AMR on ICE, shaken not stirred

[Barfbag]

Iceland Fund Puts heat on AMR

Money manager has Frequent Flier Plan , A/C Maintenance Jobs and Am.Eagle in it's sights. Wall Street Journal 9/27

Can anyone post link?

From PlaneBuzz:

Well, isn't this interesting? FL Group, which took a substantial position in AMR earlier this year, said today that it has increased its position in AMR to 8.63%. Unless one of the two biggest AMR shareholders has recently upped their positions, that would indeed make FL Group the largest single AMR shareholder.

Very interesting. Because as we all know, investment funds like this don't take a position in a company unless they see a potential for turning a nice profit. And I can't see that happening unless some kind of "deal" is part of the short-term landscape.

Ticker: (NYSE:AMR)

Posted by Holly on February 22, 2007 11:59 PM | Permalink

 

[The Goose]

Iceland Fund Puts Heat on AMR
Money Manager Has
Frequent-Flier Plan
In Sights for Spinoff


AMR Corp. has an unruly passenger on board.

FL Group, a $6 billion investment fund from Reykjavik, Iceland, sent a letter to the American Airlines parent's board on Tuesday urging the company to consider alternatives, including the spinoff of its AAdvantage frequent-flier program, to boost a stock that has fallen almost 50% since January.

• Shareholder Push: FL Group, which says it holds an 8.3% stake in AMR, is asking the airline to consider alternatives.
• Eyes on Miles: FL said spinning off frequent-flier business could add value.
• Tougher Skies: The move comes as U.S. airlines face the threat of higher fuel costs with little ability to pass them on to passengers.FL Group said in the letter it has accumulated an 8.3% stake in the carrier. Previously, it had disclosed a stake of less than 6%.

FL Group says AAdvantage is worth about $6 billion. That is greater than the $5.4 billion market capitalization of all of AMR, based in Fort Worth, Texas, the world's biggest airline by passenger traffic.

"It's a no-brainer," said Hannes Smarason, chief executive of FL, in an interview. He also said AMR should consider offloading its aircraft-maintenance and -repair unit and its American Eagle regional airline. "It's a tough environment for the airlines now, and it's incumbent on the management and the board to find avenues where value can be created."

1 FL GROUP'S LETTER TO AMR


• Read the full text of the letter2 sent by FL Group to the AMR board.The fund has tried quietly engaging the company's management, but "we're not getting the response we're looking for."

An AMR spokesman said the company values input from shareholders. It declined to comment on specifics about FL, saying it typically doesn't comment on communications with holders. He added: "Our board and our senior management regularly give careful consideration to the best use of our strategic assets and the impact that those decisions might have in the long run for our shareholders."

Buffeted by surging fuel prices, AMR said late Friday that third-quarter revenue would fall short of analysts' forecasts. The stock, hurt also by fears of a slowing economy, plunged 14% to $20.77 on Monday, its worst percentage drop since April 21, 2003. In 4 p.m. composite trading on the New York Stock Exchange yesterday, the shares rose 22 cents to $21.77.

If AMR were to spin off the frequent-flier program, it would follow in the footsteps of Air Canada parent ACE. ACE's former frequent-flier unit, Aeroplan, has a market value of about $4 billion, double what it was originally worth. Australia's Qantas Airways Ltd. has said it is considering spinning off its frequent-flier program, and United Airlines parent UAL Corp. has said it is considering strategic options for its frequent-flier business.

FL specializes in airline investments. It used to own Icelandair and had a 16.9% stake in easyJet, the European low-cost carrier. It now has a 23% stake in Finnair, the Finnish carrier. Based on data from FactSet Research Systems, an 8.3% stake would make FL the No. 2 AMR holder, after Tontine Management LLC.

FL began accumulating the stake in the fall of 2006. In December, Mr. Smarason called the shares, which were trading at more than $30 each after a 37% 12-month run, "quite attractive."




Full Text of letter to AMR board -

The Board of Directors
AMR Corporation
4333 Amon Carter Boulevard
Fort Worth, TX 76155
Attention: Gerald J. Arpey
Chairman, President and CEO AMR Corporation/American Airlines
VIA EMAIL AND OVERNIGHT DELIVERY

Reykjavik, September 25, 2007

Ladies and Gentlemen,

As you are undoubtedly aware, FL Group is one of the largest shareholders of AMR Corporation, currently holding 8.25% of the company's outstanding common shares. FL Group is also a highly experienced player in the airline industry, with a strong track record of value creation in the sector through its investments in easyJet, Sterling Airlines, Icelandair and Finnair. We generally hesitate from approaching the board of directors regarding value creation strategies, preferring to speak directly with management. However, subsequent to our conversations with members of the AMR management team, we are not aware of any specific plans that management may have to enhance shareholder value. This, when taken with the company's recent disappointing and surprising earnings guidance, has meant that we now feel compelled to write to you directly.

A Time to Act

AMR's share price has dropped some 50% since January 19th 2007. Given the close to $5 billion this has cost AMR shareholders, we believe serious consideration of strategic alternatives is long overdue. Instead of blaming the company's poor share price performance on external factors such as "fuel prices" and "intense competition," we believe that it is now time for AMR to act. We therefore urge AMR's management and Board of Directors to consider all options to enhance shareholder value and outline a clear path forward for value creation.

The Problem

AMR's structure as a fully integrated legacy carrier means that the profitability of its individual business units is not easily understood by investors and analysts. AMR holds different businesses that are less cyclical and have more favorable growth prospects than a pure aviation play, but its share price remains saddled with a blended valuation multiple that fails to capture those growth prospects. The fact that AMR does not disclose detailed financial information on its various business units results in difficulty capturing individual unit value and likely exacerbates the pure play valuation discount.

AMR is an industry leader in terms of size and scale, but given the factors outlined above, and the difficult industry environment, we believe the company will find it very challenging to outperform its competitors over the long term. We strongly urge AMR's management to aggressively evaluate strategic alternatives to generate shareholder value.

The Opportunity

Significant opportunities for value creation at AMR exist that are both practical and actionable. In short, FL Group believes significant value potential can be unlocked by unbundling AMR's ancillary business units, whose revenues are currently being valued at mainline airline multiples instead of multiples that correspond with their particular business lines. In our view, the separation of AMR's business units, such as the AAdvantage Frequent Flyer program, is potentially more than just a zero-sum game. Unbundling can eliminate a valuation discount, especially in complex corporate structures such as legacy carriers, and can also lead to greater management focus and improved operational performance. In this specific case, we believe the AAdvantage Frequent Flyer program is the AMR business unit with the most value upside, although other AMR units could also unlock value.

The frequent flyer/loyalty industry is attractive due to strong profitability, stable cash flow and growth rate potential. AAdvantage's size and market position provides an excellent platform for future growth and industry leadership. Our analysis suggests a value upside of over $4 billion from unbundling AAdvantage. Given the limited financial information available to us on AAdvantage, the valuation is based on conservative assumptions taking into account available performance metrics from other frequent flyer programs. In addition, the concept of unbundling has already been proven to generate value. One need only examine Aeroplan, the loyalty program spun off by Air Canada's parent ACE, to find a successful example. Since 2004, Aeroplan has grown rapidly and analysts expect the company to grow revenue by almost 100% from 2004 to 2008. We recognize there are differences between the U.S. and Canadian airline sectors; nevertheless, we believe the case for enhanced value is clear and has already been proven. Since its IPO in June 2005, Aeroplan's stock performance has significantly outperformed the North American airline sector.

While we urge AMR to commit to a strategic review to monetize AAdvantage's value for shareholders, we happen to believe that AMR should keep effective control of AAdvantage in the short-to-medium term and that an outright sale is less advantageous at the present time. AAdvantage could instead be separately listed with a limited free float to be distributed to a mix of original and new shareholders. This type of multi-step spin-off would provide operational benefits to AMR and allow the company to fine-tune the intra-company relationship. Such a gradual process would also have the benefit of allowing AMR to capture the full value of AAdvantage as investors become more familiar with a pure "frequent flyer/loyalty" play.

Regardless of any difference of opinion over these mechanics, we should be able to agree that AMR's stock is undervalued and poorly reflects the success and growth potential of AAdvantage; and that the Board, management and shareholders should look for ways to capture that hidden value.

A Call to Action

Any realistic assessment of a spin-off, as described above, must acknowledge that there are risks involved. But leadership is about evaluating those risks and making prudent choices. A separated AAdvantage will impact AMR's performance; however, we believe that the ongoing partnership could be properly managed and that the net effect would substantially increase shareholder value. As stated above our conservative analysis indicates that the unbundling of AAdvantage could lead to value creation of more than $4 billion.

We strongly encourage you to look at the opportunity to unlock shareholder value by spinning-off AAdvantage as outlined above. At an absolute minimum, better disclosure of AAdvantage's financial results and a robust review of strategic alternatives will help convince shareholders that you view value creation as the key objective. We are more than prepared to assist AMR in any way to achieve that end.

We look forward to your prompt response demonstrating a serious evaluation of these matters.

Yours sincerely,

Hannes Smarason
CEO
FL Group

 

[jimntx]

Hey, Lucy. 'Splane to me how the AAdvantage program has a "value" of $6 billion. A liability on the books for $6 billion--i.e., commitment by AMR to provide future travel/benefits to FFs which at the time of redemption will not generate revenue to the company--yes, I could see that. But, a "value?"

Why would anyone pay $6 billion for AAdvantage? Exactly how would they recoup their investment? I don't see AMR paying you or me (as the purchaser) to handle miles redemption that they already have a liability for? That would simply increase the liability. What else could the purchaser offer the members other than airline tickets? A free taco at the Wal-Mart snack bar (with purchase of a taco at full-price, of course)?

There is a goodwill value to the program in that it keeps FFs coming back to AMR for their travel needs, but every time they buy a ticket, a future liability is created on the books.

Don't say that it would relieve the company of the liability, thereby increasing the stock value. Every single airline out there right now (with which we compete) has a flyer affinity program of one sort or another--even SWA. To eliminate the AAdvantage program would hurt us in the same way that we would be hurt if we did away with First Class and went to all coach. The big dollar flyers would cease to see a reason to choose AMR's product.

 

[FWAAA]

I agree with jimntx; one loser airline (Air Canada) spun off/sold its frequent flyer program in a desperate attempt to raise cash and all of a sudden the financial oracles in Iceland think it's what AA should do.

Memo to the FL Group: Leave the airline biz to the pros who know what they're doing. These idiots bought AA stock last fall on the way up and now they're crying because their investment is worth substantially less. Boo Hoo.

Spinning off SABRE was necessary (for business reasons) but in the long run, losing that diversification hurt AA. Selling off Eagle or AAdvantage would similarly harm AA. Maintenance? No way.

 

[jimntx]

The argument that companies should divest themselves of ancillary operations--maintenance, FF programs, Information Technology departments, etc--to enable them to "concentrate" on what they do best has a large hole in it. I was on the losing end of the argument at a major oil company when they decided to start outsourcing various operations to India and beyond.

Yes, in the short run, outsourcing saves money. However, (and this is a huge however)...

1. When you outsource an operation (and concomitantly eliminate those company employees who were doing those jobs), you lose what is known as "corporate memory." Everyone of us can given examples of "How the manual says the job is done" vs. "How the job is actually done in real life."
2. Along the same line, when something out of the ordinary happens--inclement weather, power outages, etc--people who have been doing the job for some time know how to modify their operation to fit the temporary situation. An outsourced operation only knows how to do what you have told them in advance to do in the case of very specific events. If the event has never happened before, they will need someone from the company to tell them every step of the modified operation, AND they will (I promise you) charge you extra for requests not covered in the contract.
3. In the case of an IT department, for instance, (my particular area of extensive experience), if they needed me to work on a weekend, it simply took a phone call like "Jim, we are working this weekend to get this rush modification installed on the computers before Monday. Come on down and join us." I went and I did not get paid extra because I was a salaried employee. If a modification did not work as expected when installed, I worked in the office until it did. An outsourced IT department charges you for every single thing not previously specified in the contract. In the long run, the "savings" evaporate.
4 The outsourcing companies have no vested interest in the long-term survival of the client company as an employee would. All they are concerned about at the end of the day is did the last check bounce or did it clear the bank.

Now, I'm not saying that outsourcing and selling off parts of the company caused the demise of Texaco. However, they outsourced the IT department. They outsourced the credit card operation. They sold off majority interest in the marketing department to Shell and ARAMCO. Texaco does not exist today. A few of the Texaco executives still survive within the corporate walls of Chevron, but not many. There are a few Texaco gas stations around, but here in Dallas I've noticed that they are always 5-10 cents higher on each grade of gas than other retailers.

 

[The Goose]

I agree with jimntx; one loser airline (Air Canada) spun off/sold its frequent flyer program in a desperate attempt to raise cash and all of a sudden the financial oracles in Iceland think it's what AA should do.

Memo to the FL Group: Leave the airline biz to the pros who know what they're doing. These idiots bought AA stock last fall on the way up and now they're crying because their investment is worth substantially less. Boo Hoo.

Spinning off SABRE was necessary (for business reasons) but in the long run, losing that diversification hurt AA. Selling off Eagle or AAdvantage would similarly harm AA. Maintenance? No way.

Loser airline I can agree with - wasn't it this or another Canadian group that Carty came from?

As far as leaving the airline business to the pros, who might that be? All USA airlines are grossly mismanaged. The only "shareholder value" the executives are interested in is their own and endless layers of management personnel is the best method to reduce one's exposure to accountability.

As far as selling or spinning off AAdvantage - AAvantage has created a great deal of liability for AMR. If those members actually cashed in on their miles, AMR would be hurting. Why not get rid of it? Give the liability to someone else and pick up a few billion bucks in the process.

Maintenance is a different story, however. American enjoys the control it has over its aircraft's maintenance. This would change if another company ran the maintenance end of things. Romano stated a while back that they weren't looking at selling the maint. business "at this time" (his words).

Agreed - FL made a bad investment but knows they could recoup a good deal of it if they could gain control of the board (getting rid of other companys' rejects) and start running the airline like a real business instead of an executive piggy bank. There's no doubt that all employees would suffer (except, of course, all but the top brass), but - that's what the wonderful world of business is all about - right? Hide and watch.

Agreed, it would be very stupid to sell these assets, but that's exactly why I believe it will happen. Arpey and the BOD are not interested in accountability and, I believe, will do the minimum necessary to shut FL up.

 

[jimntx]

As far as selling or spinning off AAdvantage - AAvantage has created a great deal of liability for AMR. If those members actually cashed in on their miles, AMR would be hurting. Why not get rid of it? Give the liability to someone else and pick up a few billion bucks in the process.

That was the whole point of my post. AAdvantage is a liability to AMR. Now, explain to me why it would be of value to anyone else? If they pay us $6 billion for the program, how do they recoup their investment and make a profit?

It's very easy to say rid yourself of the liability. DUH. It's another thing to come up with a reason why anyone would take this liability off your hands.

 

[The Goose]

That was the whole point of my post. AAdvantage is a liability to AMR. Now, explain to me why it would be of value to anyone else? If they pay us $6 billion for the program, how do they recoup their investment and make a profit?

It's very easy to say rid yourself of the liability. DUH. It's another thing to come up with a reason why anyone would take this liability off your hands.

Actually, I was agreeing with you.

The backyard deposits of your dog are worthless also, but if you can find a fool to give you $5 per, would you sell?

 

[jimntx]

Actually, I was agreeing with you.

The backyard deposits of your dog are worthless also, but if you can find a fool the give you $5 per, would you sell?

Yes, and someone that dumb might come along. However, I rather doubt you are going to find someone that dumb who also has a spare $6 billion dollars burning a hole in their pocket.

 

[The Goose]

Yes, and someone that dumb might come along. However, I rather doubt you are going to find someone that dumb who also has a spare $6 billion dollars burning a hole in their pocket.

FL may have someone in mind - their reason to make the comment.

 

[FWAAA]

That was the whole point of my post. AAdvantage is a liability to AMR. Now, explain to me why it would be of value to anyone else? If they pay us $6 billion for the program, how do they recoup their investment and make a profit?

It's very easy to say rid yourself of the liability. DUH. It's another thing to come up with a reason why anyone would take this liability off your hands.

AAdvantage is a very small liabilty to AMR. AAdvantage miles and the awards they represent comprise a very small portion of AA's liabilities, despite the $1.6 billion figure in the 10-K. Most of that amount represents deferred revenue from the sale of AAdvantage miles to partners, not the liability to fulfill flight awards. Flight award liability is only about $300 - $400 million. The rest is deferred revenue.

AA takes in several hundred million dollars a year from its partners like Citibank, the hotel chains and car rental outfits, together with hundreds of smaller businesses who buy miles from AA to award to customers. Since fulfilling flight awards can be done on the cheap, the AAdvantage program is hugely profitable. Maybe that's how the financial wizards think it's worth a few billion dollars.

Since it's hugely profitable, however, that argues in favor of AMR keeping those profits for itself.

 

[mrman]

Hey, Lucy. 'Splane to me how the AAdvantage program has a "value" of $6 billion. A liability on the books for $6 billion--i.e., commitment by AMR to provide future travel/benefits to FFs which at the time of redemption will not generate revenue to the company--yes, I could see that. But, a "value?"

While AAdvantage is a liability on the books, you are missing the "Asset" and revenue generator. You are seeing only the liability to provide travel. These programs are revenue generators through the purchasing of miles by third party credit card companies, car rentals, FTD, hotels, mortgage companies etc. Add to that the largest intangible asset that is not on the books. No not goodwill, but the FF member list. This list can be used for marketing purposes not only for the airline, but third party users as well. AA FF list is second only to WN with members. At one point during Delta's pre bankruptcy period, the Delta's list and the annuity revenue from selling miles was worth more than the net assets (assets-liabilities) of the airline itself.

 

[jimntx]

Thanks for the answers. I didn't think about the fact that we sell those miles to outside entities to use as a "carrot" to their customers--despite the fact that my sister is a MAJOR user of the AAdvantage miles Citi card.

And, I agree with FWAAA. If it makes a bunch of money for us, why would we sell it?

However, I just had a thought. (Didn't you smell rubber burning? ) If AMR sells the program to me, I'm guessing there will be a restriction of some sort in the number of miles I can sell to others in the future because every mile I sell is creating a new liability (however small) for AMR. I can see how this makes money for us, but WE control how many miles are made available and we control how/when those miles are redeemed--just try to get travel rewards to popular destinations during high season for that destination. :angry:

There's still something missing as to how an outside entity makes the program profitable.

 

[mrman]

Thanks for the answers. I didn't think about the fact that we sell those miles to outside entities to use as a "carrot" to their customers--despite the fact that my sister is a MAJOR user of the AAdvantage miles Citi card.

And, I agree with FWAAA. If it makes a bunch of money for us, why would we sell it?

Some thoughts. New China routes need aircraft. Should would be nice not to have to finance. MD80's getting long in the tooth. If you paid cash, you could get in the same mode as WN and not have financing costs for aircraft thus being more competative. Increase employee wages , thus making happier employess and better customer service, thus making happier customers which makes happier stockholders which would prevent the selling of Eagle

 

[jimntx]

Increase employee wages , thus making happier employess and better customer service, thus making happier customers which makes happier stockholders which would prevent the selling of Eagle

What are you smoking?