The Washington Post October 15, 1995, Sunday, Final Edition SECTION: FINANCIAL; Pg. H01 LENGTH: 1933 words HEADLINE: Eyes on Eastern Skies; If It Buys USAir, United May Start Another Airline Industry Revolution BYLINE: Frank Swoboda; Don Phillips, Washington Post Staff Writers DATELINE: CHICAGO BODY: Just a year after becoming the world's largest employee-owned corporation, United Airlines is looking to take advantage of its new relationship with organized labor to seize control of the crowded skies over the eastern United States. By the end of October, United must decide whether to bid for USAir, the nation's fifth-largest airline and the dominant carrier on the East Coast. The plan would be to pattern much of USAir's operations after United's highly successful low-fare, no-frills West Coast shuttle. If United makes the move, get ready for the next revolution in the airline industry. After nearly 20 years of deregulation, the nation's airline industry has been reduced to four major carriers -- United, American, Delta and Northwest -- and a large number of smaller regional or niche airlines. That is pretty much what deregulators predicted would happen when they wrote the deregulation legislation in 1978. Some of the oldest and biggest names in commercial aviation -- Pan American, Eastern, National, Braniff and Western -- have since disappeared. A merger of United and USAir -- under the plans being considered by United -- would be the first nationwide venture into low-fare, no-frills flying by a major airline. If it happens, it would force the other major carriers to follow, if they could. Such a merger also would give employees control of approximately half of the nation's air passenger seats, because employees already have ownership and board representation at Northwest and Trans World Airlines. United, a subsidiary of UAL Corp., has built itself into the only truly global U.S. airline. It dominates Pacific travel and competes well in service to Europe and South America. It also dominates transcontinental traffic in the United States with more than 60 percent of the nonstop flights between the two coasts, double the number for American Airlines, its nearest competitor. The acquisition of USAir Group Inc. instantly would make United the dominant airline in the United States. Ironically, the edge for United in achieving industry dominance may be the same factor that has made financial analysts wary of the company for the past year: employee ownership. Most of United's major employee groups have given the airline the reduced labor costs it needs to compete, in exchange for a financial stake in the company. United's and USAir's employees are represented by the same international unions. If United acquires USAir, it could simply apply to former USAir employees the same concessionary contract terms already negotiated at United in exchange for stock ownership. Even hard-line union officials said last week they thought that was possible. None of the same unions represent employees at American, a fact that some United officials believe works in United's favor. If American buys USAir, it would have to go through the high-tension process of holding elections to see which unions would represent its employees. A 'Vision' Evolves United's interest in USAir began early this year, when the Arlington-based airline contacted United about a possible joint marketing arrangement, according to UAL Chairman Gerald Greenwald. "The first contact came from USAir," said Greenwald, who described USAir's discussions as a "vision" rather than a specific operational proposal. "The vision was that there is a great potential in having the East Coast routes combined in some fashion with United. At the time, the discussions were no more or no less than that," Greenwald said. Last month, the situation dramatically changed. "About three weeks ago, I got a call which said there is another suitor and that the USAir board was going to discuss the subject and USAir wanted to know where we stand. That's when the circumstances went from preliminary discussion to serious study," Greenwald said. The other suitor is AMR Corp.'s American Airlines, which also is considering a bid either to purchase the airline or possibly create a marketing arrangement that would pump cash into financially strapped USAir in exchange for an instant major East Coast feed to American's international operations. Crandall's Response AMR Chairman Robert L. Crandall would not comment directly on American's potential interest in USAir. "I have said in the past that the most effective way for an airline to grow is internally," Crandall said last week. "What I have not said and will not say today is what I would do if others made the first step." He strongly emphasized "others." The Justice Department ultimately must approve any merger with USAir and has kept its counsel so far. Since that September phone call warning of another suitor, Greenwald and United's top management have been involved in an intensive study of the possible purchase of USAir. "We're trying to do in 30 days what typically would take a lot longer," Greenwald said. Greenwald insists that no final decision has been made. But last week he was talking like a man who had made up his mind as he outlined the success of United's West Coast shuttle and how much of that type of service would be transferable to USAir's operations in the East, where many flights are short hauls. The Shuttle by United, as it is officially called, provides multiple daily flights between several California cities, with service stretching as far as Phoenix, Las Vegas and Seattle. It is an airline within an airline -- a low-fare, fast-turnaround service with its own maintenance personnel and flight crews who are paid at lower rates than United's "main line" crews. Costs Are the Key Before United was purchased by its employees, it made an unsuccessful attempt to gain a major foothold in the East with hubs at Dulles International Airport and Orlando, but the effort was abandoned in the early 1990s in part because the high-cost United of that time could not compete with USAir's market dominance in the East. Greenwald said United's research shows that passengers flying less than two hours want the lowest price and on-time service with a smile. He said the key to doing that was to have anywhere from five to 12 flights a day between cities, so there is enough volume to make consistently low fares produce profits. Passengers demand more amenities on coast-to-coast flights, he said. "Today, USAir is relatively vulnerable" to low-cost competitors, Greenwald said. If United were to buy USAir and bring the efficiencies of its shuttle operation to the East Coast, he said, "USAir would certainly be dramatically less vulnerable and other airlines would be more vulnerable." Greenwald said that should be an appealing thought to USAir employees interested in job security should United make a bid for their airline. The three unions at USAir -- the Air Line Pilots Association, the International Association of Machinists and the Association of Flight Attendants (AFA) -- have remained silent about the possibility of a USAir merger with either United or American. Privately, however, they have been scrambling for information and meeting with their counterparts at United. The AFA is the only union at United that is not part of the employee stock ownership plan. In the early months of employee ownership last year, flight attendants could often be seen wearing buttons declaring: "We just work here." Greenwald said last week that United would not require either its own or USAir's flight attendants to buy into the company or provide concessions as part of any USAir purchase. "I don't see how we can place either flight attendant group on the same footing as most other employee groups," he said. Greenwald said he did not see the flight attendants' situation as a deal breaker. The Buyout That Flew The thought of United buying another airline would have been unthinkable in July 1994, when employees took over the company by providing $ 4.8 billion in salary and work rule concessions to acquire majority stock ownership and representation on the board of directors. Unlike many other employee buyouts, this was of a profitable firm, which at the time ranked second in the industry. Wall Street skeptics questioned whether a company owned by its employees would be able to make the tough management decisions that might be necessary to run the airline efficiently. Adding to the skepticism was the notion of the West Coast shuttle, with lower wage rates and fewer work rules to make the operation competitive with low-cost rivals. So far, it's working. UAL's stock has nearly doubled in value since the employee takeover, Wall Street analysts are begining to talk glowingly about the the company's continually improving financial performance, the shuttle appears to be a success and United recently launched the biggest experiment in "ticketless" travel, which many in the industry see as a major future cost saver. United this month is No. 1 in the industry in almost all statistical measures, with a cash reserve of approximately $ 2 billion. Greenwald said United plans to spend about half of that to further reduce its debt. He said the airline expects to end the year with cash reserves of about $ 1 billion. A Few Labor Pains For the airline's new employee-owners, the conversion to a kinder-gentler system of labor-management relations seems to be going better than expected, especially in a company long noted for its acrimonious, top-down management style. "It's no Utopia, but it's going pretty good," said John Peterpaul, the former machinists union leader who now serves on United's board of directors. He admits that labor relations at the airline "could be going a lot better, but they're 100 percent better than they ever were in the past." Even so, United in the last year has been on what Peterpaul describes as a "tightrope," balancing the needs of the airline and the desires of its employees. He calls the current situation an "exercise period." Kevin Lum, who heads the flight attendants unit at United, is less generous. Employee relations "have changed superficially," Lum said. "There was a warm and fuzzy feeling for the first 12 months and that's beginning to wear off." Julius Maldutis, airline analyst for Salomon Brothers Inc. and an early skeptic, acknowledges that the view from Wall Street seems to be changing. "I think the facts are clear. You've got the numbers," he said of United's financial performance over the past year. Maldutis said it was impossible to tell how much of United's strong financial performance is the result of good times for the industry as a whole and how much, if any, could be attributed to employee ownership. Whatever the reason, Maldutis said, "I think it's quite clear that United's financial results are going to be quite outstanding relative to its principal competitors." The Next Merger Wave? Paul Karos, an analyst with CS First Boston Inc., said that a buyout of USAir likely would begin a new round of airline consolidation. He predicted these mergers would be better for the industry than the airline marriage binge of the late 1980s. Unlike those mergers, which were often designed to expand service for the acquiring airline, Karos said the new mergers would be designed to rationalize routes and cut costs. United has not gained the full confidence of everyone, however, and ranks toward the bottom of some financial fitness surveys. The Air Watch Report of Aviation Forecasting and Economics Inc., for example, designates United as "neutral transition," meaning it is not a high financial risk and is neither improving nor declining.