Delta Air Lines, Inc. and Aeromexico Join Forces

By Adam Levine-Weinberg Markets Fool.com

On Wednesday, Delta Air Lines (NYSE: DAL) and Aeromexico formalized their plans to create a new joint venture for U.S.-Mexico flights. This will enable them to coordinate their efforts in the transborder market.

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Delta and Aeromexico are going ahead with the joint venture even though U.S. regulators are forcing them to divest up to 28 airport slot pairs in New York and Mexico City. Last month, the two companies had suggested that they might drop their joint venture application due to the harsh conditions that regulators were demanding.

Delta has decided to move ahead with its joint venture with Aeromexico. Image source: Delta Air Lines.

Indeed, smaller carriers like JetBlue Airways (NASDAQ: JBLU), Volaris (NYSE: VLRS), and Southwest Airlines (NYSE: LUV) could be big winners here. These low-fare carriers may get valuable opportunities to expand in Mexico City using the slots that Delta and Aeromexico will have to divest.

What a joint venture means for customers and investors

The joint venture between Delta Air Lines and Aeromexico will allow them to coordinate schedules and pricing on U.S.-Mexico routes. They will share the revenue generated on transborder routes, such that it won't matter from a financial perspective whether customers travel on a Delta plane or an Aeromexico plane. In essence, the two carriers will be operating as a single airline for the purpose of U.S.-Mexico flights.

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For customers, the risk of a joint venture agreement is that prices will go up. In this case, Delta and Aeromexico don't have overlapping service on many routes, with the notable exception of the busy (and strategically important) New York-Mexico City route. Regulators hope to prevent price increases by encouraging new competitors to enter that particular market.

The potential benefit is that by working together, Delta and Aeromexico can coordinate their flight schedules to give customers more flight options. That includes maximizing connecting opportunities at their respective hubs.

For Delta investors, a joint venture will be extremely beneficial as it will help Delta leapfrog its legacy carrier rivals in the U.S.-Mexico market. With harmonized schedules and pricing, Delta and Aeromexico's transborder flights should become more profitable. Delta also plans to increase its ownership stake in Aeromexico to 49%, which will help Delta shareholders capture more of the upside from the joint venture.

The DOT relaxes its divestiture requirements -- slightly

To get the green light from regulators, Delta and Aeromexico had to agree to give up a lot of slots, particularly at Mexico City's heavily congested airport. They will also have to divest some slots at New York's JFK Airport. However, the carriers may not have to give up as many slots as the Department of Transportation originally asked for.

In its preliminary decision issued last month, the DOT said that Delta and Aeromexico would have to give up 24 daytime slot pairs in Mexico City and six daytime slot pairs in New York. Both carriers strenuously objected to those terms, calling them onerous and unnecessary.

The revised order issued last week only requires Delta and Aeromexico to divest 14 slot pairs in Mexico City and two in New York to low-cost carriers -- for now. However, if eligible low-cost carriers try and fail to secure more slots at those airports for transborder service, Delta and Aeromexico could have to divest another 10 slot pairs in Mexico City and two slot pairs in New York in 2018 to enable that additional competition.

In essence, the DOT is taking a wait-and-see attitude in light of some proposed changes to how slots are allocated in Mexico City. If smaller carriers can get enough slots without taking them away from Delta and Aeromexico, that's fine. Otherwise, a larger divestiture is necessary.

Great news for those smaller carriers

Volaris, JetBlue, and Southwest all vigorously pushed for major divestitures as a condition of permitting the Delta-Aeromexico joint venture. Now they are getting them.

JetBlue probably has the most to gain. Today, it flies from Mexico City to its Fort Lauderdale and Orlando focus cities, but both departures leave before 6 a.m. because those were the only slots available. This has depressed customer demand. With more slots, JetBlue could add flights to those cities at more convenient times, while also launching service to its larger New York and Boston focus cities.

JetBlue hopes to expand and get better flight times in Mexico City. Image source: JetBlue Airways.

Meanwhile, Southwest Airlines has three slot pairs in Mexico City right now, including one of the dreaded early morning slots. As of early January, all of those slots will be used for flights to Houston. Southwest has numerous focus cities across the country that could support service to Mexico City, though. As a result, it will likely request a large block of slots to expand there.

Finally, Mexican ultra-low-cost carrier Volaris already has 58 slot pairs in Mexico City. However, it uses the vast majority of those slots for flights to more than two dozen domestic destinations. As of now, it has to cut a domestic flight every time it wants to add a transborder flight.

As a result, Volaris flies to more than twice as many U.S. destinations from Guadalajara as it does from Mexico City, even though Mexico City is a much bigger market. Thus, Volaris has plenty of room for growth in its transborder business out of Mexico City if it can get more slots. It will also probably try to get additional slots at JFK Airport so it can add more routes to New York.

The coming increase in low-cost carrier service in Mexico City will help keep fares down in that busy market and open up growth opportunities for the likes of JetBlue, Southwest, and Volaris. Meanwhile, Delta and Aeromexico will get to go ahead with their joint venture. This situation looks like a win-win for all the parties involved.

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Adam Levine-Weinberg owns shares of Volaris and JetBlue Airways and is long January 2017 $17 calls on JetBlue Airways and long January 2017 $40 calls on Delta Air Lines. The Motley Fool recommends JetBlue Airways. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.