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A Wing, A Lot Of Loans, And A Prayer


If America West and US Airways pull off their planned merger, they will have a lot of people to thank. About half of the $1.5 billion in new capital behind the deal is expected to come from the carriers' own vendors, including a couple of other carriers, a manufacturer, and even a credit-card company or two. "They're grabbing financing wherever they can," says Calyon Securities Inc. airline analyst Raymond E. Neidl.

To some critics, the financing scheme that will enable America West Holdings Corp. (AWA) to buy the far bigger US Airways Group Inc. (UAIRQ) out of bankruptcy and take its name amounts to a house of cards. By snuggling up even more closely with their customers, vendors such as Air Wisconsin Airlines Corp., Air Canada and planemaker Airbus will be making themselves much more dependent on the merged airline's success, which is not a sure bet. What's more, says Stuart Klaskin of Miami's KKC Aviation Consulting, vendor financing is "another artificial force keeping excess capacity in the industry."

The arrangements mark a bold extension of the industry's use of vendor financing that other carriers -- and other sectors -- could easily try to mimic. Manufacturers, such as Boeing Co. (BA) and Airbus, and financiers like GE Capital have long helped the airlines finance big-ticket items such as planes and jet engines. But this merger would expand such financing into new areas such as air miles for incentive programs and maintenance. Also, the bargains the various partners have struck give all the players a far bigger stake in making the new US Airways a winner. "Airline mergers in general have a pretty dismal track record," warns Standard & Poor's analyst Philip A. Baggaley. "It's a risky move."

ACE'S GAME

The risk isn't evenly spread in the complex recapitalization plan announced on May 19. Air Canada's parent, ACE Aviation Holdings Inc. (ACEAF.PK), will wind up holding 7% of the equity in the new US Airways in return for a $75 million cash infusion. While its outlay will then be subject to the rises and falls of the new carrier's stock price, ACE will be exposed to less risk than other investors. That's because it will get contracts to maintain an expected 361 planes for the merged outfit, providing a steady stream of business worth about $1.2 billion over five years after spending about $20 million on upgrading maintenance facilities -- provided US Airways stays aloft that long. ACE Chairman and Chief Executive Robert A. Milton calls the deal "a win-win all around."

There's another reason ACE feels driven to do the deal in an increasingly interdependent airline world: US Airways and Air Canada both share passengers through the Star Alliance, a marketing arrangement among 16 global carriers. If US Airways can't emerge stronger from Chapter 11, Star Alliance will lose a big contributor of traffic. On the other hand, if America West finally ties up with US Airways, Star potentially scoops more passengers into its global network.

For the other carrier chipping in finance for the merger, Air Wisconsin, the stakes are even higher: its very survival. United Airlines Inc. (UALAQ), trying to cut costs, this year is dropping the Appleton (Wis.) regional carrier as a partner that gets thousands of passengers for its short routes from Chicago, Denver, and Washington, D.C. By anteing up $125 million for stock in the new US Airways through its Eastshore Holdings LLC unit, Air Wisconsin is buying the right to get new feeder traffic from the merged carrier. The smaller, privately held airline is betting that a reinvigorated US Airways will generate more than enough business over several years to justify the financial outlay.

Other vendors crucial to the deal are making similar bets that US Airways will be around and paying its bills for a few years at least. The carriers are counting on so-far unnamed credit-card companies to sign on to get the right to provide mileage-based credit-card services in exchange for a $300 million "signing bonus" and loan. A similar arrangement last year proved crucial for struggling Delta Air Lines Inc. (DAL) when its credit-card partner, American Express Co. (AXP), advanced the carrier $500 million in sorely needed financing. The card companies have a lot to gain, too. "Airline frequent-flyer cards can easily generate three times the annual spend of other credit cards," says David Robertson, publisher of The Nilson Report, an industry newsletter.

The outfit that is making the longest-term bet, however, is European planemaker Airbus. It has agreed to lend the merging carriers $250 million. In exchange, they will become the North American launch customer for Airbus' planned A350 aircraft. US Airways has pledged to order 20 of the 250-seater planes, starting in 2011. That's important to Airbus, which is trying to line up financing for the A350 and needs to demonstrate that the plane is marketable. The deal is hardly unprecedented, but in this case, it represents a wager that the merged carrier will survive at least six years.

WHITE KNUCKLES

Might all these vendors take a big bath someday? Deal boosters say such industry insiders certainly should be smart enough to judge how risky their bets are. But one big vendor, GE Capital, is downsizing its wager by taking back some of the planes it has leased to both carriers. "It's difficult when the guy who is paying the bills is not making money," warns Roger E. King, a senior analyst with the CreditSights Inc. independent research firm in New York.

Investing in the airline business has been a white-knuckle affair for years. The big difference now is that more of the people taking the trip have more at stake than just a few million dollars' worth of stock. It's enough to make even a veteran traveler a little queasy.

By Joseph Weber in Chicago, with Carol Matlack in Paris and Mara Der Hovanesian in New York


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