US Airways, American Airlines Move Closer To A Merger

| About: American Airlines (AAL)

After making investors wait for several months, finally the two companies are getting together. This is extremely bullish for US Airways (LCC) whose shares already saw a massive rally this year. Last Month, American Airlines (AAMRQ.PK) sent non-disclosure agreements to a number of airlines including US Airways, and today, a deal is signed which will allow the two companies to share confidential information with each other. This is usually considered one of the later stages in a merger between two companies.

The two companies will refrain from making any kind of comments until the discussions end with either a positive or a negative outcome. This might also help to explain why the CEO of American Airlines Tom Horton has been quiet in the last month after having made many comments regarding the merger. As a result of the discussions between the two companies, American Airlines will not be discussing merger with a third party until after talks with US Airlines are finalized. If the two companies can't reach a final agreement on the merger, American Airlines will discuss a merger with other possible partners. Reportedly, the parent company of British Airways is also interested in buying American Airlines and they also signed a similar deal with the US Airways.

The creditors of American Airlines, which also happens to include US Airways, will be also part of the discussion, because a possible deal between the two companies is still subject to approval of all stakeholders. If such merger occurs, the stockholders of American Airlines will probably get nothing as the creditors of the company will have the priority. Once the creditors of American Airlines get all their money back, the stockholders of the company will come next; however, given the company's assets and liabilities, it is highly doubtful that the stockholders will get anything.

Of course, the merger is still not a sure thing. The discussions between the two sides will be going on for a while and the final decision should come before the end of this year. Apart from the CEO of American Airlines, there is very little resistance for a merger between US Airways and American Airlines. The merger will make the resulting company the world's largest airliner. Becoming the world's largest airliner should give the company a lot of pricing power and increase its margins. Even without the merger, US Airways is expected to triple its earnings in this fiscal year compared to the last fiscal year.

The CEO of US Airways Doug Parker wrote a letter to the US Airways employees saying "We are pleased to be working directly with American to study a potential merger and we consider this very good news…It does not mean we are merging -- it simply means we have agreed to work together to discuss and analyze a potential merger." This means that while the merger is not final, another hurdle in the way of the merger is cleared. Tom Horton also reached out to his employees by saying that American Airlines is "also now looking at other strategic options that could make the new American even stronger." At this point, the nature of the merger is still being disputed as both companies would rather buy the other. If the more likely option happens and US Airways buys American Airlines, the role of Tom Horton at the new company will be unclear. I think this is probably one of his biggest concerns at the moment.

US Airways wants to merge with American Airlines while the company is still in bankruptcy protection, whereas American Airlines wants to delay any possible merger until after it emerges from bankruptcy. At the moment, it is difficult to tell when the merger will actually materialize; however, I believe that the merger will happen sooner or later.

As I always say, even if the merger doesn't happen, US Airways is still a strong buy as it is one of the most undervalued companies in the market. The company's PEG ratio is near zero at 0.06 as its current P/E ratio is 4 and the forward P/E ratio is 3. The company's market cap of $1.7 billion is below its cash reserves of $2.5 billion.

One concern about the company is its debt level. The company's long term debt passes $4 billion and it may have to raise additional debt in order to buy American Airlines. On the other hand, if the company buys American Airlines, its future revenue and income will be more than enough to service its debt. At the current income level, the company has no trouble servicing its short term and long term debt.

I continue to rate US Airways as a "buy." In a perfect world, US Airways would trade for more than $20 per share. The company's management is one of its most important assets.

Disclosure: I am long LCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.