Devil in the details in potential US Air, AMR merger 7.30.12

DEALTALK-Devil in the details in potential US Air, AMR merger  7.30.12
Reuters News
By Soyoung Kim and Nick Brown
30 July 2012
 
An aggressive campaign beginning this year has positioned US Airways Group as the clear favorite to merge with AMR Corp, winning backing from the reluctant rival's labor unions, alliance partners and most of Wall Street.
 
Now comes the hard part.
 
In the coming months, the bankrupt parent of American Airlines plans to review a range of potential merger partners, including US Airways, to determine if any combination would deliver better returns for creditors than a standalone reorganization plan.
 
The process began in earnest on Friday, when the company said it had begun sending non-disclosure agreements to potential merger partners.
 
But differing views on some of the grittier questions surrounding a merger – like its timing, and how the new airline's equity would be split between the companies' shareholders – mean a difficult road ahead for US Airways Chief Executive Doug Parker and his takeover effort.
 
Adding another level of uncertainty, the list of companies American is considering for a merger is not limited to US Airways, according to people familiar with the matter. It also includes JetBlue Airways Corp, Alaska Air Group, Republic Airways', Frontier Airlines and Virgin America, the people said.
 
VALUATION
 
AMR went bankrupt in November, dogged by high labor costs.
 
Creditors generally agree that a combination with US Airways would generate additional revenues, reduce costs and make the combined carrier more competitive against larger rivals United Continental and Delta Air Lines, themselves the products of mergers.
 
But with numerous diverse constituencies, including members of AMR's creditors' committee, having a say in how a deal would get done, disputes could arise over how much a restructured carrier would be worth and how to split up the spoils from a merger among AMR's creditors.
 
AMR's nearly $24 billion of 2011 annual revenue dwarfs that of US Airways, and both carriers acknowledge that American's post-bankruptcy shareholders – which will likely consist of unsecured bankruptcy creditors to be paid off in the form of equity – would hold the majority of stock in a merged entity. USAirways had $13.2 billion in annual revenues last year.
 
US Airways estimates the combined airline's equity would split about 65 percent to 35 percent in favor of American creditors, according to people familiar with the matter. That split is based on the revenue and earnings contributions from the two companies and assumes an all-stock deal.
 
American, on the other hand, sees the equity split closer to 75-25 or even higher, separate people familiar with the matter said. As US Airways has a market capitalization of nearly $ 2 billion, a 75-25 equity split would imply a roughly $6 billion equity value for American post-restructuring.
 
The people asked not to be identified because the estimates are preliminary and based on publicly available data, and the companies have yet to conduct detailed due diligence on each other. US Airways and AMR both declined to comment.
 
US Airways' equity stake could rise if it offered to pay off some AMR creditors, such as retirees or trade vendors, in cash rather than equity. But the merged company would also carry more debt on its balance sheet in that scenario, because US Airways would have raised debt to pay off the creditors.
 
AMR's plan calls for unsecured creditors to be paid off only in stock of the reorganized company, at some amount less than par, said Jack Butler, the lead attorney for American's creditors committee, in court testimony.
 
BEFORE OR AFTER
 
Debate is also brewing over whether a merger should be the basis for AMR's plan of reorganization, or if AMR should exit independently and then negotiate a merger.
 
The airline would prefer to leave Chapter 11 protection as a standalone entity, then consider a merger. But, at the behest of its creditors, it has agreed to give consolidation a fair shake while still under Chapter 11 protection.
 
AMR believes it would have more leverage to negotiate a deal upon emergence, while US Airways believes a deal in bankruptcy would give American creditors a better equity split, according to people familiar with the matter.
 
"What we're suggesting is bringing the two companies together before they exit bankruptcy is the right model," US Airways' Parker told Reuters last week. "How it's structured is less important than getting it done."
 
If American waits until after exit, as the larger airline, it would most likely acquire US Airways and pay a premium for a deal, said a person familiar with US Airways' thinking.
 
But that scenario may not be as attractive to creditors as a deal in which US Airways plays the role of acquirer, said one industry banker not involved in the situation.
 
"From the position of AMR creditors, it would be much better for them to basically sell to US Air," the banker said. "The higher the price that American pays (for US Airways), the lower its overall ownership will be, because it will have to give away more shares to US Air shareholders."
 
People close to American brushed off that notion, saying any deal premium would go to the smaller shareholder faction – in this case, US Airways – regardless of whether a merger comes before or after bankruptcy.
 
The people also noted that US Airways has pledged certain concessions to American's labor unions in the event of a merger, which would come at the expense of the rest of American's creditors.
 
US Airways President Scott Kirby said in April that his company's plan would cut from labor only the amount necessary to bring the company in line with industry standards – about $800 million. That's less than the $1.06 billion in labor cuts contemplated in AMR's latest standalone offer.
 
US Airways is seeking $240 million in cuts from unionized pilots, while AMR would cut $315 million from that group.
 
That could be a factor for creditors who care only about financial recoveries, said one of the people close to American.
 
"All of that (labor concessions) comes out of the pocket of the American Airlines creditors," the person said. "It's an extraordinarily complex dynamic and it's going to be ruled by greed."