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United's Note to US Airways: Mergers Can Be Ugly

Tickers in this article: AAMRQ.PK DAL LCC UAL

CHARLOTTE, N.C.( TheStreet) -- While Delta (DAL) and US Airways(LCC) spent their fourth-quarter earnings calls extolling their 2012 results, United (UAL) was almost apologetic.

The big difference was the number of years since the carriers engaged in mergers. US Airways began a merger with America West in 2005, Delta began a merger with Northwest in 2008, and United began a merger with Continental in 2010. They all created problems, but United's problems were not only the worst but also the most recent, consuming the airline in 2012 even as Delta and US Airways soared and American (AAMRQ.PK) worked its way through a largely successful bankruptcy reorganization.

United executives reiterated Thursday that not only did the merger bring higher cost and lower revenue in 2012, but also labor costs will rise in 2013 as a result of new contracts that resulted at least partially from the merger.

On the United call on Thursday, CEO Jeff Smisek called 2012 "the toughest year of our merger integration" and said, "We are absolutely not satisfied with the financial results we produced last year."

In its summer schedule, United sought for the first time to fully merge operations of the two airlines. Operational performance plummeted, reaching a low in July when the carrier's 64% on-time arrivals rate was the worst in the industry. Problems included the introduction of new fleet types in various stations, unaccompanied by the introduction of appropriate jet bridges; a series of computer glitches; and a reduction of the number of spare aircraft in the fleet. One result of the latter miscalculation: in the second week of July, 300 passengers were stranded in Shanghai for three days.

To compensate, United invested heavily in resolving its problems -- adding extra spare aircraft, boosting aircraft flying time and ground time, and increasing staffing. Said Rainey, "We have attacked some of our operational problems with a blunt instrument -- we've thrown head count at (them)."

As costs rose, revenue fell, because passengers, particularly corporate customers, were booking away. "The operational challenges we faced last summer influenced corporate customers," Rainey said. "Some of our corporate customers took a detour while the road was under construction."

United said its passenger revenue per available seat mile rose just 1.7% during the year.

"The biggest disappointment from my perspective was the revenue 'dis-synergies,' " said Jim Compton, chief operating officer. Lost revenue cost United "one or two points in RASM that we underperformed," he said. During the year, Delta PRASM rose 7%, AMR PRASM rose 5.8%, and US Airways PRASM rose 3.9%.

One final metric: Instead of a targeted goal of a 10% return on invested capital, United came in at 8%, executives said.

This year, several analysts are recommending United, saying the problems have passed. But S&P Capital IQ analyst Jim Corridore retained a hold on the shares. "We see improvement this year and expect UAL to narrow the gap between itself and peers on revenue performance," Corridore wrote Thursday, in a note. But, he said, "UAL's ongoing integration challenges keep us cautious on the shares, despite our positive view on the overall U.S. airline industry." Corridore has a price target of $26. Shares closed Thursday at $25.54.