Is American Airlines Helping DOJ Make Its Case?

Federal regulators have recently thrown up roadblocks to the planned merger of US Airways (UNKNOWN: LCC.DL  ) and AMR (UNKNOWN: AAMRQ.DL  ) , the parent company of American Airlines. The Department of Justice is worried that allowing two of the top five U.S. carriers to merge will hurt competition. DOJ lawyers also argue that the merger is unnecessary because AMR and US Airways can be successful independently.

American Airlines and US Airways planes tail-to-tail. Photo: AMR.

Executives at both companies have staunchly denied the DOJ allegations. They claim that the merger will provide the best restructuring option for AMR and that it will improve competition. AMR and US Airways leaders claim that by combining their complementary networks, they will be better able to compete with Delta Air Lines (NYSE: DAL  ) , United Continental (NYSE: UAL  ) and Southwest Airlines (NYSE: LUV  ) : all the products of recent airline mergers.

Unfortunately, AMR and US Airways executives have showed a distinct tendency to incriminate themselves. It's becoming increasingly clear that an AMR-US Airways combination will earn higher profits than would be consistent with vibrant competition. As a result, the DOJ -- which is already taking a hard-line stance toward the merger attempt -- is likely to become even more strongly opposed to the merger.

Full recovery
This week, AMR disclosed that it earned a record profit of $349 million before reorganization costs on revenue of $2.48 billion in July. That implies an adjusted profit margin of 14.1% and an adjusted operating margin of 16.6%. These figures are very high by the standards of the airline industry.

By contrast, Delta -- which has been the top-performing legacy carrier recently -- last month projected an 11%-13% operating margin for Q3. While that forecast also includes the seasonally weaker month of September, it's still unlikely that Delta earned a higher profit margin than AMR last month.

In other words, despite having less scale than Delta, AMR is already earning comparable or higher margins. That undermines the argument that AMR needs to merge with another carrier to remain viable.

Because of its ongoing bankruptcy case, AMR has to report results monthly. Thus, while AMR's strong July results appear to bolster the DOJ's case, releasing them was unavoidable. However, CEO Tom Horton aggravated matters with a triumphant memo to employees, in which he described AMR's restructuring as one of the most successful in aviation history.

American is already profitable enough to easily earn returns in excess of its cost of capital. If a merger  improves American's profitability even further, it will be a clear indication that the company is benefiting from a dearth of competition.

Furthermore, AMR and US Airways have been pushing for a speedy trial to resolve the DOJ's antitrust agreement. The two companies want the trial to occur in November so that they can complete the merger by year's end (if they win). Part of their argument for a quick trial is that AMR is still under bankruptcy protection and that it would be "unreasonable" to prolong its stay there.

However, as AMR's results show -- and Horton's memo emphasizes -- American Airlines has never been in better financial shape than it is today. Not surprisingly, lawyers for the DOJ have already cited AMR's record July profit in its request to set the trial for March 2014 -- nearly four months later than the timeline AMR and US Airways proposed. With AMR doing just fine in bankruptcy, it will be hard for the airlines to convince a judge of the need for an accelerated trial.

Foolish bottom line
AMR and US Airways can make a good case for why they should be allowed to merge. After all, DOJ allowed Delta to merge with Northwest, allowed United to merge with Continental, and allowed Southwest to buy AirTran. Nevertheless, the case is not airtight. While it may seem unfair to prevent AMR and US Airways to follow in their competitors' footsteps, some aspects of the merger would be clearly anti-competitive.

AMR's management didn't do itself a favor by highlighting how profitable it is as a standalone entity. It merely gave the DOJ further ammunition in its bid to delay the antitrust trial and ultimately derail the merger. Over the next several months, we'll see just how much damage was done.

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

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 August 31, 2013, at 1:24 PM, JSnowe1 wrote:

    Of course it's not helping the doj's case. The doj case is very weak, there is nothing of any value in it. The only thing they have of substance is the HHI they used for 1000 1 stop connects. That use of the HHI was flawed as there are tens of thousands. They alos excluded swa from that metric.

  • Report this Comment On August 31, 2013, at 2:04 PM, cammi1 wrote:

    Delta's profit margin may be less because they pay their employees industry wages, unlike the bankruptcy wages many employees at USAirways and American still operate under. Merger would change some of that.

  • Report this Comment On August 31, 2013, at 2:36 PM, kmo12 wrote:

    American's profitability was tied directly to bankruptcy and changes made in anticipation of the expect merger, it was not the result of proper management or any type of viable restructure. Rather than reporting misleading information, why don't you investigate WHY American realized a profit? Delta has had to negotiate fair wages with its employees, whereas American dumped pensions, wages, and benefits in BK. (And that's just one factor.)

  • Report this Comment On August 31, 2013, at 4:57 PM, Retire14 wrote:

    It is not the DOJ's business whether a merger is "needed." It is simply to judge on being a detriment to competition The previous approval of Delta/NorthWest and United/Continental mergers guarantee an permanent, unfair advantage to those two mega carriers.

    Three healthy international competitors is a very healthy situation.

    Too late and unfounded opposition, and it would be unfortunate if the merger was approved only if a significant amount of slots are given up at Reagan National.

  • Report this Comment On August 31, 2013, at 7:23 PM, usairmrt wrote:

    doug parker talking to much always has been a problem! What worries me most that he has not shown any respect for the people that built these two great airlines. I just wish he would keep his hands out of our pockets and stop filling his..

  • Report this Comment On September 01, 2013, at 5:13 AM, joanofarc13 wrote:

    American Airlines unloathes its uncouth cable show. AMR and US Airways is a coupe reinstatement of Italian American dealings on boeings. Keeping its Nielsen ratings stub misleading Americans to believe the convergence protects the airline business industry.

  • Report this Comment On September 02, 2013, at 1:39 PM, TMFGemHunter wrote:

    @Retire14: It's not as cut-and-dried as you imply. If AMR and/or US Airways were not viable standalone businesses, then a merger would clearly be better for competition than the alternative of one or both ceasing operations.

    Why should DOJ necessarily want 3 "healthy international competitors"? From a consumer perspective, healthy sounds very much like content. If you want the lowest prices, you need to have edgy competitors, which is basically what US Airways is today. US Airways has hubs in smaller cities and therefore has to discount to fill its planes. Post-merger, those discounts are likely to be radically scaled back as capacity gets shifted towards bigger markets.


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