[Gerald A]

April 28, 2008

Continental Airlines has called off talks with United Airlines because of United's weak financial condition and a feeling that a merger would risk its own financial health, a source briefed on the matter said.

The source also said Continental is in "advanced talks" with British Airways and American Airlines about a potential alliance, with plans to seek antitrust immunity.

Continental's decision comes after Delta Air Lines and Northwest Airlines said nearly two weeks ago they planned to merge and become the world's largest airline, seeking to counter rising fuel prices, a weak economy and growing competition from European carriers as trade barriers fall on trans-Atlantic travel.

Continental said on Sunday in a letter to its employees it has chosen not to merge with any other airline but will continue to consider an alliance with other carriers.

"We have significant cultural, operational and financial strengths compared to the rest of the industry, and we want to protect and enhance those strengths -- which we believe would be placed at risk in a merger with another carrier in today's environment," Chief Executive Larry Kellner and Vice President Jeff Smisek said in the letter.

Continental's decision comes a few days after United's shares dropped more than 40 percent in one day when it posted a loss of USD$537 million in the first quarter.

One source familiar with the matter said the development came as a surprise to United, which had been negotiating in expectation of reaching a deal by late this week.

After racking up USD$35 billion in losses and finally emerging from a 5 year slump in 2006, US airlines are hoping mergers could give them greater market power to reduce flights and raise fares.

The airlines also face a renewed sense of urgency to cut costs as jet fuel prices have more than doubled since the start of last year.

Continental, which has said it would prefer to remain independent unless the competitive landscape changes, had laid most of the groundwork for a merger with United, sources had said.

Under terms that were being negotiated, Continental's Kellner would have been CEO of the combined company and Smisek would have been president, sources said. United CEO Glenn Tilton was to get a seat on the board of the combined company.

But talks broke off this weekend, with Continental now focusing on an alliance with BA and American.

Airline alliances allow partners to streamline costs while sharing revenues. Without antitrust immunity, the data and revenue shared on the routes would normally be considered collusive.

American and British Airways have tried twice, without success, to win immunity from the government for their transatlantic alliance.

Regulators have long been concerned that stronger ties between American and BA would jeopardize competition at London's Heathrow Airport for other US carriers.

But air travel restrictions have eased under a US-European Union "Open Skies" agreement that took effect in March, creating new opportunities for transatlantic air services.

Earlier this month, the US Department of Transportation granted tentative antitrust immunity to the SkyTeam alliance involving Delta, Northwest, Air France-KLM and Alitalia.

Continental, which has a marketing alliance with SkyTeam but was not part of the group that received antitrust immunity, will review its participation in that alliance.

American Airlines is part of the 10 member oneworld alliance, which includes BA, Cathay Pacific, Finnair, Iberia and Japan Airlines. But Continental's talks, for now, would focus on grouping with only BA and American.

This paves the way for a deal between United Airlines and US Airways, which have had serious merger talks of their own, according to sources briefed on the matter.

UAL's market value stands at USD$1.8 billion, while US Airways is valued at USD$657 million, one of the lowest among major carriers.

A United-US Airways deal foundered in 2001 on antitrust concerns. But consolidation proponents say the industry and the two carriers have changed dramatically.

Both have restructured hubs and routes during long periods in bankruptcy, and United has reduced domestic capacity to focus more on international routes.

Analysts have said a United-US Airways merger would not be very complex as wages at the two carriers are closely aligned and their fleets mesh well. The two are also part of the same global marketing alliance.

(Reuters)

Gerald