5 Takeaways From DoJ’s Bid to Block US Air-American Merger

by Susan J. Aluise | August 14, 2013 1:52 pm

Wall Street and the airline industry are reeling in the wake of the surprise, last-minute move by the Justice Department and a group of state attorneys general to block the $11 billion mega-merger between US Airways (LCC[1]) and American Airlines (AAMRQ[2]).

What investors need to know after watching both stocks get pummeled is whether the suit is a knockout blow, or if the airlines can get up off the mat.

The early rounds look ugly. The suit filed on Tuesday puts the brakes on a deal that would have created the world’s largest airline — just 48 hours before a federal bankruptcy court in Manhattan was set to approve American’s plan to emerge from bankruptcy protection by merging with LCC.

Attorneys general of six states and the District of Columbia joined the DoJ in the suit, which says the merger “would substantially lessen competition for commercial air travel throughout the United States,” Assistant Attorney General Bill Baer said in a statement.

Taken alone, that remark suggests DOJ would be willing to haggle with US Air and American over steps they could take to mitigate those competition concerns — including, but not limited to, transferring takeoff and landing slots to competing carriers at airports like Washington D.C.’s Reagan National, where the post-merger American would control nearly 69% of the total slots.

But Baer’s statement doesn’t end there: “Importantly, neither airline needs this merger to succeed,” he said. “We simply cannot approve a merger that would result in U.S. consumers paying higher fares, higher fees and receiving less service.”

Translation: if you’re looking for DOJ to bless a US Air-American marriage, look elsewhere.

That’s bad news for airline investors who have wildly bid up both stocks over the past year in anticipation of the massive economies of scale and a combined airline that generates $47.8 billion in annual revenue by 2017.

The market reacted as expected — US Airways stock closed down 13% on Tuesday; AAMRQ stock plummeted nearly 45% on trading volume of nearly 111 million shares — 17 times the stock’s average trading volume.

Traditional legacy airlines Delta (DAL[3]) and United Continental (UAL[4]) were dragged down about 7% on fears that the antitrust suit could signal an aggressive departure from the nation’s 35-year-old posture of airline deregulation.

Predictably, US Airways and American defiantly vowed to mount a vigorous defense of the deal. “We believe that the DOJ is wrong in its assessment of our merger,” the companies said in a joint statement Tuesday. “Integrating the complementary networks of American and US Airways to benefit passengers is the motivation for bringing these airlines together. Blocking this procompetitive merger will deny customers access to a broader airline network that gives them more choices.”

So what happens next — and what does it all mean for shareholders?

  1. US Air Will Be OK, But Not Great: If antitrust concerns skunk up the merger, LCC will ride out the breakup turbulence, although the opportunity cost of US Air coming this far only to fail in the 11th hour could leave it vulnerable to Delta, United and Southwest (LUV[5]) for the next couple of years. Investors can expect LCC shares to fall back into the $5 to $6 a share range they held before merger mania took hold.
  2. American Would Take A Huge Hit: A breakup would hit American harder. DOJ’s assertions aside, this far down a road to a merger with US Air, it is far more challenging for American to “thrive as a standalone competitor.” The carrier’s parent listed some $30 billion in liabilities when it filed for bankruptcy in 2011 — expect creditors to lose a sizable chunk of that change if the deal is scrapped.
  3. Don’t Expect a New Deal to Arise From the Ashes: Other mergers at this late date would be difficult to pull off — United and Delta are too big to clear antitrust hurdles, Southwest is in the process of integrating recently acquired AirTran, and smaller or regional carriers wouldn’t deliver the necessary economies of scale American needs. Last year, David Bonderman’s TPG Capital was widely reported to be interested in American. While it would not be Bonderman’s first time quarterbacking an airline deal (he had stunning success in the 1990s turning around the then-bankrupt Continental Airlines) it’s pretty late in the game to call that big an audible. The likeliest outcome: The bankruptcy court would give American an extension to regroup — and the airline likely would wind up liquidating assets and/or scaling back into a smaller, niche-focused carrier.
  4. If American Stands Alone — and Falls — Boeing Could Feel the Pinch: There’s an interesting note here for Boeing (BA[6]) as well. American owes BA about $30 million, which leaders of the combined airline have vowed would be repaid in full with stock issued after the merger. Additionally, American ordered $20 billion in next-gen aircraft from Boeing in 2011 (and $20 billion from Airbus as well) — planes that both aircraft manufacturers are counting on big right now[7].
  5. DoJ Could Lose the Suit: The best outcome for American and US Air at this point obviously would be for DoJ to drop the lawsuit or lose the case, and the carriers could move forward with their merger plans. But high-stakes legal matters seldom are resolved quickly — best case, the airlines are looking at a forest full of legal briefs and thousands of billable hours before they can move on. Delays aren’t necessarily denials, but in the cut-throat airline business, there’s a huge opportunity cost associated with putting the brakes on a merger at such a late date. US Air could ride out the delay reasonably well because it could gain its prize eventually. But American can ill afford to spend several more months cooling its heels in bankruptcy court awaiting a verdict.

Bottom Line

As US Air Chairman and CEO Doug Parker scrambles to save the deal of a lifetime, it couldn’t hurt to launch a charm offensive toward Capitol Hill. While loss of competition at D.C.’s Reagan National is not the only issue fueling opposition to the merger, the issue came up a lot in Senate Judiciary subcommittee hearings earlier this year.

Congress always has taken a very personal interest in operations at the conveniently located airport — and in political Washington, the interests of lawmakers and regulators have a funny way of syncing up at the darnedest times.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

Endnotes:
  1. LCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=LCC
  2. AAMRQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAMRQ
  3. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  4. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL
  5. LUV: http://studio-5.financialcontent.com/investplace/quote?Symbol=LUV
  6. BA: http://studio-5.financialcontent.com/investplace/quote?Symbol=BA
  7. both aircraft manufacturers are counting on big right now: http://investorplace.com/2011/11/boeing-amr-airbus-airplane-finance/

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