AMR's Bankruptcy - It's About Time

AMR, the parent company of American Airlines and American Eagle, filed for Ch 11 bankruptcy last week. The timing of the move is somewhat surprising considering that they company still has over $4 Billion in cash on its balance sheet. I personally thought they were going to hold out until a little later. However, looking deeper into the situation of the airline, it actually looks like a pretty shrewd, albeit still later than it should be, move.

The Motivation

The Dallas based airline is the only existing legacy carrier to never have filed for bankruptcy since the industry's 1978 deregulation. Some carriers have gone through it several times. Although initially it may seem that bankruptcy is a bad move, it can be an efficient way to clear out your obligations when business is bad (and business has been really bad for airlines for a while now). This is especially true when many of your competitors have gone through the process already, and you're left with a structural cost disadvantage. 

In the case of AMR, the company has a higher cost structure than its competitors, particularly in the labor cost arena. It also has one of the oldest fleets (I abhor flying those MD-80s) and, after a round of mergers that AMR chose not to (or couldn't) participate in, the company was in pretty bad shape. After the Delta/Northwest and UAL/Continental mergers the company was left in a danger zone of being a major carrier but still having a scale disadvantage to its major competitors (US Air is in the same boat in my opinion). So my thought is that a bankruptcy was inevitable, and management has been delusional trying to avoid it but still not making aggressive moves on neither the cost nor scale front to still be competitive. 

So, why bankruptcy now? Well, I think this question is particularly interesting considering, just a few weeks ago, AMR made the largest single aircraft order in history by buying 200 Boeing and 260 Airbus aircraft. Although it is unlikely that the bankruptcy will impact these orders, the move does give credence that the Ch 11 filing is more of a strategic move. The straw that broke the camel's back, I think, is labor negotiations. The pilot association had just rejected a new labor agreement. So, AMR, realizing that it has a wave of pilot retirements coming up, and those pilots increasingly taking the lump-sum payout (worth around $800k/pilot),  the $4B in cash was going to dwindle even more quickly. And this is an expense that AMR can much more easily reduce in bankruptcy court. 

The Fallout

So what are the impacts? You can expect to see some capacity reductions. You can also expect to see new labor contracts negotiated, and probably some planes taken out of service (they're actually still making payments on Fokker F100s that have been out of service for 5 years). Overall, you'll see an AMR that is leaner, but there shouldn't be drastic changes to the flying experience in the near future. 

The Model Going Forward

I think you'll see a few strategic changes going forward. First, AMR still has a scale disadvantage (albeit not a huge one). They're also relatively weak on Asia service. So I think a merger may be in play here. US Air might be an opportunity, although I don't think the route system commonality is there, particularly in the more profitable international travel. JetBlue is a name that's thrown around and is likely a stronger possibility as it will allow AMR to beef up its NYC presence. The recent Airbus order also addresses fleet commonality issues. The one that I think is also possible is Alaska Air. They already have a codeshare agreement. AMR doesn't have a major presence in the west, and the Alaska is solidly profitable.  

Finally, I think what you'll have to see is an AMR that's much more aggressive in managing its product. I've been a loyal AA flyer for years (and last year had their highest frequent flyer status), but it wasn't for their superior service. The planes will need to get better, the service will need to improve, and the capacity will need to grow in the long run. All of these have generally been heading the wrong direction in the 4 years I've regularly flown the airline. 

PS - I'm only saying this because a friend told me he bought Northwest Airlines stock after they declared bankruptcy, not realizing that the stockholders usually get wiped out completely, but DON'T buy AMR's stock. It's in the realm of arbitrage hedge funds now until it's value turns into a big fat zero. 

What are your thoughts?

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