(Agencies)
Updated: 2008-04-26 10:53

NEW YORK - American Airlines (AMR.N) has had early-stage merger talks with US Airways (LCC.N) and is in advanced talks for an alliance with Continental Airlines (CAL.N), sources briefed on the situation said on Friday.

American Airlines MD-80 aircrafts sit on the tarmac at Chicago's O'Hare International Airport April 9, 2008. [Agencies]

News of the talks comes after Delta Air Lines' (DAL.N) and Northwest Airlines' (NWA.N) announced nearly two weeks ago they planned to merge to become the world's largest airline, seeking to counter skyrocketing fuel prices, a weak economy and a growing competitive threat from European carriers as trade barriers fall on trans-Atlantic travel.

American Airlines' talks with Continental are focused on forming an alliance that could share passengers, much like the SkyTeam partnership that includes Air France-KLM (AIRF.PA), Alitalia (AZPIa.MI), Czech Airlines, Delta Air Lines (DAL.N), and Northwest Airlines (NWA.N), the people said.

Alliances have flourished in the industry because they generate profits through marketing programs and flight code-sharing without the headaches of combining operations.

But Continental is also in advanced talks with United Airlines (UAUA.O) for a full merger, the sources said. Continental will choose either the merger or the alliance, not both, sources said.

Meanwhile, United Airlines is also in serious merger talks with US Airways, and will choose to merge with either Continental or US Airways soon, the people said.

American's talks with US Airways were not serious at this point, one person said.

Aviation consultant Bob Mann said a US Airways-American Airlines merger would not be a marquee matchup and would give American, currently the largest U.S. carrier, little extra depth overseas.

"It doesn't match Northwest-Delta and it would not match the global presence of a Continental-United, if that were going to happen," Mann said. "But I think if Delta-Northwest does happen and Continental (and United) does happen, about the only thing left on the board is US Airways."

All of the airlines declined to comment.

MEGA-MERGER?

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 even before Delta and Northwest announced their deal, the sources said.

Under the terms being negotiated, Continental Chief Executive Larry Kellner would be CEO of the combined airline and UAL CEO Glenn Tilton could be chairman, the people said. Other details are still being negotiated in what would be another all-stock deal.

Combining United with Continental would create a company with a combined $35 billion in revenue and nearly 100,000 employees, surpassing the Delta-Northwest combination.

But that merger may not happen. United Airlines, whose shares plunged 40 percent when it reported a quarterly loss earlier this week, is also talking to US Airways.

Analysts have said a merger of United and US Airways would be less complex than a United/Continental combination.

JP Morgan analyst Jamie Baker said earlier this week a deal between United and US Airways could be easier when it comes to aligning pilot pay, combining fleets and cutting flights and seats.

Baker also said the merger would be easier because United and US Airways already have code-share agreements and are part of the Star Alliance.

"United was interested in America West in 1998, US Air in 2000. Today, both are available under one roof," Baker said. America West and US Airways merged in 2005.

REGULATORY APPROVAL

After racking up $35 billion in losses and finally emerging from a 5-year slump in 2006, U.S. 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.

The carriers will be forced to make decisions in the coming weeks as they would like to have any mergers approved under the administration of President George W. Bush, which is considered more merger-friendly but ends in January.

All talks have been ongoing since January this year, after people heard that talks between Delta and Northwest had become serious. Delta and Northwest announced their merger April 14 in an all-stock deal then valued at just above $3 billion.

The Justice Department has said it would, if necessary, weigh multiple merger proposals in the airline industry and try to complete any reviews before the Bush administration leaves office.

While there is broad industry belief that the Northwest/Delta combination stands a good chance of being approved, some competition experts believe a follow-on deal could face a tougher challenge due to a further narrowing of competition that could lead to higher fares and fewer choices for travelers.