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American Airlines (AAMRQ.PK), which is currently going through bankruptcy court proceedings, has announced its merger with US Airways (NYSE:LCC) to emerge from bankruptcy. In a joint press conference held on February 14, chief executives of both carriers announced the merger, which will create one of largest airlines in the world with an estimated market capitalization of $11 billion. [1]

The merged carrier will be a formidable competitor to other large global U.S. airlines such as United (NYSE:UAL) and Delta (NYSE:DAL) and will also provide benefits to stakeholders of both American Airlines and US Airways as the combined entity will realize annual synergies of $1 billion by 2015 and benefit from a strong financial base as well as an expanded operational network. [1] However, the consolidation of the airline industry could lower competition and thereby lead to higher fares, which will hurt passenger interests and is a consideration for regulators' approval.

US Airways, for its part, wanted to merge with the larger American Airlines as it would propel it to the league of the largest airlines in the world - a feat it could not have achieved otherwise in the foreseeable future. We currently have a stock price estimate of $12.73 for US Airways, approximately 10% below its current market price.

American Airlines Shareholders will not be completely disappointed

US Airways shareholders will get one share of the merged entity for every share of the US Airways stock they own. In all, the shareholders will own 28% of the combined company and the remaining 72% will be owned by stakeholders (largely creditors) of American Airlines. The deal has been structured in such a way that the shareholders of American Airlines will also get to own 3.5% (of the 72%) of the merged entity. Such a step is a first for the industry as in previous bankruptcy restructurings, stakes of shareholders were completely wiped off.

Merger will create one of the largest airlines in the world

The merged carrier will retain the American Airlines brand due to its greater recognition compared to the US Airways brand.

In terms of network, the combined carrier will operate approximately 6,700 flights daily to 336 destination in 53 countries. In the U.S., American Airlines has hubs in Dallas/Fort Worth, Chicago, Los Angeles, New York and Miami, while US Airways has hubs in Phoenix, Philadelphia and Charlotte. Thus, the combined network will have a leading presence in eight cities which are also among the busiest in the U.S. Delta Airlines also has eight hubs in the U.S. Further, the flight networks of American Airlines and US Airways are also highly complementary as only 12 out of their 900 routes overlap. [2]

Value for customers and shareholders

The members of frequent flier mile programs of both carriers will also benefit tremendously as post-merger they will be able to redeem their already earned miles on a much larger network. In addition, the expanded network will add to growth in new frequent flier registrations.

The carriers project $40 billion in combined revenues in 2013, [1] which compares to revenues of $37.2 billion for United and $36.7 billion for Delta in 2012. [3] [4] Additionally, passenger traffic for the combined entity will likely increase, taking advantage of improved connectivity and scheduling and redeployment of the combined fleet to better match capacity with demand. The top line will benefit from this growth in passenger traffic and the bottom line will benefit from new labor contracts signed with American Airlines' staff which will lower operating cost structures. On the whole, an improvement in operating health will translate into returns for shareholders.

Regulatory approvals

The merger has approval of labor unions of both American Airlines and US Airways. However, it will be concluded only after receiving approvals from several authorities including the U.S. Bankruptcy Court for the Southern District of New York and US Airways shareholders.

The approval from the Department of Justice, which weighs competition concerns, should come only after consideration of a dozen or so routes where both carriers have a presence. In the case of the Washington Reagen Airport, the department could insist on giving up slots as the combined entity would have a dominant position at this airport. On the whole, we anticipate the merger to receive the required regulatory approvals because large airline mergers like those of Delta and Northwest in 2008, United and Continental in 2010, and Southwest and AirTran in 2011 have received approvals in the past.

Finally, for the foreseeable future, this will possibly be the last merger in the U.S. airline industry that involves large airlines, but the industry could see further consolidation with mergers of some smaller airlines.

Notes:

  1. American Airlines and US Airways To Create A Premier Global Carrier -The New American Airlines, February 14 2013, www.usairways.com
  2. AMR, US Airways predict clear skies, February 14 2013, online.wsj.com
  3. Delta 2012 10-K, February 13 2013, www.delta.com
  4. Fourth quarter and full year 2012 earnings results - Form 8-K, January 24 2013, www.unitedcontinentalholdings.com

Disclosure: No positions

Source: American Airlines And US Airways Merger Will Create An Industry Behemoth