Northwest Signs Strategic Alliance With Continental

Northwest Airlines and Continental Airlines unveiled a strategic alliance Monday that one analyst called “a synthetic merger,” and others said the deal might spark the first major consolidation of the airline business in a decade.

The pact between Northwest and Continental, the nation’s fourth- and fifth-largest carriers, respectively, also thwarted a conventional merger bid for Continental made by Delta Air Lines, the third-biggest U.S. carrier.

Delta, which had first explored a merger with Houston-based Continental more than a year ago, returned for fresh talks with the airline this weekend after reports surfaced last month that Northwest and Continental were negotiating an alliance.

Delta’s interest was confirmed by Continental Chairman Gordon Bethune at a news conference, but terms of Delta’s proposal weren’t disclosed. Delta spokesman Todd Clay declined to comment.

Northwest, based in Minneapolis, and Continental said the agreement will connect their global route systems, meld their frequent-flier mileage programs and link the airlines’ international partnerships.

Continental, for instance, already has “code-sharing” links with such foreign carriers as Alitalia of Italy and Air France, while Northwest’s overseas partners are led by KLM Royal Dutch Airlines.

Northwest flies to 160 cities in 23 countries and operates hubs in Minneapolis-St. Paul; Detroit; Memphis, Tenn.; and Tokyo. Continental serves 125 U.S. cities and 67 foreign destinations and has hubs in Houston, Cleveland and Newark, N.J. But the two have few overlapping routes.

The pact means consumers would be able to fly both carriers’ routes as though dealing with a single airline. Continental noted, for example, that a passenger could book a seamless flight from Minneapolis (a Northwest stronghold) to Rio de Janeiro (a Continental destination).

It also means travelers would be able to spend their frequent-flier miles with either carrier, and that’s important for the airlines’ growth, said Thomas J. Gallagher, aerospace director for banking and securities firm CIBC Oppenheimer Corp.

When travelers are given more choices for spending their frequent-flier miles, “the greater their brand loyalty to your airline,” said Gallagher, who called the deal a synthetic merger.

The alliance also was triggered by the desire of Continental’s biggest stockholder, Air Partners, to sell its shares to a party that would help preserve Continental’s independence. Air Partners is an investor group led by financier David Bonderman, which brought Continental out of bankruptcy reorganization in 1993 and has helped engineer the airline’s dramatic recovery since then.

Northwest agreed to pay $519 million in cash and stock to buy Air Partners’ Class A shares, which represent a controlling 51% voting stake in Continental. But Northwest also agreed to generally vote the stock in support of Continental’s management. One exception: Northwest could vote against, and thus block, an outside takeover bid for Continental.

Analysts expect more U.S. airlines to try to strike such deals, because they provide immediate growth without forcing carriers to incur the costs associated with a flat-out merger. It’s especially helpful in the United States, where the airlines have already divided up the best hub cities, said analyst Jeffrey Long of J.P. Morgan Securities Inc.

But Long also said he’s “not convinced” that more alliances will occur quickly. The Continental deal is unique because it has a controlling stockholder that’s selling its stake to Northwest, thus “removing the risk of somebody else disrupting the alliance” with another offer, he said.

Most other airlines don’t have that arrangement, so even if they enter into an alliance with a given airline, they run the risk of having other airlines swoop in with rival offers. Knowing that, the remaining U.S. airlines for now “will probably just be circling each other,” Long said.

Northwest was looking for growth because of problems overseas. It’s facing more competition on its service to Japan under a new treaty being negotiated by the United States and Japan.

Airline mergers have been rare over the last decade in part because they are hard to implement. Among other things, it’s expensive to combine their employees, many of whom are unionized, and thus have different salaries and seniority levels they want protected.

Indeed, Continental said it opted for the Northwest deal in part to avoid employee layoffs and other disruptions common with mergers.

“Obviously, in a merger, whether it be with Delta or any other carrier, there would be a significant loss of jobs,” Bethune said.

Wall Street cheered the deal. Northwest’s stock jumped $4.56 a share to close at $55.31 on Nasdaq; Continental’s widely held Class B stock rose $1.88 to close at $49.38 on the New York Stock Exchange. Delta shares fell $1.69 to close at $112.31, also on the NYSE.

Investors also sharply bid up another carrier thought to be an alliance or takeover candidate: US Airways. Its stock gained $3 to close at $60 in NYSE trading.