Airlines typically hedge fuel costs in futures markets, just in case rising crude prices threaten to take a massive bite out of profitability. No matter how much hedging the airlines do though, substantially increased prices of crude make for tough business conditions over the long haul, which is exactly the case right now. Airlines are facing a tough business environment with elevated fuel costs and as of now, something's got to give. The solution could come in the form of mergers.
Just One Big Jumbo Jet
The New York Times recently reported Delta Airlines (NYSE:DAL) executives, "plan to ask the carrier's directors on Friday for permission to engage in merger discussions with United Airlines (NYSE:UAUA) and Northwest Airlines (NYSE:NWA), a step that could push the industry's much-talked-about need to consolidate closer to reality" ("Delta Executives Consider Merger Talks", January 11, 2008).
In the current business environment, we could be on the eve of one of the largest airline rollups ever seen. The basic principal is this - even with the initial cost and headache of consolidating airlines, technology and employees, a larger conglomerate airline could close several hubs, operate more efficiently and eventually save millions, even billions, of dollars when the dust settles.
And while this strategy is great on paper, bigger isn't always better. One issue with a massive consolidation would become the implementation of change, should it become necessary. And, the larger the corporate entity, the more they usually become increasing sluggish.
While many airlines are currently finding buying support on the merger news, there might be another paradigm lurking, which Wall Street seems yet to consider - private equity.
How To Make Decisions Fast
Over Christmas, I was able to spend time with an incredible business mind, John Gunning, the owner of Manassas Dodge in Virginia. Gunning has been on the National Dealer Council Board representing the Dodge Dealers for roughly 10 years, serving as Chairman for one year, and has been party to many major business discussions within the industry throughout the 1990s. In our conversation, Gunning and I talked about the recent move of Chrysler Group to private equity, and how it has affected business.
Gunning talked about the speed at which the new business entity is now able to make cost-related decisions, and how the ability to do so has created a much more efficient decision. Specifically, Gunning cited a recent call in which the company discussed cutting vehicle production in North America. In the old days, when Chrysler Group was public, the decision could have taken several weeks, involved numerous studies and many meetings. In one six-minute call though, with only a handful of people, the decision was made to cut production.
At the end of the day, the company was able to make a major decision in a matter of minutes, something often unheard of in the world of large, public corporations. With this in mind, private equity may actually be the answer to many of the airlines' woes. Indeed, sometimes smaller is better, since smaller, private entities are able to dynamically make cost-cutting decisions, and implement new strategies in a fraction of the time of typical corporate lethargy. (To read more about investing in airlines, check out Is That Airline Ready For Lift-Off?)
The Bottom Line
At present, there isn't much talk of private equity entering airlines, but I wouldn't be surprised if we begin to see some talk of various privatized buyouts. The U.S. government will certainly play a significant key in any consolidation within the industry, but for now, this story is far from over. In the coming weeks, expect the story around all airlines to significantly heat up.