American Airlines Makes A U-Turn Regarding The Merger

| About: American Airlines (AAL)

Each day, the story of a possible merger between American Airlines (AAMRQ.PK) and US Airways (LCC) looks more and more like a soap opera. The story has so many twists and updates that I lost the count; not only that but I also stopped counting anyways. In my last 2 articles I mentioned how it was interesting that the CEO of American Airlines Tom Horton suddenly became quiet after badmouthing US Airways for weeks. It felt to me like he received a warning from his board of directors. Now, there is another twist in the story.

On August 13th Tom Horton told Financial Times that he was actually open to the "attractive" idea of a merger with US Airways and the final decision could come fast as within weeks. He then goes on to say: "Our view (earlier this year) was not that the combination was unwise. It was that was not the right time to discuss it." Now all of a sudden the man makes a U-turn. For the last couple weeks, Tom Horton was stubbornly against the idea of a merger with US Airways unless the merger happened strictly under his conditions which include American Airlines buying out US Airways and him running the new company.

American Airlines has until December to evaluate its options and come up with a plan to present to the bankruptcy court in order to be able to emerge from the bankruptcy protection which it applied for in November of 2011. If the company fails to present a feasible plan to the court by then, the court might either impose its own plan or let a third party come up with a feasible plan. In this case, the "third party" we are looking at is likely to be none other than the US Airlines. Doug Parker of US Airways was smart enough to buy bonds of American Airlines earlier last year to become one of the stakeholders in the issue in order to have a say in the court.

Although Tom Horton's past announcements regarding the merger were able to pressure the share price of US Airways down in the recent months, his latest announcement didn't move the share price much. On Friday, US Airways traded at $10.07 per share. Upon Mr. Horton's announcement, the share price of US Airways first rallied up to $10.37 but fell down to $10.11 by the end of the trading day. As the road to the merger gets clearer, the share price of US Airways is likely to benefit from the event. Earlier this year, shares of US Airways were trading for as much as $14, but now they are down nearly 30% due to Tom Horton's earlier announcements, increasing oil prices and apparently slowing demand in the airline industry.

In the last 5-6 trading days, the share price of US Airways moved within a very narrow range with relatively low volume. This indicates me that the investors of the company are waiting for a catalyst to move the stock price to either direction. In the short to medium term, if the merger with American Airlines materializes, I expect the share price of US Airlines to jump by $2 to $3. If the merger dies off, the share price is likely to decline by another $2 to $3. In my opinion, the chances of this merger happening is around 75-80%. At this point, American Airlines is pretty much cornered and it doesn't have many options. Recently, things got even more complicated for the company when its pilots rejected a new employee contract. At the end, we might even see a hostile takeover if the issue is not solved soon enough.

Apart from the merger drama, US Airways has been doing really well lately. After tripling its earnings in the last quarter compared to the same period a year ago, the company continued to improve its performance in non-financial areas too. A recent study found out that US Airways was the best airline company when it came to being on time and not losing baggage of the customers. Based on the company's future earnings projections, analysts see the company's shares trading for anywhere between $14 and $20 in the next 12 months. I continue to be long in US Airways and my opinion is independent of the possible merger with the American Airlines. I believe that the company's current and future earnings alone warrant a share price much higher than its current share price.

Disclosure: I am long LCC.