The impact of the American Airlines – US Airways merger on American Airlines AAMRQ stock: a curious case of stock piggy-backing

So I have been investing in stocks for 3 months now. My portfolio is in good shape; I lost a bunch of money from some bad trades, and gained a bunch from the good ones. Overall, I have come out ahead and learned a good deal about the stock market. Funny enough, most of my gains have been huge gains (think 20% or more) and come from incredible trades. One such a good trade gave me more than 50% return and really boosted my confidence for investing. And I have American Airlines and US Airways to thank for that. Specifically, I have the merger deal between them to thank for the gains from American Airlines stock. At this point I have already sold my entire position in the stock, and little did I know at the time that the movement of the stock was such a unique case in the world of investing.

The decision to sell my stake came 3 weeks ago when I decided to dedicate myself to studying for an actuarial exam and did not want to monitor the stock daily. And of course the stock has gone up another 40% since then, mostly in the past few days. Since I took the exam last Thursday, I have been fighting myself to get back in, but in the end I chickened out and missed out on the run. Oh well. Anyway, here is the deal (pun intended).

American Airlines stock files even higher.
American Airlines stock files high.
Thanks for the deal, US Airways.
Thanks for the deal, US Airways.

To give you some background, American Airlines is owned by AMR Corporation, and when I say American Airlines stock I really mean AMR Corporation stock. The stock symbol is AAMRQ. US Airways is owned by US Airways Group; their stock symbol is LCC. AMR Corporation filed for bankruptcy in late 2011. Usually that means all shares of the company become worthless, but there was an exception to this case, an exceptional exception. In early 2013, US Airways Group and AMR Corporation announced a plan to merge to become the largest airline in the world. As part of the deal, current stockholders of AMR Corporation would be rewarded with some US Airways shares.

Exactly how many? Here is where the fascinating stuff comes in, but at least we know that AAMRQ stockholders would receive something, and I jumped on the bandwagon on the news. I actually had planned to jump in earlier since I anticipated the merger to be announced soon, but I did not have my investment account soon enough: AAMRQ, since the mother company was in bankruptcy, was traded on the pink sheets, and since my Scottrade account was so new I had to wait for a few days upon opening to start trading it. The bad timing resulted in me missing out on the overnight 60% jump. But I digress.

Under the agreement between the two companies’ stockholders, apparently AAMRQ stockholders would divide 3.5% of LCC’s stock among themselves. People tend to think that this 3.5% is fixed, but according to some sources this is the minimum. Take Bloomberg for an example: http://www.bloomberg.com/news/2013-02-14/us-airways-leads-amr-merger-to-create-largest-airline.html

[Tom] Horton [CEO of AMR Corp] said AMR’s shareholders will recover β€œat least a 3.5 percent aggregate ownership stake” under an agreement with creditors.

The percentage of LCC stock that AAMRQ holders will receive when the deal closes is not fixed at all. It is almost free to vary. Assuming what Horton said is right, it can go down to 3.5%, or up to the double-digit.

What is determined is, AMR stakeholders will receive 72% of LCC. When a company emerges from bankruptcy, any equity is distributed to debt holders first, then to employees, and finally to stockholders. So AAMRQ holders will receive whatever is left after the 72% is distributed to creditors and employees. If LCC is high valued, the leftover is potentially huge, and if LCC is low valued, there may be nothing left over. The SEC filing for the merger can be found here: http://www.sec.gov/Archives/edgar/data/4515/000119312513060746/d487000dex21.htm

Before we get to the math, let me take a minute to thank Jamie Baker from JP Morgan for providing the analysis that I am going to walk you through. He is the only analyst I know that accurately explains the terms of the merger and values AAMRQ stock. They set a price target of almost $7 for AAMRQ, and today the stock got really close to this level. https://markets.jpmorgan.com/research/EmailPubServlet?action=open&hashcode=-khht4o7&doc=GPS-1058079-0

Math time again
It’s simple math. Don’t be intimidated.

I will be using numbers provided by JP Morgan for the calculations. We have some variables:

LCC price: let’s call it X
LCC shares oustanding: 736.8 million
AMR liabilities to creditors and employees: $7.565 billion, or $7,565 million
AMR shares outstanding: $335.3 million

To simplify, let’s get rid of the millions.

The value of US Airways is 736.8*X
The portion allocated to AMR is 72%*736.8*X=530.5*X
The leftover for AAMRQ shareholders is 530.5*X-7565
Value per AAMRQ share is (530.5*X-7565)/335.3

AAMRQ price = 1.582*LCC price – 22.56

—————————————————————————————————————————————————————-
You see, AAMRQ price totally depends on LCC price. To give you perspective, if LCC price is $15 per share, then AAMRQ will be worth $1.17. On the other hand, if LCC price gets to $20 per share, AAMRQ will be valued at $9.08. If LCC price drops below $14.26, AAMRQ shares will be worthless.

I have drawn a graph that tracks LCC price, AAMRQ price estimated from the formula, and actual AAMRQ price:

AAMRQ stock

The estimation is meaningful after February 14, the day the merger deal was announced, and only when the estimate is above 0 since a stock price cannot go negative. You see, from early March on the actual stock performance has been closely following the estimate, and finally the gap was closed about 2 weeks ago. But more importantly, a change in LCC stock price enormously amplifies a variation in AAMRQ price. If tomorrow LCC price goes up $1, which equals 5.6%, AAMRQ price will go up $1.58, an increase of a whopping 27%!

And this has happened. As LCC went from $17 to $18.1, or 6.5% between 5/6/13 and 5/14/13, AAMRQ increased to $5.79 from $4.42, or 31%.

Basically AAMRQ stock piggy-backs on LCC with much more volatility. The value of AAMRQ stock depends not only on the movement of LCC but also on the date the deal is closed, which is expected to be some time in the 3rd quarter this year. On this date, the price of LCC as well as AAMRQ will be locked in. Both stocks will be canceled, and each stockholder will receive a share of the new company equivalent to the value of their shares pre-merger.

In closing:

AMR Corporation is one of the rare bankruptcy cases where stockholders may be able to recover 100% value when the company emerges. What’s more interesting is that the price of one stock is determined completely by that of another. If you believe that US Airways will do well and see their stock appreciate, you should actually invest in American Airlines stock since the latter will go up in value even faster. If you are unsure about US Airways’ short term performance, I’d be cautious: AAMRQ is much more volatile than LCC in both directions. I would not recommend investing in AAMRQ if you are risk-averse.

This is my second article on investment, and you can expect more in the future.

I can’t tell you how liberated I feel after my exam. Feels good to start writing again. Thank you for patiently awaiting for my comeback!!!

Best,
Richard (Hiep Tran)

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43 thoughts on “The impact of the American Airlines – US Airways merger on American Airlines AAMRQ stock: a curious case of stock piggy-backing

  1. According to Yahoo Finance AAMRQ has less than 7.6B debt that you mention above

    Total Cash (mrq): 4.24B
    Total Cash Per Share (mrq): 12.66
    Total Debt (mrq): 9.50B

    That amounts to a net debt of about 5.26B
    Who is correct?

    1. Thanks for your feedback. The debt amount you quoted is correct as far as I know. And then labor claims add an extra $2 billion + on top of that. I have not dug into these numbers enough to verify their accuracy, but I trust JP Morgan’s number, and using it results in a very accurate estimation model as you can see from the graph.

      1. Surendra and greg,

        If you look again at the graph you will notice that until very recently the stock was traded at a premium. In the long run the estimated and actual numbers should come close, and random irregularities along the way are to be expected. The reason the stock fell all of a sudden last week and earlier this week was because investors started cashing out, causing a big swing and triggering sell limit orders, which in turn caused the stock to plummet. After a few days of correction, the stock price came back to the estimate, which is expected.

        When we look at a trend, there will always be deviations. It’s important to acknowledge that in order to focus on the big picture.

  2. Richard, thanks again. Have written a short program to track the AAMRQ price relative to LLC. There appears to be approximately a 10% discount to the calcualted price per your formula above. Which answers Surendra’s question above. The market is tagging the deal with a 10% discount due to the uncertainty of the future value of LLC and any uncertainty as to the merger effecuating. As the actual merger date and certainty of the merger approach, this 10% discount should theoretically lessen.
    cpaman50

  3. Nice analysis but there is one correction. AMR actually announced that their shareholders would receive some value for their stock BEFORE the merger was announced, so while you are correct that this is unusual, it wasn’t as a result of the merger.

  4. greg and DS,

    Thanks! I was not aware that AMR made such a promise before the announcement of the merger, but a scenario where stockholders would be paid anything while creditors were not paid back the full amount is rather unlikely. Could it be that AMR were already in the talk with US Airways about a likely merger at that point? I would be interested in knowing if that’s the case!

  5. Recently a story surfaced that Arpey had actually approached US Airways pre-bankruptcy (obviously since Arpey resigned when AMR filed) about a relationship that would eventually lead to a merger post-bankruptcy, but who knows what really happened. Remember AMR also had about $4B in cash / cash equivalent when they filed.

  6. Hello,
    I am kinda fresh in finance. Can you help me understand the exchange of stock between 2 companies? American Airlines creditors, stakeholders, and stockholders will own 72% of the combined firm stock whereas US Airways–the company who buys American Airlines will just own 28% of the combined firm. It doesn’t make sense to me. Can you help?

    1. Hi,

      I thought I responded to your question the day after you asked, but for some reason my reply is not showing, so let me answer your question again. The American Airlines-US Airways combination is a merger, not an acquisition, so US Airways Group does not buy AMR Corporation; rather, they combine assets (as well as liabilities) to form a new company. Since AMR Corporation holds more assets than US Airways Group, it is only natural that AMR Corporation will take a larger share in the new company.

      Let me know if you have further questions.

  7. Hello,
    I really liked your analysis of this. For the formula you stated above, does this price for AAMRQ represent the dollar amount (per share of AAMRQ) I will be given in the new company post merger (ie: if I have 1000 shares of AAMRQ and AAMRQ =$4.00 in the above equation, I will be given $4,000 worth of shares in the new company), or does this only apply up until the merger?

    Also, I have extra money that I would like to invest before the merger is complete; is US Airways better to invest in, or AAMRQ, or are they the same because they are proportionally related at this point?

    Any advice would be appreciated.

    Respectfully,
    Andrew

    1. Hi Andrew,

      The price of AAMRQ in my analysis is the dollar value per share equivalent to the value of the shares in the new company awarded to AAMRQ shareholders. Before the merger closes, AAMRQ does not have a redeemable cash value since AMR Corporation is still in bankcruptcy.

      As I mentioned at the end of the article, AAMRQ is a lot more volatile than LCC, which means you will win more or lose more if you invest in AAMRQ as opposed to LCC. In my humble opinion, LCC is currently undervalued and will go up before the merger, and therefore AAMRQ will go up even further. If I had more cash right now I would put the money in AAMRQ, but I have other stocks I’m investing in…

      I’m not certified to give professional advice on investment. What I wrote represents my personal opinion only! πŸ™‚

      If you have further questions please let me know. Good luck!

      Best,
      Richard

  8. Hi Richard, thanks a lot for the analysis.
    I purchased 5000 shares at $ 0.35 back in december 2011. I recently missed the $ 7 peak at which I wanted to sell. Is it correct that with the AAMRQ stock we have to make a short term decision in any case as once the stock value is locked you are either stuffed or lucky? I want to know when UAL is hitting the $ 15 price and afterwards will go up if I will still benefit with my new shares?
    Hope my question makes sense. Thanks

  9. Hi Bart,
    Kudos on your smart decision to buy those shares at that price. Are you going to buy a new card with the profit now? πŸ™‚ By UAL I assume you meant LCC. When the deal is closed you will receive shares of the new company, and if those shares go up in value you will keep profiting. Hope that answered your concern.

    Best,
    Richard

  10. What would you speculate the price of the NEW American Airlines Group (AAG) stock will be when they emerge from bankruptcy?

  11. Hi Richard,

    Sorry for the late reply and thanks for your response. Yes I indeed meant LCC πŸ™‚
    Ok, question is, will I retain 5000 shares in the new “merged” company or will I be assigned an amount of shares in relation to the value of my shares on the date of the merger? Just not sure if I am better off selling them now at around $ 4,40 or receive shares in the new company…

    Thanks

  12. Ken: I honestly do not know enough about valuation for airlines to be able to come up with a reasonable guess. Will post on that topic when I know more about the new company. At this point, the value of the new company is anyone’s guess. Valuation for merged companies is tricky.

    Bart: You will be awarded with common shares of the new company. Whether you should sell your AAMRQ shares depends on how much you think they’ll be worth in the future. Since stocks are liquid, it doesn’t matter whether you’ll be compensated with cash or with stock. Hope that helps.

    Best,
    Richard

    1. Richard,

      Thank you for sharing. Now that we have more details I think I’ll shamelessy copy your math πŸ˜›

      Total shares = 756,060,441
      US airways share price = $23.00 (around as this is what I saw in some websites)
      Portion allocated to AMR is 72 % ==> 72% of 17.3 Billion ==> 12.4 Billion
      Left over for AAMRQ share holders => 12.4 Billion – [a total of 8 Billion which the company owes to creditors and labours. I have rounded this which I took from your math]
      =4.4 Billion

      Value of AAMRQ = 4.4 Billion/ 335.3 [i.e AAMRQ outstanding shares]
      Therefore value of AAMRQ = $13.09…

      phew….but Richard what I am still not sure is
      a) Is it really 8 Billion dollars that creditors and labour unions are owed?
      b) If I buy today before 6th, will I still get new shares in the new company?

      Any ideas

      Note: So again the above is just math..I do NOT claim that the numbers are correct. I could be horribly wrong and it’s your own decision when you buy/sell the stoc of AAMRQ or anyother stock.

      1. Ra,
        The latest liability number I got from the case, $7.7b, was from July this year. Check out this follow-up post: https://hiepsfinance.com/2013/07/20/follow-up-on-aamrq-stock-price-analysis/
        5 months later, I have no doubt the liability has increased. $8b is probably a good estimate on the conservative side. Accordingly the revised estimate of AAMRQ would be: AAMRQ = (0.72*756*LCC-8,000)/335.5 = 1.623*LCC – 23.86
        If LCC stays around $23, that results in AAMRQ=$13.47
        If LCC goes up to $24, AAMRQ=$15.09
        If LCC drops to $22, AAMRQ=$11.85

  13. I have had the pleasure of 30 years within the commercial finance field'(started with reeses overcash-associates commercial in 77) ended in our own small finance company-250m assets,we saw probably 125 really good hi-potential mergers,or acq. out of 1000’s almost none have ever worked as planned-most usually software platform non-compatability, management issues etc. to much debt,business plans that demand impossible performance-etc,etc.
    AMR-LCC has the best chance for success of any-i have seen. I do not know what success really means in terms of price/share,or earnings, etc but this new company can perform and grow. Your analysis was one of the best i have seen-great job. Now if politics will stay out of the way a lot of mom&pop investors can pick up real money on a real deal, not done behind closed doors because of the US bankruptcy courts. AAMRQ even at $5.00 for the long term player is (OR COULD BE)) a huge return over the next 5 years. i am not licensed to sell,or advise,anyone anything. Great job, that should be a best seller. bmw
    by the way i worked with crocker,BA,Bank one,Chase. M&A segment.and owned as a partner providers funding corp for ten years, $175mm in medical finance annually, and acquisitions.

    1. Bill,

      Thank you for your insight. I hope and think the deal will go through. Airlines have been losing money for too long; the system has not been sustainable. With the recent merger activities in the industry, hopefully including this particular case, the industry will face less cut-throat competition and begin functioning and posting profits like any other industry out there.

  14. ‘Stiff competition, highly leveraged balance sheets and volatility in operational costs driven by fuel expenses has led to major consolidation within the industry. Since 2007, 13 US airlines – both big and small – have filed for bankruptcy.’ http://goo.gl/ITXLIm

  15. so it could happen that aamrq could be for example at 10$ per share and LCC at 24 before the merger and then once cancelled the stock could decrease to below 10$? so it could be better to sell before the merger and then rebuy the merged stock?

    1. Mi Michael,

      Once cancelled AAMRQ will be de-listed; all trading will cease. However, you will be granted shares in the new company and of course have the option to purchase additional shares on your own.

  16. Dear Richard:
    I bought 10,000 share at $0.58-$1.0/share. I don’t know what to do now. If new AAL comes, that means I would loss all shares. Or turns AAMRQ into new AAL.

    1. Wow Jenny,

      I am seriously jealous πŸ˜‰ ..anyways could you please tell peeps here like what made to decide to buy shares at that price given the fact that it was filing for bankruptcy at that point?

      Well done by the way…

      Regards,
      Ra.

  17. Hi Richard,

    I am suddenly confused…Hope you can help me out please

    “The final AAMRQ share count and conversion ratio from AAMRQ into AAL stock for the initial 3.5% distribution will not be available until the Effective Date, December 9, 2013.”

    But 3.5 % of 756,060,441 is rougly 26.4 Million shares..this means 26.4 Million shares * share prices (24) == 607.2 Million.

    The current outstanding share for AAMRQ is 335.0 so that means 607.2/335 gives me a share price of roughly $1.81!..this is confusing..what is that I am doing wrong here?

    Regards,
    Ra

      1. It’s confusing because 3.5% of 756,060,441 is rougly 26.4 Million shares..

        This means 26.4 Million shares * share prices (24) == 607.2 Million.

        The current outstanding share for AAMRQ is 335.0 so that means 607.2/335 gives me a share price of roughly $1.81..

        Does that mean common stock holders of AAMRQ are going to get $1.81 worth of share since they did tell that shares are ‘ratio’ based (i.e they did not say 1 for 1)

        That’s what is confusing unless I am missing some thing here (I am hoping I am wrong)

  18. Hi Richard,

    Yes I do see your point however there is no promise made here like “you will get 1 share for 1 share that you hold”. It says it’s a ratio and who know what that ratio could be..

    But at 3.5% and not more than that then current AAMRQ will get less I think..But I truly hope that’s not correct..i am just trying to clear out the confusion..that’s all πŸ™‚

    Have to wait and see Dec 9th.

    Regards,
    Ra.

    1. It’s a ratio, and that ratio can be derived from my formula written above though frankly at this point it is a little outdated. If you are nervous about the transition process, I would go ahead and close your position. Should give you several good nights’ sleep! πŸ˜‰

      1. No not nervous about the transition process at all πŸ™‚ Anyhow will wait and see how this turns out!..

  19. A Dallas paper quoted the aamrq stock price was only worth 1.65$ as of yesterday. ….Google aamrq to aal stock….. Is that true?

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