Why US Airways Should Buy American Airlines and Why You Shouldn't
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There has been much speculation in the airline industry that US Airways (NYSE: LCC) will buy now-bankrupt American Airlines as a way to expand their business and compete with the other major carriers. At this point, I contend that US Airways does not only want to merge with American, but they need to if they are going to survive industry consolidation and rising jet fuel prices.
Mergers Mergers Everywhere!
To solve the problems of overcapacity and to integrate flight networks more efficiently, airline mergers have been increasing substantially over the past few years. One of the most common ways for airlines to acquire other airlines is to buy them out of bankruptcy. This has been accomplished so often partly based on the willingness of the bankruptcy courts to sell the airlines to repay creditors, but also because so many airlines have been going bankrupt that a steady supply of bankrupt airlines is available for purchase.
Republic Airways Holdings (NASDAQ: RJET) purchased bankrupt Frontier Airlines for a little more than $100 million in August of 2009 after fending off a competing bid from Southwest Airlines (NYSE: LUV) in the months before. Legacy airline, Delta (NYSE: DAL) purchased recently reorganized Northwest Airlines in 2008 and took to calling the new merged company the world's largest airline soon after.
In a move that shook up the entire industry, United Airlines announced its buyout offer for another major carrier, Continental Airlines, and completed the merger in May 2010. Continental shareholders received 1.05 United shares per Continental share in a transaction worth about $3.47 billion. However, it has not all been smooth sailing for the new company. According to the New York Times, the costs of absorbing Continental temporarily depressed profits as workers dealt with problems of fewer spare planes and the merging of computer networks.
While some criticized the merger as "bumpy" and "chaotic," the new United Continental Holdings (NYSE: UAL) could certainly reap rewards from its merger once the systems are fully integrated. Flights can be consolidated, and hubs can be picked and chosen to provide the best use of fuel and dollars. In addition, competition will be reduced allowing United Continental to raise its fares and generate more revenue per passenger in the years to come.
The Hub Systems
Like spokes on a wheel, planes fly in and fly out from all directions but centralize around a few major locations where passengers can be most efficiently exchanged between flights. United, merged with Continental, has its largest hubs in Houston and Chicago. Delta, merged with Northwest, has its largest hubs in Atlanta and Detroit. In both cases, these hubs are centrally located resulting in less fuel usage overall and generally shorter flight times than if those hubs were coastal based.
By contrast, US Airway's hubs are Charlotte, Philadelphia, and Phoenix, none of which are centrally located. While most other major carriers have some coastal hubs, those carriers largest hubs are centrally located. US Airways is not able to take full advantage of the hub system with their current setup resulting in longer flight times and, consequently, more fuel usage.
Why They Should Buy American
After the mergers that happened over the last few years, US Airways continues to remain the one who never got invited to the dance. But the bankruptcy of legacy carrier American Airlines presents an opportunity US Airways cannot afford to ignore.
The takeover of American Airlines will allow US Airways to eliminate overlapping flights thus helping to solve the overcapacity problem as well as reducing labor costs by cutting redundant employees. If US Airways is going to compete with the big dogs, and it will need to, it must find a partner so that it can operate on the same economies of scale that Delta and United Continental are able to do.
Integrating American into its system also would solve US Airways' awkward setup of hubs. Right now their system is the result of " a crude amalgamation of Arizona-based America West and Northeast favorite US Airways" according to Christopher Steiner, author of $20 Per Gallon. He sees them as one of the first airlines to collapse as gas prices rise and continues on to say "but by the time you read this, the airline could already be filing for Chapter 11 bankruptcy protection for the third time since 2002."
The acquisition of American would allow US Airways to run flights through the centrally located Dallas and Chicago hubs, thereby helping to fill in the massive gaps between their existing network. Steiner is still bearish on the prospects for American under higher gas prices due to its aging fleet of "fuel-guzzling" MD-80s. However, American has since placed an order for 460 new aircraft to update its fleet. With the new planes, American could cut fuel costs and is therefore more likely to survive higher jet fuel prices. A merger of US Airways and American Airlines would provide a fix to the current US Airways network while allowing the merged airline to take advantage of American's new order of more fuel efficient aircraft.
Why You Shouldn't Buy American
Buying American Airlines may look like a good idea at first, after all it is ripe for a takeover and discussions are reported to be happening. However, American Airlines is a bankrupt company. Their primary interest now is repaying creditors, not increasing shareholder value. When American filed for Chapter 11 bankruptcy in late 2011, it did so with about $5 billion more in liabilities than in assets. In nearly all bankruptcy cases, creditors must be repaid in full before shareholders ever see a dime.
There is an outside chance US Airways may throw the common shareholders a few pennies to make the process a little easier, but American's shareholders are most likely not going to receive anything for their shares. American Airlines' own website even leads to this conclusion stating that "in most Chapter 11 cases, owners of equity securities receive little to no recovery of value from their investment" and warning the stock "may have very little liquidity" after it began trading on the OTC market. American Airlines has become a classic case of airline bankruptcy, which is disappointing to see since they were on of the last legacy carriers not to file for bankruptcy.
A Great Investment for Some
The bankruptcy of American Airlines offers a unique opportunity for US Airways to strengthen its future prospects for survival. In an industry of consolidation, those who do not employ the new economies of scale will find their continuing operation as a viable business in doubt. Conversely, combining their awkward setup of hubs with American's centralized network could spell major benefits for US Airways in terms of reducing fuel expenses, as well as passenger flight times. US Airways doesn't just want American Airlines, it needs them to survive in the new airline environment of consolidation and higher jet fuel prices. But if you're an American Airlines shareholder, it may be time to seek new destinations for your investment.
Alexander MacLennan does not currently own shares in any of the companies mentioned in this entry. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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.