Markets & Finance

AMR and American Airlines: CreditWatch Negative


Standard & Poor's placed its ratings on AMR Corp. and unit American Airlines Inc. on CreditWatch with negative implications on Jan. 10, following the announcement of American's agreements to acquire Trans World Airlines Inc. and certain assets of US Airways Inc.

The transactions would provide American with a geographically well placed hub in St. Louis and strengthen the company's position at key East Coast airports, which would help offset competitive damage from UAL Corp.'s proposed acquisition of most of US Airways parent US Airways Group Inc. However, the transactions would cost $5.1 billion in cash and assumed leases, and involve potentially difficult labor integration problems.

The proposed acquisition of TWA would be an asset purchase, whose terms were agreed between American and TWA prior to TWA's

filing for bankruptcy today. American is to pay $500 million in cash (secured by certain TWA assets pending bankruptcy court approval) for TWA's assets and provide $200 million debtor-in-possession financing to allow TWA to maintain operations in Chapter 11. American would also assume TWA's aircraft and facility leases, subject to satisfactory renegotiation of some leases. American estimates the value of those leases after renegotiation at about $3 billion. The plan is conditioned on approval by TWA's creditors and agreement by its unions, which appears likely, to waive their contractual rights to be integrated into American's employee group by seniority.

In a separate but related transaction, American has agreed to buy certain assets of US Airways Inc for $1.2 billion cash and $300 million assumed leases. These include 86 aircraft, 14 gates, and 36 landing slots at several major East Coast airports. American will also acquire a 49% interest in DC Air, the Washington, D.C.-based small airline to be created as part of the UAL-US Airways Group merger, for $82.4 million. Together, these assets represent about one-fifth of US Airways Group. The AMR purchase of US Airways assets and UAL's bid to acquire the remainder of US Airways Group are subject to approval by the U.S. Department of Justice and (in the case of the UAL-US Airways combination) European Union regulators.

TWA's principal asset is its St. Louis hub, which is geographically well-positioned to serve connecting traffic on both east-west and north-south routes. If the UAL-US Airways combination proceeds, American's competitive position at Chicago's O'Hare International Airport, its second-largest hub, would be undermined. St. Louis would supplement Chicago and American's main hub at Dallas-Fort Worth International Airport as midcontinent hubs. However, St. Louis has a much smaller local market than Chicago or Dallas, and low fares on many short-haul routes due to competition from low-cost Southwest Airlines Co. TWA also has some desirable gates and landing slots which, along with the assets to be purchased from US Airways, would bolster American's position in several large East Coast markets (Boston, New York City, and Washington, D.C.). This is particularly important, because UAL's acquisition of the remainder of US Airways would challenge American's stronger position along the East Coast.

Still, the combined United-US Airways route system, even with some asset sales, would be more comprehensive and attractive than the enlarged American route system. AMR's purchase of TWA and US Airways assets, on the other hand, would cost only about half as much as UAL's proposed acquisition (net of the assets being sold to American). UAL's pro forma revenues would be about $25.9 billion and AMR's $22.6 billion, both far ahead of Delta Air Lines Inc., the third-largest U.S. airline, according to AMR.

AMR estimates that its lease-adjusted net debt to capital will rise to about 70% from the current low-60% area, but decline gradually thereafter. That would still leave the company with one of the better balance sheets in the highly leveraged airline industry. However, the effect of the proposed transactions on AMR's earnings and cash flow measures is likely to be more damaging. AMR acknowledges that its earnings per share will decline in 2001, relative to what they would otherwise be, but believes they will improve thereafter.

Although American is likely to obtain agreement from TWA's unions regarding seniority integration, it still faces potentially difficult labor issues. The TWA employees will likely be relieved to work for a more financially secure company, and may be willing to accept junior seniority positions. Over time, though, there would likely be pressure to raise their pay. Equally important, American's unions will no doubt use the need for their cooperation in integrating TWA into American to bargain for higher pay, as are unions at United Air Lines Inc. in regard to that airline's combination with US Airways. American is already engaged in difficult contract negotiations with its flight attendants' union, and faces similar talks with its pilots later this year. The prospects for labor support are helped somewhat by the fact that American proposes to acquire more assets than it is hiring employees from TWA and US Airways Inc., implying promotion and hiring opportunities for American's employees.

Standard & Poor's will meet with AMR management and evaluate the benefits and risks in the proposed transactions. Resolution of the CreditWatch is unlikely to occur before TWA's sale is approved or rejected by the bankruptcy court and the various transactions involving US Airways are resolved.

If AMR Corp. and American Airlines Inc.'s corporate credit ratings are downgraded to double-'B'-plus from triple-'B'-minus, American's equipment trust certificate rating of triple-'B' and the ratings on all enhanced equipment trust certificates would likely be affirmed at current levels. The equipment trust certificate ratings of major U.S. airlines rated in speculative grade are typically two notches higher than the corporate credit rating (e.g. triple-'B' if the corporate credit rating is double-'B'-plus), whereas the equipment trust certificate ratings of investment grade major airlines are typically one notch higher than the corporate credit rating (e.g. triple-'B' if the corporate credit rating is triple-'B'-minus). This reflects the greater differentiation of ratings for speculative grade issuers based on potential post-insolvency default and recovery prospects. From Standard & Poor's CreditWire


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