(By Tim - iStockAnalyst Writer) The merger of Northwest Airlines [NWA] into Delta Airlines [DAL] has raised the question whether this is a good move for investors in the new Delta. The merger will create the largest airline in the world in terms of traffic. These are legacy airlines that have struggled to generate profits in the face of increasing fuel costs and competition from low cost carriers. During the 1970's and 1980's Delta was considered by many to be the best U.S. airline for service and as an employer. Northwest made its reputation with long haul flights to Asia and providing service to the northern tier of the U.S. from its hubs in Detroit and Minneapolis. My perspective is from my days as a U.S. Air Force pilot during the 1980's and many of my compatriots who left the service to go fly for these airlines. Recent gatherings of old friends are filled with tales of pay and pension cuts and dissatisfaction with working conditions.
The terms of the deal gave NWA shareholders 1.25 shares of Delta stock for each of their NWA shares. The new Delta is trading at about $10 a share, giving the company a market cap of just over $3 billion. It is hard to believe that the world's largest airline has only a $3 billion market cap. Recent results give the reason for the low valuation of Delta. In the first 3 quarters of 2008 NWA managed to have net earnings of minus $18.41 per share. Delta in its first 9 months came in with minus $17.51 per share. In fairness, both companies took goodwill write offs in the 1st quarter that were about 70% of these shocking numbers, but both were still bleeding cash on an operational basis. The recent cause of losses has been record fuel prices. Now that fuel prices are falling the fear is that an economic recession will reduce the amount of air travel.
The merger itself has some serious challenges. One has an all union workforce, one does not. They have incompatible computer systems. They only fly one aircraft model in common. The only real benefit of the merger (besides the opportunity to sink together rather than separately!) is a route structure that is very complimentary and gives the company a truly global reach. Management has reported the two airlines will continue to act separately for now and a fully integrated airline will not emerge for two years.
This is not a merger of a strong company with a weak one, but two struggling companies hoping the merger will allow them to grow strong as a single unit. I have always found U.S. airline stocks to be tough investments. The high fixed costs plus an unnatural willingness to drop prices in mass to gain market share has left an industry that has paper thin margins when everything works as planned. And how often does that happen? I see the new Delta as a carrier with so much baggage to carry that success may be a long time in the future. Delta's near term progress will be entertaining to watch but I would not be an investor until there is evidence that the single is more profitable than the pair.
