Will US Airways Take Off if it Acquires American Airlines?
Jonathan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
US Airways (NYSE: LCC) is negotiating against itself in its attempt to buy the bankrupt American Airlines. That is never a wise move in any bidding process. But, so far, the market is rewarding these efforts as US Airways is up more than 185% for 2012, in large part due to its efforts to acquire American Airlines. By contrast, United-Continental (NYSE: UAL) is up only 27.93% for the same period; and Delta Airlines (NYSE: DAL) higher by just 33.75%.
According to US Airways Chief Executive Officer, Doug Parker, in a recent interview in USA Today, US Airways, the fourth biggest in the country, needs to acquire American Airlines, the third largest, so that it can compete with Delta Airlines and United-Continental. Stated Parker in the USA Today article by Nancy Trejos and Ben Mutzabaugh about United-Continental and Delta Airlines: the two major airlines, "are doing a really nice job of building a global brand that can be everything to everyone. But there are only two of them...This would create a third, and choice is good for the consumer."
If there is one thing the consumer has choice in it is air travel. That is one reason that there have been more than 200 bankruptcies since 1978 and that the present profit margins are so slim. The profit margin for US Airways is 1.75%. For United-Continental, it is 0.86%. Delta Airlines has a negative profit margin of minus 28.06%. For Southwest Airlines (NYSE: LUV), the carrier with the best long term record of making money, the profit margin is only 1.64%.
While the low profit margins are worrisome enough, the associated debt loads are staggering for the cash flows of US Airways, Delta Airlines and United-Continental. Southwest Airlines has a modest debt-to-equity ratio of 0.47. That means to create every dollar in equity value it cost Southwest Airlines just $0.47 in borrowing. The debt-to-equity ratio for United-Continental is 8.24. For US Airways, the debt-to-equity ratio is a staggering 22.19.
A major factor in the precarious financial conditions entailing high debt loads and low or non-existient profit margins for United-Continental, Delta Airlines and US Airways is the costs of previous mergers and acquisitions. US Airways Group is the result of a merger with American West. Delta Airlines merged with Northwestern. United-Continental is a result of the union of United and Continental.
Even if US Airways does not acquire American Airlines, there will be still be more than three choices for consumers. Based on domestic passengers, Southwest Airlines is the largest carrier in the United States, flying 3300 flights per day to 97 destinations. Alaska Airlines, JetBlue, Republic Airjet and Spirit Airlines are also domestic competitors, along with a host of others from the United States and abroad. International travel is just as competitive.
Other factors raise questions about the wisdom of acquiring American Airlines. If it was so desirable, there would have been a move to buy it or merge with it as US Airways did with American West in 2005, Delta did with Northwestern in 2008, and United did with Continental in 2010. Instead, American Airlines was forced to file for Chapter 11 bankruptcy in November 2011. It appears as if US Airways is the only party interested in bidding, despite the very public efforts of American Airlines to attract multiple suitors.
In addition, airlines are not in favor with investors at this time. American Airlines tried to sell its regional carrier, American Eagle, but could not. Republic Airways has been trying to sell Frontier Airlines since late last year, but there have been no takers. There is obviously a reason no entity stepped forward to buy American Eagle, Frontier Airlines or American Airlines before it had to file for bankruptcy.
In a recent report by Wichita State University business professor Dean Headley and Purdue University aviation technology professor Brent Bowen that ranked the 15 largest airlines in the United States on customer satisfaction, based on 2011 data submitted to the Department of Transportation as well as consumer complaints to the department, both US Airways (#8) and American Airlines (10) were in the bottom half. American Eagle was the worst at #15. It is difficult here to see the upside to the merger.
US Airways is barely profitable after a strong six-month period for the airlines. The costs of acquiring American Airlines will undoubtedly drag it back into the red. Blending the two cultures and business operations will be even more draining, both in terms of dollars and other resources.
There are two lessons for US Airways to heed here from the article, "The 100 Things I've Learned in Investing" by Anand Chokkavelu of Motley Fool.
The first is lesson is #27: "One of my favorite lessons from the poker table: Action is overrated. The best players (and investors) are constantly weighing the opportunities, but rarely are they moved to act."
The next Lesson #80: Mergers and acquisitions are overrated. Somewhere between 50% and 85% of mergers fail to boost value. The frequency of achieving promised "synergies" should be filed somewhere between unicorns and no-hitters."
That is shown by the failure of many airline mergers to maximize shareholder value, the main goal of any member of a publicly traded company. The market capitalization for Republic Airways is $271.1 million and it cost $1.1 billion to acquire Frontier Airlines. As for Wall Street's view for the future of shareholder value, Goldman Sachs just issued "Sell" ratings for United Airlines and Delta Airlines. Goldman cited weak economic growth and higher fuel costs.
It is difficult to understand why US Airways is taking action with American Airlines, especially when no other party seems interested. American Airlines did not fail because it loved too much or tried too hard: the customer satisfaction ranking reveals much about it shortcomings. In 2005, when Chief Executive Officer of American West, Parker said that the merger with US Airways would create "the nation's first full-service airline with the customer-friendly pricing structure of a low-fare carrier." Now the acquisition of a bankrupt American Airlines, with additional new costs and burdens in a period when Goldman just advised investors to sell United-Continental and Delta, will somehow make US Airways more competitive and profitable for its shareholders. Even though the share price of US Airways has risen, the market is making an even bigger point with no other buyers lining up to bid for American Airlines.
jonathanyates13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Southwest Airlines. Motley Fool newsletter services recommend Goldman Sachs Group and Southwest Airlines. 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.If you have questions about this post or the Fool’s blog network, click here for information.