For the airline sector, consolidation is in the air. And with good reason too.

Last year, the industry lost $9.4 billion. This year, the International Air Transport Association expects it to lose another $2.8 billion.

On the positive side, that makes buying up rivals very cheap.

That’s a good thing, considering that no-frills companies like Southwest Airlines (NYSE:LUV) are adding customers, thanks to the recession. The higher-end competition needs to make a profit somehow.

Airlines on both sides of the Atlantic leapt at the chance to conduct mergers. Over in Europe, British Airways ADR (OTC: BAIRY) and Iberia announced potential plans last November. And they just recently reached an agreement on the tie-up, which will create the third-largest airline in Europe.

Meanwhile UAL Corporation (NASDAQ:UAUA) – a.k.a United Airlines – and US Airways Group (NYSE:LCC) just resumed talks on a possible merger.

U.S. airline stocks jumped in reaction to that news, seeing it as a win-win situation across the board. They all benefit from reduced competition. And the merger would target overlapping routes and excess capacity overall from the industry.

But the question still remains… Will it be enough?

The Possible Deal

This isn’t the first time US Airways and United Airlines have tried to get along. Their merger talks fell apart two years ago, though the deal itself made strategic sense.

But they thought the cost of integrating their complicated operations could outweigh the benefits. At the time, dishing out wage increases to win agreement from the pilots’ unions was too high. And oil prices were skyrocketing.

Fortunately, things changed a bit last year. Airlines managed to raise capital and bolster their balance sheets, leading industry executives to change their minds. They now think they can handle the extra costs.

Back in October, United Airlines CEO Glenn Tilton explained that in order “to build a bridge to the synergies, you’ve got to have a checkbook.” And he went on to say that the industry might finally have the means to pay for the 12-18 months of messy integration required.

In fact, both his company and US Airways could save substantial amounts from a merger today.

Based on 2007 data, analysts at Barclay’s Capital agree. They see a United merger with US Airways or Continental Airlines (NYSE:CAL) creating up to $400 million synergies annually, even after higher labor costs.

Bad History

Still, even with that kind of benefit, getting an airline deal off the ground remains a challenge.

Combined airlines mean fewer flights, fewer aircrafts and fewer opportunities for pilots’ advancement. They also often force pilots from each carrier to merge seniority lists, which determines pay levels. For that matter, the lists also affect what aircraft and missions the pilots fly.

So any merger between United and US Airways could confront bitter opposition from their pilot unions, who hold significant sway. Just back in 2008, pilots at Delta Airlines (NYSE:DAL) and Northwest nearly derailed their companies’ merger. Despite promises of higher pay for all flying staff, they couldn’t agree on who got seniority.

Appeasing the unions in question this time could simply cancel out any benefits the deal has to offer.

Posing another problem, are antitrust issues, which have been raised in the past. In this case, the merged companies would control over 60% of departures in the D.C. metropolitan area. And the U.S. Department of Justice is apt to look very closely at any merger between the two airlines.

Is It a Good Deal?

In the end, even if everything goes perfectly for United and US Airways, the industry will still suffer. It suffers too much from government meddling to ever make a decent profit.

After WWII, international parties drew up rules for air travel and they haven’t changed since. Today, those regulations only get in the way. They entrench surplus capacity and restrict airlines from merging internationally. And they especially hurt carriers in mature markets like the U.S.

Anyone considering investing in airline stocks should heed Warren Buffett’s words on the subject. The legendary investor once said that any right-minded capitalist who saw the Wright Brothers’ aircraft take to the skies at Kitty Hawk should have shot it down and saved investors a century of agony.

Unfortunately, he’s right. Airlines have made negligible returns since the dawn of commercial aviation.

And that probably won’t change anytime soon.

Good investing,

Tony Daltorio

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