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Why this merger still makes sense

Thursday - 5/3/2012, 11:48am  ET

What I was thinking while going through United Continental's first-quarter results was that the company could have taken steps to prevent the integration-related glitches that led to a loss.

Given high fuel costs, one thing airline companies should know is that they simply cannot afford more problems. Too bad the company allowed its technical support to go haywire over the past few months. However, I wouldn't be too critical of its prospects, as the loss should be a one-off situation and the company looks set to reap the benefits of this integration.

Take a look.

The necessary evil
While the first quarter tends to be weak for airline companies, UAL subsidiary United Airlines had a unique set of problems. Early in March, the company fully merged with Continental, after acquiring it in 2010. Converting United and Continental into a single passenger service system that included integrating into a single website and loyalty plan was a whopper of a technical challenge. It included 1.7 million hours of training and required the upgrade of 12,000 work stations, not to mention the integration of 17 million passenger records.

This uphill task was not a smooth one, leading to several technical glitches that led to delayed flights and jammed phone lines, annoying passengers. As a result, United experienced low bookings, unsold tickets, and also had to turn away last-minute customers who are generally willing to pay extra, all of which weighed on its top line.

The impact of weak sales can be clearly seen in its passenger revenue per available seat mile (PRASM), an important metric that measures profitability. During the quarter, United's PRASM grew by 5.2%, which was weaker than the 14% posted by peer Delta Air Lines . Delta also outpaced United in terms of overall revenue growth. While United generated $8.6 billion in revenue, a modest 5% increase compared to last year, Delta's revenue surged by 10% from last year to $7.2 billion.

Clearer skies
However, the worst seems to be over. United looks better-positioned following this integration. The company can now begin to take advantage of its updated computer network, which should help it keep track of passenger information and improve forecasts for ticket demand. The integration synergies are also likely to improve passenger revenue in the long run.

Barring the effect of the integration charges, the company posted a loss of $286 million. This translates into earnings of $0.87 per share, which was better than Street expectations of a loss of $1.04 per share.

Looming concern
Spiking fuel costs have been biting into the profits of all airline companies and United was no exception. Once again, rising fuel prices outpaced the company's top-line growth. United paid $3.2 billion in fuel bills, which was 21% higher than the previous year. Competitor Southwest Airlines complained of a staggering 45.5% increase in fuel costs that was, however, partially offset by increased passenger traffic and higher fares.

United, the world's largest carrier, has its own strategy to combat these costs. In 2012, the company plans to reduce its seating capacity by 0.5% to 1.5%, which should put it in a better position to command fares.

The Foolish bottom line
United Continental has had a turbulent quarter, but it looks like the pieces are falling into place. The company should be stronger given its increased efficiencies and scale. In addition, many airlines seem to be grabbing for additional routes to increase their pricing power in the industry.

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This article was originally published as Why This Merger Still Makes Senseon Fool.com

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