The Company

The News

Delta Air Lines

Northwest Airlines

The $17.7 billion all-stock deal, if approved by regulators, would create the nation's largest airline, and could well prompt more consolidation among U.S. carriers. The entire domestic airline sector has been buffeted by bad news, from the apparent scraping of the Delta deal in January to Friday's bankruptcy declaration by Frontier Airlines Holdings.

The new airline will retain the Delta name and that company's Atlanta headquarters. Delta Chief Executive Richard Anderson will be CEO of the combined company. Delta Chairman Daniel Carp will become chairman of the new board and Northwest Chairman Roy Bostock will become vice chairman. Delta's finance chief, Ed Bastian, will retain his title and additionally serve as president.

Under the terms of the deal, announced Monday, Northwest shareholders would get 1.25 Delta shares for each share they own.

The two airlines cited the need to create a "more stable platform for future growth in the face of significant economic pressures from rising fuel costs and intense competition" in their announcement of the deal.

On Tuesday, oil prices hit a record high of $113.40 a barrel, a major factor in spurring U.S. legacy carriers toward merge-or-die transactions. Continental Airlines and United Airlines parent UAL remain the focus of intense merger rumors, though neither airline has made public comment on any negotiations.

The Analysis

Regulatory issues and concerns that Northwest's pilots will oppose the deal still exist, but the need for change has been evident for several years, as stratospheric fuel costs hammer the entire sector.

Delta has cut flights to reduce expenses, and this year faces a fuel bill that could be $2 billion more than last year's. Coupled with consumer and business travel reductions in the face of a recession, and the market's reaction is no surprise.

Because the two carriers have relatively little overlap on routes, it's tough to see how their twinning does much beyond a 12% cut in the workforce of the combined company, Soleil Securities analyst James Higgins wrote Tuesday.

"Details at this point are sketchy, but our initial impression is underwhelming, as the obvious benefits of the combination fall short of our expectations," he wrote.

While Calyon Securities analyst Ray Neidl wrote that the merger could cut costs by about $1 billion, he also noted the one-time expenses of creating the new carrier could run to $1 billion, deferring any benefit to shareholders of the battered carriers. Delta shares were down 56% over the past year before the merger was announced.

"We believe that industry consolidation is necessary and that this is the first step in the process of bringing rationalization to the fragmented industry, but our main concern is that past airline mergers have generally proved to be more expensive and messier than originally forecasted," Neidl wrote.

Normally, merger announcements mean the acquirer's shares dip a bit and the acquisition target's shares rise, but high oil prices loom so significantly as an overhanging concern they may well have dampened any potential pop.

"I don't understand why the market doesn't like this," says Roger King, an analyst with CreditSights, a New York-based capital structure research firm. "This all should have already been in the market price. We're finally announcing a marriage after they've been living together for a while."

The Bottom Line

Small investors usually get ground up when tectonic shifts take place in troubled industries. The rocky, protracted path to the Delta-Northwest union squeezed most of the potential upside out of this deal a long time ago, leaving mostly hedge funds and large institutional investors committed to each carrier.

"Relative to our February 11 estimate of a combined equity value of $32 per Delta share, fuel prices are 13% ($1.2 billion) higher, merger synergies are about $400 million lower, and shares outstanding are at least 2% higher," Soleil Securities' Higgins wrote. "Nothing there suggests a higher valuation for these merged companies."

Kings says there's no winner in a merger done for survival reasons, and that the airline sector's health remains far from robust.

"Being long in airlines makes no sense" for the small investor, he says. "I don't understand how anyone can put buys, outperforms or market performs on any airline stock."

Adventurous investors might speculate on the Continental-United deal and see some short-term benefit, but as a long-term play, airlines were grounded a long time ago.