September 3, 2010 - In April Continental and United Airlines negotiated a merger and on May 3, 2010, United and Continental announced an agreement to merge the two airlines. The new airline would retain the United name and headquarters in Chicago while the current Continental Chief Executive Officer, Jeff Smisek would keep that title with the new airline.

The merger would be financed exclusively through an all-stock transaction with a combined equity value of $8 billion split roughly with 55 percent ownership to United shareholders and 45 percent to Continental shareholders.

One of the primary financial benefits that airlines consider when merging with another airline is the cost reduction that may result from combining complementary assets, eliminating duplicative activities, and reducing capacity. A merger or acquisition could enable the combined airline to reduce or eliminate duplicative operating costs, such as duplicative service, labor, and operations costs—including inefficient (or redundant) hubs or routes—or to achieve operational efficiencies by integrating computer systems and similar airline fleets.

“Continental is firmly committed to Cleveland and will remain so after its merger with United,” said Smisek, who will head the new United Airlines after the combination with Continental. He referred to reports insinuating that Continental would drastically reduce its service to Cleveland as a result of the merger.

Smisek joined the airline in March 1995 as senior vice president and general counsel. In December 2004, he became president and was elected to the company's board of directors. He became president and chief operating officer in September 2008 and assumed the role of chairman, president and chief executive officer in January 2010.

The reports were based on one of many simulations analyzed before the merger was announced, and modeled the most severe recession or disaster scenario. The simulation was promoted by the plaintiffs’ attorney in the trial of a lawsuit filed in California challenging the merger.

“Other simulations showed Cleveland maintaining its size and others showed it growing,” Smisek said. “This was never a plan for Cleveland or any of our hubs.”

Highlights of Domestic Airline Mergers and Acquisitions

Since deregulation in 1978, the financial stability of the airline industry has become a considerable concern for the federal government owing, in part, to the level of financial assistance it has provided to the industry by assuming terminated pension plans and other forms of assistance. Between 1978 and 2008, there have been over 160 airline bankruptcies. While most of these bankruptcies affected small airlines that were eventually liquidated, 4 of the more recent bankruptcies (Delta, Northwest, United, and US Airways) are among the largest corporate bankruptcies ever, excluding financial services firms.

During these bankruptcies, United and US Airways terminated their pension plans and $9.7 billion in claims was shifted to the Pension Benefit Guarantee Corporation (PGBC). Furthermore, to respond to the shock to the industry from the September 11, 2001, terrorist attacks, the federal government provided airlines with $7.4 billion in direct assistance and authorized $1.6 billion (of $10 billion available) in loan guarantees to six airlines.

Although the airline industry has experienced numerous mergers and bankruptcies since deregulation, growth of existing airlines and the entry of new airlines have contributed to a steady increase in capacity, as measured by available seat miles. Although one airline may reduce capacity or leave the market, capacity returns relatively quickly. Likewise, while past mergers and acquisitions have, at least in part, sought to reduce capacity, any resulting declines in industry capacity have been short-lived, as existing airlines have expanded or new airlines have expanded. Capacity growth has slowed or declined just before and during recessions, but not as a result of large airline liquidations.

Volatile earnings and structural changes in the industry have spurred some airlines to explore mergers as a way to increase their profitability and financial viability. Over the last decade, the U.S. passenger airline industry has incurred more than $15 billion in operating losses. Several major airlines went through bankruptcy to reduce their costs and restructure their operations, while others ceased to operate or were acquired.

Most recently, U.S. airlines responded to volatile fuel prices and then a weakening economy by cutting their capacity, reducing their fleets and workforces, and instituting new fees, but even with these actions, the airlines experienced over $5 billion in operating losses in 2008 before posting an operating profit of about $1 billion in 2009. Furthermore, over the last decade, airfares have generally declined (in real terms), owing largely to the increased presence of low-cost airlines, such as Southwest Airlines, in more markets and the shrinking dominance of a single airline in many markets.