Stock of bankrupt companies usually trades for pennies.
But not the shares of American Airlines’ parent company, AMR Corp.
After almost two years of operating under bankruptcy court protection, the Fort Worth-based carrier’s stock shot up above $13 a share this week before closing Friday at $11.77 — a 1,380 percent increase since the beginning of the year.
And as the airline prepares to exit bankruptcy and merge with US Airways following the settlement of a federal antitrust lawsuit, shareholders are poised to join the pay day. Under the restructuring agreement approved by the court, shareholders — who typically get nothing during a reorganization — are guaranteed 3.5 percent of the equity in the new combined airline. And they’re likely to get more than that.
Clearly, Wall Street feels good about the merger. With both airlines posting profits and record revenues, investors seem confident that the new American Airlines Group will be flying high, including its stock price. US Airways stock has risen almost 77 percent this year as the merger plans have progressed, indicating that the combined company is worth billions.
“There is potential upside for the shareholders,” said Don Shelly, a finance professor at Southern Methodist University. “Everybody seems to be really optimistic.”
What usually happens
When a publicly-traded company files for bankruptcy, debt holders have priority to collect what they’re owned, and there’s usually nothing left for shareholders. For example, in the recent bankruptcy case of the snack-maker Hostess Inc., the shareholders received nothing as the company’s assets were sold off to pay off debts.
“It is uncommon for equity owners to retain any interests in contested bankruptcy cases, since in the vast majority of bankruptcy cases the creditors are not receiving 100 cents on the dollar, in money or value, and at least one class doesn't vote to accept the plan,” said Wayne Barnes, a bankruptcy law professor at Texas A&M University School of Law in Fort Worth.
It appeared that AMR shareholders were going to be in a similar situation when the carrier filed for bankruptcy in November 2011. In its filing, AMR listed $29.6 billion in debt and only $24.7 billion in assets.
“On the AMR books the liabilities exceeded the assets. There was negative equity and so from that standpoint there was nothing that should be given to the equity holders,” said Larry Lockwood, a finance professor at Texas Christian University. “You couldn’t take the assets and use them to pay off the creditors. There wasn’t enough.”
As a result, shares of AMR stock plummeted the day it filed for bankruptcy, closing at 26 cents.
Why AMR stock bounced back
For all of 2012, AMR shares traded below $1. The stock was delisted from the New York Stock Exchange in January 2012 because it could not maintain the listing requirements and began trading at over-the-counter markets.
But then in February 2013, AMR announced plans to merge with US Airways as part of its bankruptcy restructuring and shareholders were told they would receive at least 3.5 percent of the new company. And if the value of the new combined entity grew and all of AMR’s creditor claims were paid in full, shareholders could get even more.
“What you’re seeing in the AMR price right now is that expectation of receiving additional shares of the new company,” Lockwood said.
As new labor contracts were put in place and cost-cutting measures were implemented, AMR’s earnings improved. The carrier posted profits in the second and third quarters bolstered by record revenues.
Some Wall Street analysts, who typically don’t follow over-the-counter stocks, reinitiated their coverage of AMR’s stock this fall as it continued to rise.
Wolfe Research analyst Hunter Keay told investors in October that shares of AMR could be worth as much as $13 a share if a merger was completed, but less than $2.50 if the Justice Department was successful in blocking the deal.
“Our extensive analysis leads us to believe that a merger will happen but there is extreme upside/downside risk associated with that call, and a complete loss is entirely possible,” Keay said in a research note, adding that investing in AMR’s stock wasn’t for the faint of heart.
Keay had an “outperform” rating and $11 price target on AMR’s stock. But he pulled it last week after the share price soared over $12 on news of the settlement and now that stock will be exchanged for shares in the new entity next month.
How equity is being divided
With the merger set to close in December, investors are waiting to see if they’ll end up with more than 3.5 percent of the new company.
But figuring out what much they’ll get is very complicated.
AMR’s unsecured creditors are split into two groups: double-dip and single-dip creditors. Together, their claims for what AMR owes them is an estimated total of $5.6 billion before accrued interest. These creditors will receive preferred stock on Day One of the new company that will convert to common stock on Day 30, Day 60, Day 90 and Day 120 to pay off their claims.
As part of the new labor contracts negotiated during bankruptcy, American’s labor unions and other nonunion workers were also promised an equity stake of 23.6 percent of the total claims allowed by AMR, which for employees is valued at about $1.7 billion, assuming the other two creditor groups are repaid in full.
The estimated total amount of claims is $7.28 billion, according to an illustration in the disclosure statement filed by AMR with the bankruptcy court on June 5. That illustration, based on various assumptions, says that all $7.28 billion in claims will be paid, if the new combined carrier’s stock price trades at $14.99 a share or higher during a five-day period prior to the 30-, 60-, 90- and 120-day mark after the merger closes.
At that share price, the 3.5 percent equity stake that AMR shareholders received after the merger would be worth around $400 million and the new company will have a market capitalizaton of approximately $11 billion.
However, if the new company’s market cap is higher than that — because the share price has risen above $15 — there will be excess equity in the new American. Since the unsecured claims are a fixed value, the extra equity would be distributed among the old AMR shareholders at the same 30-, 60-, 90- and 120-day marks.
US Airways shares closed at $23.89 Friday, giving the airline a market cap of $4.7 billion. US Airways shareholders will receive one share of new American stock for each share they own of US Airways, and according to the merger agreement US Airways shareholders will receive 28 percent of the equity in the new combined carrier. So if the merger were to occur now, the market cap of the new airline would be around $17.95 billion.
If the new combined company is worth $17.95 billion on the 120th day after the merger is completed, all of AMR’s unsecured creditors and labor unions would be paid in full plus interest and the old AMR shareholders would be given the excess equity value, almost $5 billion in this scenario, in the form of additional shares. The illustration in AMR’s filing shows old AMR shareholders could end up holding 28 percent of the new company’s equity under this scenario, which is almost the same amount that existing US Airways shareholders will have received.
“Given the dynamics of claims recovery associated with a successful merger, we estimate that holders of [AMR stock] could witness outsized potential gains at [US Airways’] current share price,” J.P. Morgan analyst Jamie Baker told investors in a research note last week..
On the flip side, if the share price of the new American drops below $15, the value of the 3.5 percent equity stake owned by AMR shareholders will be worth much less and they would not have received any additional equity.
End of the rainbow
Although airlines stocks as a group have increased this year, the large increase in AMR’s share price means some investors will likely sell off the stock to reap profits.
“Profit-taking is inevitable,” Baker said, noting that AMR’s shares are up 1,300 percent and US Airways shares up 70 percent year-to-date.
In fact, shares of AMR have declined slightly this week, down 12 percent from a high of $13.50 reached the day the antitrust settlement was announced.
Shelly said he doubts hedge funds would hold onto American’s stock or shares of the new company as a long-term investment and institutional investors, who own US Airways shares, will likely re-evaluate their holdings once the merger is completed. When the merger closes, existing stock will be exchanged for new shares in American Airlines Group, which will trade under the ticker AAL on the Nasdaq exchange.
“We had a situation where everybody was happy and then the DOJ nixed it and now it’s back on again,” Shelly said, describing the ups and downs of American’s situation since it announced its proposed merger in February. “Hedge funds tend to like volatility because that’s where they make money.”
But for those individual investors who have held on to their AMR stock through the two-year bankruptcy process, there may be a pot of gold at the end of the rainbow.
“It is rare that equity holders come out with anything at all and in this case it looks like it could be a very good deal,” Lockwood said.