 seem quite positive and certainly that's what we're seeing."

During recent months four new airlines had announced plans to come to New Zealand.

"That shows the level of expansion that's now starting to re-emerge in the industry and the confidence that's starting to emerge in the industry."