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Delta and Northwest have embarked on their long-awaited flight to safety. Whether the two airlines will get there is unclear. The pressing reason for their all-stock merger is the oil price, a point amply demonstrated by the market’s reaction to the deal. In initial trading on Tuesday, Delta and Northwest’s combined market capitalisation jumped by 6 per cent. Then crude prices hit a record and that swung quickly to a combined drop of 12 per cent.
Wary of the need to get regulatory approval and mitigate political opposition, both airlines emphasise the minimal overlap between their routes. The flip-side of courting Washington, however, is minimal savings – annual cost synergies of up to $400m equate to just 1.4 per cent of pro forma operating expenses.
Rather, Delta and Northwest aim to fly faster than the speed of oil. The companies hope for $800m of annual revenue synergies by 2012, as a bigger global airline attracts passengers, to offset higher fuel costs. Give Delta and Northwest the full benefit of the doubt, ascribe a generous 10 per cent discount rate, and the after-tax net present value of the total synergies is $4.6bn. To put that in perspective, the two airlines’ combined market cap at Monday’s close was $5.7bn.
Investors have good reasons to be sceptical. Revenue synergies are slippery in any deal. And, while Delta’s pilots are onside, Northwest’s are not as yet. Antitrust regulators, meanwhile, may weigh the deal’s likely effect of catalysing more airline deals when passing judgment.
In spite of the challenges, the rationale is solid. The problem is this is not yet a done deal and the benefits are “strategic” and long-term. Investors looking for immediate relief from the impact of high oil prices and potential recession will find little solace here.
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