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A Continental Airlines jet passes a United Airlines jet as it prepares to take off from O'Hare Airport in Chicago. (Scott Olson/Getty Images)
A Continental Airlines jet passes a United Airlines jet as it prepares to take off from O'Hare Airport in Chicago. (Scott Olson/Getty Images)

United, Continental rumoured to be in merger talks Add to ...

United Airlines likes to say "It's time to fly." Now, it may also be time to merge.

An improving economy and a healthier balance sheet has put United's Chicago-based parent UAL Corp. in an ideal position to make a deal with Continental Airlines Inc.

Media reports say the two airlines are poised to announce a stock swap as early as Monday that would create the world's largest airline, eclipsing Delta Air Lines Inc. Delta, based in Atlanta, became No. 1 when it acquired Northwest Airlines in 2008.

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"As good times return, this industry should do better, and mergers will help," said Richard Aboulafia, an airline consultant at Teal Group Corp. in Fairfax, Va.

"They get to be a truly global player, and a dominant one in many markets."

A United-Continental merger might also herald better times for an industry that is still reeling from two recessions, high jet fuel prices, intense competition from new low-cost carriers, deadly terrorist attacks and crippling bankruptcies during the past 10 years. Over that period, U.S. airlines piled up combined losses of $60-billion (U.S.). And that was before this month's costly global flight disruptions due to volcanic eruptions in Iceland, which is estimated to have cost the global industry $1.7-billion.

In theory, mergers allow airlines to reduce competition, cut capacity, shrink their work forces and raise prices. And while that's not good for travellers or employees, it's a step in the right direction for an industry that has chronically struggled to charge enough to cover its costs. The average price of a U.S. domestic return flight was $306 in the third quarter of last year - the lowest level in more than four years, according to the most recent U.S. Department of Transportation statistics.

Consolidation will inevitably lead to higher fares. But it also means airlines will be financially healthy so they invest in new aircraft, improved lounges and the like.

"This is a good news, bad news thing for consumers," argued Jay Sorensen of IdeaWorks, a Wisconsin-based airline consultant. "Fares will go up. But guess what? They need to."

A marriage of United and Continental could also force other carriers to make a move. US Airways, which broke off talks with UAL earlier this month, is also still likely looking to hook up with someone. The most likely partner is AMR Corp.'s American Airlines, although analysts point out that American can manage without doing a deal of its own.

Elsewhere, airlines are also consolidating. British Airways recently acquired Iberia, and Lufthansa has taken over several smaller European rivals.

UAL, which has been in and out of bankruptcy, has been courting merger partners for more than a decade, striking numerous domestic and global alliances. It briefly considered a merger with Continental in 2008.

Now as the United States and the rest of the world climb out of a deep recession, consolidation looks viable again.

"Airlines are healthier, with more cash and less debt, and the business environment is beginning to strengthen," explained Vicki Bryan, an analyst at Gimme Credit in Chicago.

"There's nothing like a merger in a fiercely competitive and chronically oversupplied industry to potentially grow revenues and cut costs."

Ms. Bryan estimated that the merger could produce costs savings of roughly $2-billion over two years - about half of that from revenue growth. That's about twice the savings that would have been generated in an earlier proposed merger between United and US Airways, she said.

"The time is right for Continental and United to merge," she said.

The two airlines have relatively little overlap in their routes and hubs, which experts said would invite less scrutiny from antitrust authorities.

United operates out of Chicago, Denver, Los Angeles, San Francisco and Washington. Continental, which also went through Chapter 11 bankruptcy proceedings, flies from Newark, Houston and Cleveland.

Ms. Bryan said United stands to gain from Continental's strong presence in the lucrative New York and Asia-Pacific markets, making it a "formidable" international competitor to Delta. Together, they would leapfrog Delta for the top spot across both the Atlantic and Pacific among U.S. airlines, with 40 and 53 per cent of traffic, respectively. The merged carrier would be No. 2 in Latin America behind American.

And in the domestic market, the two airlines would have hubs in virtually every corner of the country.

That isn't to say everything is fine in the airline industry. They are paying down debt and improving their cash flows, but every major U.S. carrier, with the exception of JetBlue Airways Corp., lost money in the first three months of 2010. UAL lost $82-million, Continental $146-million.

Officials at United and Continental declined to comment on the merger talks. CNBC reported that the proposed deal, which it said was being reviewed by the respective carriers' boards on Friday, would be all-stock transaction at a ratio of 1.05 UAL shares for every Continental share.

Follow on Twitter: @barriemckenna

 
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