Delta exec: Oil price spike won't derail NWA merger

The rapid rise in oil prices may have discouraged other airlines from proposing mergers, but Delta Air Lines President Ed Bastian said his carrier's merger deal with Northwest Airlines has been successfully "pressure tested" with oil prices at more than $135 a barrel.

Long before oil hit that price last week, Bastian said Delta's executives and board members looked at merger models that assumed oil at $135 a barrel and higher.

"We affirmed to ourselves back then, before oil did reach these levels, that [a merger] still made sense," Bastian told the Star Tribune.

But Bastian acknowledged that the heavier fuel-cost burdens that Delta and Northwest are facing has prompted their executive teams to try to speed up the financial benefits of the merger.

When the deal was unveiled in mid-April, oil was around $110 a barrel.

The two airlines' executives had estimated that it would take three years to fully capture about $1 billion in merger synergies -- cost savings and revenue growth.

Now, Bastian said, merger teams have been asked "to come in with a shorter time frame towards achievement of the synergies and a higher number." Ultimately, he expects the merger benefits to be "substantially north of $1 billion."

In the seven weeks since Delta proposed an acquisition of Northwest, no other big mergers have been unveiled and Continental Airlines shocked a number of industry insiders by walking away from a potential pairing with United Airlines.

Even as United and US Airways weighed their merger options Thursday, Fitch Ratings downgraded its debt ratings on those two carriers and raised the specter of liquidity problems for most U.S. carriers as staggering jet-fuel bills erode their cash balances.

Northwest CEO Doug Steenland warned employees a week ago that some experts are predicting oil will reach $140 to $150 a barrel this year, and he stressed that the airline industry has returned to "survival-of-the-fittest mode."

In April, Northwest indicated that its domestic capacity would fall by 12.6 percent in the fall. But that's likely not the end to the cutting of flights. In his message to workers, Steenland said "we will have to look at further capacity cuts beyond what we've already announced" if oil prices remain at high levels.

Bastian, who also serves as Delta's chief financial officer, said that Northwest and Delta are both intent on "preserving liquidity," so they are each aggressively managing their costs before any merger takes place.

Bastian said he previously estimated that at the end of the year the two carriers would have about $7 billion in combined liquidity -- roughly $6 billion in cash and access to a $1 billion Delta credit revolver. In light of higher oil prices, Bastian said he expects that figure will be "a bit less," but added that it won't alter "the overall economic analysis for doing the deal."

While the Department of Justice scrutinizes the merger deal, airline fares are expected to keep climbing, the industry's capacity is projected to shrink and some airlines may fail.

Bastian said Delta and Northwest would like to close their merger by year's end.

Delta already had said it would cut domestic seat capacity by 10 percent after the summer travel season. Now Bastian said more cuts are coming. However, he said, "It will not be nearly as large as the first round that we announced earlier this year."

3,000 take Delta buyout offer

This spring, Delta offered voluntary buyout packages to its employees with the intent of trimming its workforce by 2,000 people.

Bastian said more than 3,000 people volunteered to take severance packages, and management will accept those offers and reduce the workforce at a higher rate than it anticipated just a few months ago.

While the price of fuel is the driver behind fare increases and job and flight-capacity cuts, Delta and Northwest executives say it won't destroy their fundamental rationale for wanting to do a merger.

"We plan to maintain all of our hubs," said Tammy Lee, Northwest's vice president of corporate communications. "The cost of fuel will determine whether further capacity and personnel reductions are required, not the merger."

But the upfront costs of doing a merger are a key concern of some industry analysts, including Philip Baggaley of Standard and Poor's. Baggaley has noted that combining computer systems, jetliner fleets and other merger-related expenses will be costly.

It all depends on timing

"Depending on the timing of the up-to-$1 billion one-time investment for merger integration, and the timing of the ramp-up of merger benefits, cash outlays could exceed benefits in the first year of the merger," Baggaley wrote in a research report.

But Bastian said he anticipates those costs will be considerably less than $1 billion. He also noted that several financial benefits are possible in year one of the merger, including the combination of administrative staffs and greater purchasing power with vendors.

In 2007, Delta had $19.2 billion in operating revenue, while Northwest's operations generated $12.5 billion. With their combined $7 billion in liquidity, executives at the two carriers argue that they will survive the industry shakeout and do so without a return trip to bankruptcy court. Both carriers filed for Chapter 11 protection in 2005 and greatly reduced their costs.

Despite the unprecedented rise in oil prices, Delta executives recently said they will give their nonunion workers a 3 percent pay raise on July 1.

Bastian said the employees have been running a good airline. But there's one big reason why he said Delta can afford to pay more -- it will save about $1 billion this year because of a fuel hedging program.

Liz Fedor • 612-673-7709