Earlier this month, ProPublica published an expose on the 2013 merger between American Airlines (NASDAQ: AAL) and US Airways. The article contends that an army of lawyers and lobbyists exerted political influence over the antitrust review process through shady backroom deals, causing the Department of Justice to drop its opposition to the merger for no valid reason.
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The article also concludes that the merger has had the negative effects originally predicted by the DOJ, most notably, tacit (or even active) collusion between the airlines to restrict capacity and drive up fares.
The truth is quite different, though. While American Airlines and US Airways certainly lobbied on behalf of the deal, they also made significant concessions to address the DOJ's concerns.
American Airlines and US Airways made big concessions to get their merger approved. Image source: American Airlines.
Furthermore, the persistent airfare declines of the past two years show that while four airlines -- American, Delta Air Lines (NYSE: DAL), United Continental (NYSE: UAL), and Southwest Airlines (NYSE: LUV) -- hold about 85% of the domestic market, they have far less pricing power than airline executives had assumed and regulators had feared.
Was the government's case kneecapped?
According to ProPublica, most of the rank-and-file staffers working on the American Airlines merger case were appalled that the government settled the case. Furthermore, American and US Airways enlisted some "high-profile Democrats" to lobby (both formally and informally) on behalf of the deal.
Yet while there was clearly a gap between what the DOJ alleged in its complaint and what it got in the settlement, lawyers do sometimes make shocking allegations to enhance their bargaining leverage. Ultimately, American Airlines and US Airways made major concessions, giving up dozens of slots at two of the most crowded airports in the U.S., as well as gate space at five other airports.
Divesting slots at Washington, D.C.'s Reagan National Airport and New York's LaGuardia Airport was a huge concession that the ProPublica article wrongly downplays. Selling slots to Southwest Airlines, JetBlue Airways, and Virgin America made those markets far more competitive than they were before the merger.
As a result, the average domestic fare at Reagan Airport in the first quarter of 2016 was 10.5% lower than it was two years earlier, before the slot divestments began. At LaGuardia Airport, the average fare was down 12.2%. On the specific routes that saw the most added competition, such as New York-Dallas and Washington-Dallas, fares in Q1 2016 were down by more than a third over that two-year period!
Increased competition has driven fares lower in New York and Washington, D.C. Image source: The Motley Fool.
Had the DOJ blocked the merger entirely, rather than settling the case, low-cost carriers would have had no opportunity to grow in these capacity-constrained markets. This would have led to higher fares. Opening up Reagan Airport and LaGuardia Airport to more competition was reason enough for the DOJ to settle its case against American, regardless of any improper political influence.
Not much evidence of collusion or pricing power
In November 2013, when the DOJ decided to settle the antitrust case, you could at least make a plausible argument that the merger would make it too easy for the big airlines to tacitly collude. Executives at American, Delta, United, and even Southwest have all talked about the industry's commitment to capacity discipline (i.e., slow enough growth that fares stay high).
After two years of declining airfares, it's pretty clear that airlines don't have much pricing power and aren't colluding to drive up prices.
In late 2014 and early 2015, as oil prices were plummeting, aviation pundits warned consumers not to expect fares to fall. The management teams at American Airlines and Delta Air Lines specifically stated that they would hold fares steady so that fuel cost savings would flow straight to the bottom line.
Yet despite these pronouncements, fares have been falling. The average domestic airfare in Q1 2016 (the most recent quarter for which federal data is available) was down 5.5% from two years earlier. That actually understates how much fares have fallen, because airlines are gradually shifting their networks toward longer flights, which naturally tend to cost more. And based on airlines' reported revenue results over the past six months, it's clear that the pace of decline has accelerated.
Fares have been falling at Delta -- highlighting its limited pricing power. Image source: The Motley Fool.
Looking at American and Delta specifically, the results are even starker. Delta's yield (the average fare per mile flown) fell 5.4% in Q3 2015 and then fell another 5.3% in Q3 2016. At American Airlines, yields plunged 9.2% in Q3 2015 and then declined another 0.6% last quarter. (In case you were curious, yields at United Continental slumped 5.6% in Q3 2015 and 5.7% in Q3 2016.)
This is a textbook example of Adam Smith's "invisible hand" at work. Airline executives all wanted to keep fares high -- yet in their efforts to maximize their earnings, they ended up driving fares lower, helping consumers.
DOJ made the right call
In short, while American Airlines and US Airways put pressure on regulators to approve their merger, there's no evidence that they got the DOJ to drop its opposition through unethical means. With 20/20 hindsight, it looks like the DOJ got a very good deal, stimulating huge competition in two major cities without giving the airlines any appreciable increase in pricing power.
Skeptics of the deal would argue that fares should have fallen even further given how far oil prices dropped. But while fuel costs are down significantly, labor costs are rising. Airlines are also investing heavily in updating their fleets with modern aircraft.
After taking those factors into account, it appears that all three legacy carriers have now passed through the majority of their fuel cost savings to customers. This fits in with the longer-term trend of airfares declining steadily on an inflation-adjusted basis. The evidence available shows that the American Airlines-US Airways merger hasn't harmed competition. ProPublica's innuendo that the outcome was rigged by special interests doesn't hold up to scrutiny.
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Adam Levine-Weinberg owns shares of JetBlue Airways and United Continental Holdings and is long January 2017 $17 calls on JetBlue Airways and long January 2017 $40 calls on Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned. 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.