American Airlines' parent company AMR (NASDAQOTH: AAMRQ) announced it was filing for bankruptcy, and its stock price sank. When US Airways (NYSE: LCC) and AMR shareholders agreed to a merger, investors' newfound hopes gave shares a boost, despite the combined airline's uncertain future. But American's share price has yet to factor in the merger woes and profitless quarters that will surely accompany attempts to integrate the two airlines.
The market responds to a distracted investor focus
When AMR announced a settlement with the DOJ over its antitrust lawsuit on Nov. 12, its stock hit its current 52-week high of $13.50.
On Nov. 27, a judge gave AMR the final approval to merge. AAMRQ responded predictably as the ruling was issued, rising to $12.25, the highest it has been since Nov. 12.
Don't take this climb in the price as a signal of investment success, however -- not now, and not under the stock of the new American.
AMR shareholders are distracted, focusing on the short-term implication of the merger. While the short-term is positive -- investors will receive at least 3.5% equity in the new American -- that rosy outlook doesn't necessarily extend into the next two to three years.
Where to focus instead
Investors should start asking what the post-merger years will be like -- and remember what other airlines went through in the wake of their own mergers.
Customers' pain during the creation of United Continental Holdings (UAL 4.98%) had negative financial implications. CEO Jeff Smisek called 2012, "the toughest year of our merger integration" and admitted he was "absolutely not satisfied with the financial results we produced last year."
In 2012, only 77% of United flights arrived on time -- 5% below the industry average. Additionally, United lost more bags compared to the prior year, for a total of 3.87 per 1,000 passengers, above the industry average of 3.07. United's 2012 complaint rate more than doubled from 2011 to a 2012 average nearly triple that of the industry. In the end, United's 2012 overall Airline Quality Rating sunk to 1.07 points below the industry average.
A different batch of problems
Passengers anticipated some of the turmoil that surrounded the United merger based on experience from previous airline mergers. However, it hit passengers harder than both they and United itself expected. What customers can expect this time around is less predictable.
When Delta (DAL 3.05%) and Northwest merged in 2008, both were SkyTeam members. Likewise, when United and Continental merged in 2010, both were Star Alliance members. But with American Airlines in the Oneworld Alliance and US Airways in the Star Alliance, business and frequent fliers face a whole new set of troubles.
There will be problems integrating the two frequent flier programs and satisfactorily recognizing the elite members of each. The lack of uniformity at the alliance level may cause extra turmoil when combining computer systems. The miles US Airways and American frequent fliers earn will also soon be devalued, something both Delta and United have already done. This means booking certain free award travel will require more miles per award than it currently does.
Looking ahead
The new American will have to shake off the dust from a two-year bankruptcy proceeding and begin the merger process. Only when that is complete will it be able to pay attention to its competition. Therefore, basing any part of a company valuation on the fact that shareholders have at least 3.5% coming is to miss the mark.
American's focus will not be fully on global competition for at least two years, and when it does begin to focus on that, it will have to play catch-up. The new American will fly to just five cities across the Pacific, and 21 across the Atlantic.
Meanwhile, United's global network has been expanding all year, and it currently offers more options than American and US Airways combined -- a fact not helped by the existence of zero US Airways flights across the Pacific. When you consider the strength of United's Star Alliance, especially on those Pacific routes, American looks even weaker.
Despite the disintegration at the alliance level and the merger complexities to come, if historical context proves right, long-term investors will see the new American emerge safely.You can expect shares to dip to single digits, and kiss at least some of your checked bags goodbye, but eventually the United States will offer the global airline industry three powerful competitors.
To show its investment-worthiness, American Airlines has been trying to properly position itself for performance despite its legal focus over the past two years. American now operates the only aircraft with three classes of service on transcontinental routes, and other routes will see new aircraft as the weeks go on.
Over the next two to three years, watch how American works to appease, maintain, and grow its customer base. As the eyes of government regulators divert, watch for American to position itself for global competition. And during the ugly days of the merger, when American stock dips to a price you are comfortable with, consider investing not in the airline as it is, but as it will be in the future.
