After dropping 40% in one day, shares of American Airlines' parent company AMR (UNKNOWN: AAMRQ.DL ) undoubtedly left some red ink in airline investors' portfolios. The Department of Justice's decision to challenge the company's merger with US Airways (UNKNOWN: LCC.DL ) left shareholders of AMR in peril, since the merger provided their most likely chance at recovering any value from those shares. But could the Department's decision eventually get AMR shareholders more than they expected? It's possible -- but not certain.
All or nothing
Unlike other major carriers, whose share prices' development over time reflects various energy, economic, and industry factors, AMR shares will be made or broken by the result of the merger negotiations and lawsuit. Due to American Airlines' bankruptcy, creditors must be paid before shareholders as the airline restructures. In most bankruptcies, especially those for airlines, common shareholders receive nothing, since there are not enough funds to even pay creditors in full. The merger with US Airways calls for AMR stakeholders to receive shares in the new merged entity (American Airlines Group, or AAG), however, with some AAG shares even going to AMR common shareholders.
Under the merger plan, AMR common shareholders would receive 3.5% of AAG, and begin to receive substantially more as US Airways shares rise above $14.99. Based on the values given in the AMR bankruptcy plan, AMR shares would be worth the following amounts using the figures in the AMR bankruptcy documents divided by a share count of 335.5 million..
|US Airways share price||Value of AMR shares upon conversion|
The value of AMR shares depends on a successful merger with US Airways, since it's virtually the only way AMR common shareholders could receive anything. The DOJ lawsuit threw this merger into question by not only reducing the odds of such a payoff, but also by sending US Airways shares down, making potential investors' balance of risk and reward less enticing.
Could it pay off?
Right now, AMR shares have taken an understandable beating. With the merger now up in the air (no pun intended), the risk of an investment in AMR has skyrocketed. At the same time, many traders who saw an arbitrage play on the merger have run for the hills; they came to play on a slight merger pricing discrepancy, not to speculate on airline lawsuit battles.
If investors hope to reasonably extract any value from AMR shares, they'll need to see the merger approved in the end. Many analysts still expect this to happen, and consider the DOJ's lawsuit a negotiation tactic. If this is the case, the main effect of the lawsuit will be to delay the merger, not to stop it.
Despite much carping from the airlines about how the merger's delay will hurt them financially, this is where AMR shareholders could see potential gains. Since AMR shares rise faster in value as US Airways shares gain, they represent a leveraged play on US Airways. That leverage has an expiration date, however: the day the merger is completed or denied.
At the same time, if the merger is approved, the market will likely see such a development as a positive for US Airways and the industry as a whole. Indeed, the market severely punished airline stocks when the lawsuit threw the merger into question. And by completing the merger, this integration would continue the narrative of airlines as an increasingly consolidated industry, where fewer competitors means less competition.
In the meantime, Delta Air Lines (NYSE: DAL), which completed its merger with Northwest Airlines in 2008, has been impressing investors lately. After finishing its integration, Delta has slashed net debt, reinstated a dividend, and been included in the S&P 500 as only the second airline in the index (the other being Southwest Airlines making Delta the only legacy carrier in the S&P 500).
But there could be more to come for Delta if this latest merger is approved. As the traditionally ultra-competitive airline industry shrinks to a few major carriers, airlines get greater pricing power, allowing them to more easily raise fares and fees. While consumers are rarely in favor of paying more for plane tickets, from an airline's perspective the merger is a clear positive for the bottom line.
Although the US Airways/AMR merger is still in question, the impression of today's airlines as more stable and profitable than those of the past has fueled a general uptrend in airline stocks. Had the merger simply have been allowed to go through, AMR shares would be converted into US Airways shares a lot sooner.
However, the delay in the merger has extended the time until the AMR shares would convert -- if the merger succeeds at all. Since AMR shares are a leveraged play on US Airways shares, this delay effectively gives AMR shareholders more time to have leverage over US Airways stock.
Temporary pain for later gain?
AMR shareholders must have been disappointed to see the DOJ file a lawsuit against the airlines' merger. While there is still a very real possibility that the merger will ultimately fail and AMR shareholders will not see a dime after the bankruptcy restructuring, if the merger does prevail then AMR shares could be significantly more valuable. The delay means that US Airways shares will have more time to rise or fall before the merger is approved or denied. Any significant rise that happens in that time could cause AMR shares to more than double if the merger is approved, or leave shareholders penniless if it's denied.
None of this is for certain, of course, but we do know that this merger battle is far from over. The possibilities of losing everything or seeing multibagger returns definitely make this a speculative investment. And with this type of investment, you should always gather as much information as possible, and only use money you can afford to lose.
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