On Thursday morning, US Airways (UNKNOWN:LCC.DL) and American Airlines (UNKNOWN:AAMRQ.DL) formally announced their intention to merge. This decision was not much of a surprise. US Airways has been pursuing a merger for the past year, and numerous reports on Wednesday evening stated that the two companies' boards had already voted for the merger.
The merger agreement comes at an implied company valuation of $11 billion. That is below the $12.2 billion market cap of competitor Delta Air Lines, but well above the $8.5 billion market cap of the third major network carrier, United Continental. In the long run, the market will decide what the new American Airlines is really worth. Here is what shareholders of American Airlines and US Airways need to know for now.
Creditors and stockholders of American Airlines parent AMR will receive 72% ownership of the new company. The majority of that amount will go to "unsecured creditors," people who owned AMR or American Airlines debt, or who had contracts with American that were voided during the bankruptcy process. Labor groups will also get a substantial portion of the new stock, in return for their recent concessions. Common stockholders are set to receive a minimum of 3.5% of the new company.
Based on the proposed $11 billion valuation, AMR stockholders will receive $385 million of equity in the new carrier. If the valuation moves higher following the merger, and AMR can fully satisfy the claims of its unsecured creditors, common stockholders could end up with additional shares. Following the merger news, AMR shares spiked as high as $2.50 before falling back to around $2 in the late morning. At $2, AMR's current market cap of $660 million is well above the $385 million projected equity stake for common shareholders. In other words, unless you believe that American's ultimate valuation will be significantly higher than $11 billion, now is a good time to sell! As I wrote last week, integration costs and uncertainty about revenue synergies mean that the $11 billion valuation is already fairly "stretched."
US Airways will get the remaining 28% of the combined carrier. However, it is important to note that the percentage is calculated based on "diluted shares." US Airways has about 162.5 million basic shares outstanding, but there are also more than 40 million shares set to be issued to holders of employee stock options and convertible debt. Based on the $11 billion proposed valuation and a US Airways diluted share count of 205 million, US Airways stock would be worth $15.
Despite this news, US Airways shares sank as low as $13.50 on Thursday morning. This 10% discount may reflect investor skepticism about the $11 billion valuation assumed by the two management teams. My inclination is to stay away from either stock at this point, as the difficulty of integrating two major carriers will probably constrain profit for the next two years. However, if you want to invest in this merger story, buying US Airways stock definitely looks like the better way to do so.