Prudential released a research report on AWA last week which extensively discussed the merger. The entire report is too big to attach (550K file size), but here are the highlights:
• AWA is a full-service airline with relatively low costs that has performed well in recent quarters. Looking forward, its future now rides on its handling of the upcoming acquisition of US Airways out of bankruptcy. Although the acquisition of UAIRQ by AWA may do a lot to stop the bleeding at US Airways, we are concerned that AWA may be too optimistic in its outlook for the combined company.
• UAIRQ is in bankruptcy and is expected to emerge in the fall with the help of this merger. In the combined entity, AWA shareholders will receive 39% of the shares, UAIRQ creditors will receive 12% and the balance will go to new investors, including suppliers who are putting up capital to enhance their relationship with the combined entity. Existing UAIRQ shares will be cancelled and become worthless.
• AWA management has indicated that they have a plan that will enable the combined company to be profitable, even if oil stays at $50 per barrel. They have also forecast synergies of $600 million per year. We feel confident that the route realignment savings of $150 million are likely to be achieved and should be apparent this fall – shortly after approval of the merger. The cost savings of $250-$300 million will also likely come – but with some delays. However, we are skeptical of the overall general synergies of $150-$200 million stemming from the national scope of the combined company and we do not believe the merged company will be able to achieve its stated objective of being profitable even with $50 oil.
• The historic AWA cost structure has not been low enough to be an offensive weapon as is the case with the true LCCs (low cost carriers). We see the new combined carrier having similar capabilities. We believe It will use its lower costs to defend its current and historic markets, but is not likely to carve out new hubs in the face of meaningful competition from the other carriers.
• AWA shares have moved up nicely since the proposed merger was first announced. This move has been fueled, to some extent, by the news of various lenders and investors pouring money into the combined entity. From this point forward, we doubt there will be much in positive or surprising information for the next several months. As such, we see little to fuel further upward movement in AWA shares, other than potential positive general industry news such as fuel price decreases or fare increases.
VALUATION: We have valued AWA on a price-to-revenue basis. We have a year-end price target of $8.00 on current AWA shares for a post-merger market capitalization of $1.2 billion, or about 13% of the estimated 2006 revenue stream of $9.0 billion – equivalent to the average of Continental (CAL-$14.32-Overweight), Northwest (NWAC-$5.30-Overweight), and American (AMR-$13.40-Overweight), the three strongest and well-capitalized legacy carriers.
RISKS: As with the other airlines, fuel prices could again sky rocket to new highs and the economics of the airline business could weaken substantially. In addition, the combined company could find that achieving any of the anticipated savings is far more difficult than is currently believed. Either of these scenarios could make our outlook for the company far too optimistic. Alternatively, some unforeseen obstacle to the merger could appear and the recent increase we have seen in the current AWA shares could be retraced.
If anyone would like the full report, e-mail me and I will e-mail it back to you.
Jim
