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How Good Companies Use Bankruptcy to Their Benefit

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By now you're aware that American Airlines parent company AMR (NYSE: AMR  ) filed for Chapter 11 protection. As the latest major U.S. carrier to file for bankruptcy protection, American faces significant challenges to keep its business flying. Let's look at rival carriers and how their respective restructuring plans helped them become more competitive after emerging from bankruptcy.

Before we delve in, it's important to understand that shareholders at the time of bankruptcy usually lose everything. Businesses operating under Chapter 11 protection will generally be delisted from major stock exchanges.

When these companies go public after bankruptcy, new stock is issued as part of their reorganization plan. It's essential to understand that the old stock and new stock usually have no relation, even if they share the same ticker symbol.

An industry trend
American joins competitors Delta (NYSE: DAL  ) and United Airlines in seeking help from the bankruptcy courts. United filed for Chapter 11 protection in 2002, after the company was unable to secure a government loan guarantee to avoid bankruptcy.

At the time of filing, United's assets totaled $25.1 billion. In 2006, United emerged from what was the most expensive airline bankruptcy in history. The carrier was able to reduce its average annual costs by nearly $7 billion -- putting it back on the path to profitability. United parent UAL then merged with Continental in 2010 to become United Continental (NYSE: UAL  ) .

Over the past 12 months, United Continental has reported more than $33 billion in revenue, with a profit of $653 million. Compare that to American's $23.6 billion in revenue, and bottom-line loss of $982 million. Clearly, American needs to become more cost competitive if it wants to survive in the long term.

Delta flies into bankruptcy
Delta Airlines filed in 2005. One of the largest airlines in terms of passengers carried, Delta's assets totaled $21.8 billion at the time of its filing.

Two years later, the American Airlines rival emerged from bankruptcy stronger and more profitable. By restructuring much of its $20.5 billion hole of debt, Delta was able to remove unprofitable routes, reduce its fleet of aircraft, and lower expenses -- eliminating about $2 billion in annual costs.

Additionally, by capitalizing on international routes with the highest profit potential, the carrier was able to successfully expand its global business. Delta now offers service to 351 destinations in 64 countries on six continents.

Clear for landing
In 2007, the airline emerged from bankruptcy having posted four straight quarters of profits. By the end of that year, Delta was able to reduce its net debt from $17 billion to $7.5 billion.

The airline left bankruptcy with $2.5 billion in exit financing from six leading banks including JPMorgan, Goldman Sachs, and Bank of America's Merrill Lynch. Delta used the financing to make payments for exiting bankruptcy and to boost its cash balance.

By taking these steps, Delta was able to lower costs and improve its capital structure -- issues that American Airlines hopes to tackle through the Chapter 11 process.

An unfair advantage
American Airline's costs have dramatically outgrown the costs of its rivals. Both Delta and United Airlines used the courts to reorganize their debt, while American was left at a disadvantage.

As American looks to restructure, the company could reduce its workforce and minimize travel on unprofitable routes -- similar to other airlines before it. However, it is business as usual for the airline, as operations remain on schedule heading into the holiday travel season.

Blue skies or a crash landing?
Luckily, the company had $4.1 billion in cash and short-term investments when it filed for protection. This cash hoard may help American retain more leverage during bankruptcy, as it won't have to rely as much on outside financing to keep its business flying.

The money is more than double the $1.5 billion Delta had when it filed in 2005, as well as the $800 million under United Airlines when it sought protection in 2002.

American hopes bankruptcy will help strengthen its balance sheet and build a foundation for long-term success. Tim Horton, the new CEO of AMR, has little doubt about the airline's eventual recovery. In fact, Horton confirmed a jet deal with Boeing (NYSE: BA  ) and Airbus to deliver American's new narrow-body aircrafts.

But don't worry; the contracts for new planes are hardly a splurge. The jets come equipped with General Electric's (NYSE: GE  ) new Leap X's engines, which should boost fuel efficiency by 15% -- ultimately cutting down fuel costs for the airline.

AMR faces significant challenges and tough competition going forward. However, it wouldn't be the first U.S. airline to exit bankruptcy as a stronger version of its former self. Click here to track AMR's journey to profitability with My Watchlist, a free Motley Fool service.

Fool contributor Tamara Rutter does not have a financial position in any of the companies mentioned in this column. Follow her on Twitter, where she uses the handle @TamaraRutter. The Motley Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 08, 2011, at 8:52 PM, John10101 wrote:

    "...Airbus to deliver American's new narrow-body aircrafts."

    "Aircrafts"? Seriously? Hard to take your analysis seriously when you aren't even familiar with basic grammar of the language in which you write.

  • Report this Comment On December 08, 2011, at 10:05 PM, luvwrm wrote:

    Voiding your contractual agreements, hosing your employees out of their pay and benefits, and becoming a totally dishonest/corrupt business entity for the sake of stealing a buck from those you work with and do business with is disgusting and reprehensible. There will be accountability one day for these actions and the end DOES NOT justify the means. I'm not sure where executives get off thinking this is okay, but I can guarantee you that they will still gladly take their bonuses and would be HIGHLY offended if someone did these actions to them personally. Watch and see...

  • Report this Comment On December 09, 2011, at 2:14 AM, captainweg wrote:

    As a former United employee, I would like to see airlines or any business who defaults on their pensions in bankruptcy and turn them over the the PBGC, have to still contribute some portion to help close the gap of their promised amount and the actual amount the PBGC will pay. This will help balance the playing field with other companies that keep their promises to their employees. Corporate "Business" has far too many privileges that allow them do such things as default on their moral obligations to make good on a promise they made to employees when they hired them. It was not only 9-11, but also their bad decision making prior to that that led them to bankruptcy. United brings a guy in like Glen Tilton to run a company because he helped guide Texaco through their bankruptcy, who has no airline experience what so ever.

    I sat in on a company meeting with him and he was asked, "... what is your commitment to the airline going forward?" His response was that he was on a 5 year contract and at the end he would probably retire. What a visionary leader he turned out to be! Slash and burn corporate decisions in the protection of bankruptcy makes the sharholders feel great upon exit, but leaves bitter feelings on the folks that drive your bottom line each and everyday.

    United's focus was always on the shareholders. Even on the eve of bankruptcy, Glen reiterated the former CEO's belief, that"... we must take care of the shareholders so that we can buy more airplanes, to get more customers so that you all can stay employed." Pretty sad.

    A better model - take care of your employees, who take care of your customer and inturn will drive the share price upward.

    If you want to take a look at an airline that balances their responsibilies to their employees and customers while maintaining the bottom line for the shareholders, seek Alaska Airlines. I work for them and am proud to say so.

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