Southwest Airlines will Win the US Airways-American Takeover Battle
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Southwest Airlines (NYSE: LUV) will most likely come out on top no matter the end result of the takeover campaign being waged by US Airways (NYSE: LCC) for American Airlines. According to analysts, if US Airways does not acquire American Airlines, it cannot survive. Even if US Airways does buy American Airlines, it will be so weakened by the takeover costs, its future operations will be crippled.
This can be seen by the recent downgrades of United Continental Holdings (NYSE: UAL) and Delta Air Lines (NYSE: DAL) by Goldman Sachs. In a recent interview with USA Today, Doug Parker, Chief Executive Officer of US Airways, stated that the merger with American Airlines was essential so his airline could better compete with Delta and United Continental. Supposedly, the combination of routes by US Airways and American Airlines will result in a single, more viable airline.
But, if this were true, then why did American Airlines have to file for bankruptcy last November? Why was American Airlines unable to sell American Eagle, its regional subsidiary? Why is US Airways the only bidder, both in the airlines industry and out of it, to be making a play for American Airlines? Surely routes and other assets so valuable would have tempted at least one other bidder. But no other airline, private equity group, hedge fund or wealthy individual has so far stepped forward.
In its sell rating for Delta Air Lines, Goldman Sachs analyst Tom Kim stated, "We are 15% below consensus on our 2012 EPS estimate, as we expect EPS growth to decelerate in 3Q on weaker-than-expected traffic growth and a deceleration in yield gains albeit off of a higher base. Other than recurrent earnings risk we are also concerned about the company’s acquisition of Trainer Refinery, which closed in June 2012, given the execution risks related to operating an oil refinery and the industry’s cyclicality."
For United Continental, the Goldman Sachs report stated, "UAL has outperformed US airline stocks by 10ppts, up 25% YTD, and is now trading at 5.4x forward P/E. While this does not appear to be stretched, we do not see catalysts to reverse the trend toward low earnings multiples in view of the macro uncertainty."
The target price for Delta issued by Goldman Sachs is $9.30 a share. The target price for United Continental from Goldman Sachs is $21.30. Now around $9.95, less than a month ago Delta was over $12 a share. Now around $21.55, less than a month ago United Continental was close to $26 a share.
United Continental, Delta Air Lines and Republic Airways (NASDAQ: RJET) have all weakened themselves greatly with ill-advised acquisitions. Southwest Airlines has not. Republic Airways spent about $1.1 billion besting Southwest Airlines in a bidding war for Frontier Airlines in late 2009. The market capitalization for Republic Airways is now around $238 million.
Obviously, the takeover of Frontier Airlines has done nothing to enhance shareholder value for Republic Airways: comparing the present market cap with the acquisition cost proves that, without a doubt. In addition, Republic Airways has been trying to sell Frontier Airlines since last year. Not only have there been takers, but the two biggest jumps in the share price of Republic Airways in recent market action have come from when it announced that it would try to sell Frontier Airlines. Finding no takers, the next spike upward came earlier this year when Republic Airways announced it would consider spinning off Frontier Airlines.
From the its chief executive officer to analysts, there is widespread belief that US Airways is endangered if it does not acquire American Airlines. Earnings-per-share growth is down this year by 83.39%. Over the past year, earnings-per-share-growth has fallen by 33.47%. It is tough to see how acquiring a bankrupt airline will reverse that trajectory, particularly with the debt that US Airways will have to incur.
Already, most air carriers are staggering under massive debt loads, US Airways (22.19), United Continental (8.24), Delta Air Lines (44.71), Republic Airways (5.08) and JetBlue Airways (1.67) are all crippled by high debt-to-equity ratios. The debt-to-equity ratio for Southwest Airlines, by contrast is just 0.47.
Writing in The Wall Street Journal, financier Millken warned about too much debt for airlines and other companies in his article "Why Capital Structure Matters." In the April 21, 2009 piece, he noted that, "even a dollar of debt may be too much for some companies. Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it's happening again. Overleveraging in many industries -- especially airlines, aerospace and technology -- started in the late 1960s." Goldman Sachs just downgraded United Continental and Delta due to concerns about a decline in earnings.
Another investing legend, Peter Lynch, considers the price-to-earnings growth (PEG) one of the most important financial indicators. A PEG of 1 is adequate: the lower the better and the future growth of the company is trading at discount. Southwest Airlines has a bullish PEG of 0.85. The PEG for United-Continental is 1.67, by contrast. It is also significant that Southwest Airlines is the only airline with the cash flow to pay a dividend to its shareholders, which was just increased in May. The share repurchase program for Southwest Airlines was also increased to $1 billion.
On July 10, Southwest Airlines was upgraded from Hold to Strong Buy by Sterne, Agee & Leach. This is particularly poignant as this is after the acquisition of AirTran Airways by Southwest Airlines. For Southwest, the Sterne, Agee & Leach Strong Buy recommendation increased the forecast of 2012 earnings to 97 cents per shares from 83 cents per share and raised the outlook for 2013, too. Maxim Group LLC also raised its forecast of 2012 earnings for Southwest Airlines to 81 cents per share from 68 cents per share.
The AirTran Airways takeover is proceeding smoothly for Southwest Airlines. To maintain the cost-saving standardization of its fleet by flying only the Boeing 737, Southwest Airlines recently announced the leasing of all 88 of Airtran's Boeing 717 Aircraft to Delta Airlines. It has stopped service on the unprofitable routes acquired from AirTran. In addition, Southwest Airlines was just approved to fly international routes from Houston's Hobby Airport. The depth of opposition to this from United Continental is revealing as to how lucrative this will be in the future for Southwest.
If US Airways does acquire American, no matter what the routes are for the new entity there will be fierce competition on every one, domestic or international. It will be the same competition that drove American Airlines into bankruptcy in 2011; US Airways into bankruptcy in 2002 and 2004; and America West (who acquired US Airways in 2005) into bankruptcy in 1991. Overall, there have been more than 200 airlines bankruptcies since deregulation in 1978. Contributing greatly to this has been the crippling expenses of counterproductive mergers and acquisitions.
About this, Anand Chokkavelu of Motley Fool wrote in "The 100 Things I've Learned in Investing," about these type transactions, "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."
This is shown by how airlines have failed to respond to a favorable market place. As one analyst noted, "Supply of domestic flights has been in decline over the past six years, falling about 10% in that period. Meanwhile, demand has increased by about 9%, and has been on the rise for the past two years. Even more dramatically, the load factor has increased every year since 2001, rising from 69.15% in 2001 to 82.92% in 2011." During that period of very bullish trends, every major airline filed for bankruptcy (United in 2002, Delta in 2005, American Airlines in 2011, and US Airways in 2002 and 2004) at least once as Southwest Airlines was profitable every year.
Former heavyweight champ Mike Tyson once remarked that, "Everyone's got a plan 'til you hit 'em in the mouth." While the plans of US Airways CEO Doug Parker for his company to prosper after acquiring American Airlines are laudable in intent, prior history does not seem that reassuring. Southwest Airlines appears to be the air carrier that will benefit as it is the only one to be profitable every year since deregulation. Its acquistion of AirTran will have it challenging many of the routes of American Airlines and US Airways with a business model that has proven to be profitable rather than one prone to bankruptcy. For this and other factors, it is indeed telling that Southwest Airlines was the carrier that was recently upgraded to a Strong Buy, not United Continental or Delta Air Lines, the standard against which US Airways is measuring itself.
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