American Airlines (NASDAQ:AAL) just got a windfall of more than $425 million, according to the U.S. Department of Justice. That's the total proceeds from American selling off valuable slots at crowded airports in New York and Washington.
American Airlines CEO Doug Parker stated that the slot sale brought in much more money than expected: The slots had been appraised at just $225 million. However, as a result of these slot sales -- particularly at Reagan National Airport, which is just outside of Washington, D.C. -- American Airlines will face much tougher competition.
Making room at two crowded airports
As part of its merger with US Airways, American Airlines agreed to sell off 17 slot pairs at New York's LaGuardia Airport and 52 slot pairs at Washington's Reagan National Airport. Some of those slots were already leased to Southwest Airlines (NYSE:LUV) and JetBlue Airways (NASDAQ:JBLU), who received rights of first refusal to buy them.
The DOJ mandated that American Airlines auction off the rest of the slots to low-cost carriers. Ultimately, Southwest acquired 11 slot pairs at LaGuardia Airport and 28 at Reagan Airport (one of which it is relinquishing). Virgin America bought the other six slot pairs at LaGuardia and four slot pairs at Reagan. Lastly, JetBlue acquired 20 slot pairs at Reagan Airport.
Potential bidders could get a pretty good approximation of what the slots were worth based on the results of a similar slot auction for the two airports in late 2011. At that time, JetBlue bought eight slot pairs at Reagan Airport for $5 million each and eight slot pairs at LaGuardia Airport for $4 million each. Based on these valuations, the slots American sold would have been worth around $325 million.
However, airline industry profitability has increased significantly since 2011, boosting the value of scarce slots at these two popular airports. Additionally, it is widely recognized in the industry that there aren't likely to be any more large scale slot openings at either airport.
This caused the ultimate purchase price to exceed $425 million. Of that total, American Airlines is receiving $381 million in cash. The remaining value represents slots that it is acquiring from JetBlue at JFK Airport in New York.
Competition is rising
At Reagan Airport, US Airways long benefited from a lack of low-cost carrier competition. Since other legacy carriers used most of their slots to fly to their own hub airports, US Airways simply avoided flying from Reagan Airport to most of those hubs. This ensured that it faced little or no nonstop competition on the routes it did serve, making Reagan Airport one of the most profitable airline hubs in the U.S.
With dozens of new daily nonstops on low-cost carriers arriving later this year, the calculus is about to change radically. JetBlue has announced routes for six of its new slot pairs at Reagan Airport. In June, it will begin flying two daily nonstops each to Hartford and Charleston, S.C. Today, both routes are American Airlines monopolies (through the US Airways subsidiary).
Southwest Airlines, which won the most slots in the auction, has not disclosed its plans for the most part. However, it has announced new nonstop service from Love Field in Dallas to both LaGuardia and Reagan beginning in November. Today, American holds a monopoly on nonstop service from the Dallas area to Reagan Airport and a 76% seat share to LaGuardia Airport.
Virgin America also recently announced plans to use its newly won slots at Reagan and LaGuardia for nonstop flights to Dallas. If Virgin America gains access to two gates American is relinquishing at Love Field, it will offer four daily round-trips on both routes. This would turn two routes that American currently dominates into fiercely contested battlegrounds.
Today, American Airlines is getting a nice windfall from selling slots at New York's LaGuardia Airport and Washington's Reagan National Airport. However, investors should also recognize why American is getting so much money for these slots: low-cost carriers see underserved routes at these airports that represent big opportunities to gain market share.
The impact to American will be minimal at LaGuardia Airport, as only a few slots are changing hands and American Airlines doesn't dominate that airport. However, American dominates Reagan Airport today, making it an extremely profitable hub.
As JetBlue, Southwest, and Virgin America add flights there, American Airlines will face a vast increase in competition on multiple routes. This will undoubtedly cut into profit margins on those routes. The only question for investors is whether American can make that up through better results in the rest of its network.
Adam Levine-Weinberg has no position in any stocks mentioned, and neither does The Motley Fool. 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.