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A Whole New Chapter

American uses TWA's bankruptcy filing skillfully in its acquisition, adding pressure on rival United.
Nikos Valance, CFO Magazine
May 1, 2001

AMR Corp. quite literally courted Trans World Airlines Inc.--by insisting that TWA file under Chapter 11 as a precondition of its $500 million acquisition. But while blessed by a bankruptcy judge, this marriage may well have been made in heaven.

The integration of TWA with AMR's American Airlines unit was designed to give American a strategic advantage, of course. Still, airline-industry watchers suggest that AMR may have had another motive for acquiring TWA. "American's principal purpose is to try to derail the UAL deal," which would combine United Airlines and US Air Inc. into the world's largest carrier, says Marc-David Seidel, assistant professor at the University of Texas's McCombs School of Business, and an expert on airline industry mergers.

Taking a financially ailing takeover target through bankruptcy court isn't exactly an unusual approach. Indeed, it's "quite common," says Denver bankruptcy attorney Brent Cohen, who adds that "there are endless possibilities under Chapter 11 to reorganize and emerge, or not emerge, as an entity." For example, he says, "it allows the reorganization and restructuring of the relationship with creditors, the issuance of stock for debt, and the liquidation of assets." Some similar recent cases include the purchase of the United Artists theater chain by Denver billionaire Philip Anschutz's company; Vlasic Foods International Inc.'s acquisition by H.J. Heinz Co.; and the proposed $6 billion bailout of Finova Group by Warren Buffett's Berkshire Hathaway Inc. and Leucadia National Corp.

In the TWA case, AMR spokesperson Tim Doke confirms that without the bankruptcy-court filing, buying the St. Louis­based carrier would have been "very unattractive." Among the complications facing American was an agreement between TWA and investor Carl Icahn that allowed him to buy airline inventory at hugely discounted prices and resell it at prices that he set. TWA estimates that this agreement cost it more than $90 million last year. Also, AMR would have had to deal with "facility issues," such as an outmoded hangar at JFK International Airport. Indeed, American has already renegotiated aircraft leases that had been negotiated with TWA's bad credit rating. Before the airline's filing, "lessors had no reason to give TWA favorable terms," says Doke. "We estimated TWA was paying $120 million more than what we would have had to pay with our credit ratings for the same leases" without the filing. "We've already negotiated savings well north of that."

AHEAD: A PILOT ISSUE

Chapter 11 filings are used by other companies in the acquisition process to help them sell assets free and clear of liens, allowing the target to start with a clean slate. Leases and other contractual obligations, including, in some cases, collective-bargaining agreements, can also be rejected by the acquiring company. AMR has accepted amended versions of TWA's labor contracts, but pilot seniority may be a tough issue. "Typically, there's a 'fence' that keeps pilots of the smaller acquired airline from moving over to the acquiring airline's ranks," says Doke. He predicts it will take three to four years for that transition to be completed; however, TWA pilots can expect a "significant wage increase" no later than January 1, 2002.

Despite the advantages of this bankruptcy-aided acquisition, analysts looking at this year and next say there's more pain than gain for AMR. "In the near term there's no good news," says Sal Colak, an analyst with CIBC World Markets. "We estimate American will take a negative hit from TWA in the neighborhood of $100 million on what otherwise would have been reported. But in the long term, we believe that American will be successful in integrating TWA. There are lots of unused rights [to routes] into foreign countries that will be revenue- positive for American."

The biggest gain for American may be the systemic growth that the acquisition will allow, Colak adds. He estimates that once TWA is fully integrated, that part of American will grow at around 10 percent to 12 percent over three to five years--largely because of American's better credit rating and financial-planning expertise.

Colak says American's benefit will be especially great "if the UAL­US Air merger doesn't go through, and AMR winds up taking the number-one spot in the world in terms of size." Many analysts consider the success of United's deal a toss-up, although Colak predicts defeat, based on congressional, UAL labor, and consumer opposition lining up against it.

THE SPIRIT OF ST. LOUIS

The University of Texas's Seidel agrees that the UAL­US Air arrangement is in danger of being delayed and severely restricted--and he sees AMR's strategy as part of the reason. "The use of bankruptcy ends up helping American in two ways," he says: by drawing attention to the UAL deal's problems, and by giving its own purchase of TWA an altruistic luster. "It can be seen as saving the city of St. Louis and salvaging what's left of one of America's major symbols," says Seidel.

In his view, American's offer to participate in the anticompetitive steps connected with the UAL­US Air deal--American has agreed to purchase US Air routes on the East Coast--also is intended to upset United's plans. While American may appear to be helping United avoid concerns about possible anticompetitive routes that its acquisition might create, he notes, "precisely by doing that it helps to directly focus attention on the monopoly issues, because American and United will then potentially be controlling the Northeast."


Others also see a Machiavellian side to American's strategy. "There's more intrigue there," says Robert Peiser, a former TWA finance chief, who himself led the airline out of one of its two previous bankruptcy-court filings, in 1995. Peiser, now chairman and CEO of Vitality Beverages Inc., in Tampa, believes the latest TWA Chapter 11 filing was grounded in the economics for TWA and AMR, and not in some scheme to upset United's plans. But, he adds, "American might have been thinking, Here's another really great benefit: scrutiny, in and of itself."

Nikos Valance is a contributing editor of CFO.

TWA'S HISTORIC FLIGHT

Three bankruptcies and a wedding.

1930
Transcontinental and Western Air Inc.formed, later renamed Trans World Airlines.

1967
TWA becomes first all-jet airline.

1985
Carl Icahn acquires control of TWA.

1992
TWA files for Chapter 11 bankruptcy protection.

1993
Icahn resigns as chairman; TWA emerges from Chapter 11 reorganization.

1995
TWA files again for bankruptcy protection; emerges later in the year.

1999
TWA is the only major U.S. carrier to show a full-year loss: $353 million.

May 2000
United­US Air deal is announced.

January 2001
American-TWA talks announced; TWA files under Chapter 11; American offers to take some routes to "assist" United­US Air deal.

March 2001
American-TWA deal given bankruptcy-court and Justice Department approval.

SOURCE: MARC-DAVID SEIDEL, UNIVERSITY OF TEXAS




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