Delta Fights Back

Delta, Mergers/Finance, US Airways
duel

Who’s ready for a good old fashion duel? Apparently US Airways and Delta are, because that’s what it’s come down to. Today, Delta issued a barrage of press releases that basically told US Airways to go away. They have a better plan.

Think I’m kidding about it being a barrage? Here’s the lineup from this morning:

I’d say that’s enough to make any reporter cry. But let’s forget about that. What is really going on here?

First of all, Delta put out its own bankruptcy reorganization plan as a stand alone company instead of merging with US Airways. The plan values the company at between $9.4 billion and $12 billion. On the surface, this compares favorably with US Airways’ proposal valued at $8.4 billion, but when you dig in, it may not be as great as it seems.

In the Delta plan, the unsecured creditors get no cash at all. They will receive common stock in the new company to settle their claims. If the $9.4 billion valuation is correct, that’s 63 cents on the dollar for the unsecured creditors going up to 80 cents on the dollar if the valuation comes in at $12 billion. Of course, the exact valuation won’t be determined until a later date and it could be lower. That’s something with which the creditors would have to be comfortable.

On the other hand, US Airways offered a combination of $4 billion in cash and $4 billion in stock (which has now increased in value to $4.4 billion in stock). Back then, it meant the creditors would receive 50 cents on the dollar, but with the increase in share price, it now means 52.5 cents on the dollar. This, by the way, assumes $16 billion in claims. That’s $1 billion more than Delta’s estimate and I’m assuming it accounts for all the additional restructuring that US Airways wants to accomplish before it brought Delta out of bankruptcy.

So it’s up to the unsecured creditors to decide if they’d rather take the lower valuation with guaranteed cash from US Airways or take their chances on stock valuation of an independent Delta. Don’t forget that US Airways could also decide to sweeten the pot and increase the offer if they see fit.

In their rejection of the offer, Delta also outlines several reasons why they are against the merger. If you’d like to read through their investor presentation (pdf), you can get much more information than this. If you prefer the Cliffs Notes version, here it is with my comments. These are the reasons why they think the merger is a bad idea:

* Has an unacceptably high risk of not achieving antitrust
clearance because the US Airways proposal would harm consumers
and communities;

Well, that may very well be true, but why not let the government decide that? It seems like you could get an idea fairly quickly through back channels about what would be required to help it through the government review. Would they have to shed assets? If so, decide if it’s worthwhile or not and run with that decision. I’m sure Delta is using this to position themselves as the champion of the customer here, but really it’s just a PR move to get sympathy that shouldn’t impact the outcome. If you’d like to read more, go to this presentation (pdf).

* Has overwhelming labor issues precluding attainment of claimed
synergies;

This is an interesting one. The airline says that their pilot contract doesn’t allow them to reduce flying hours, so the US Airways plan to cut capacity 10% wouldn’t work. I’m guessing US Airways realized that and is planning to cut more regional flying on the Delta side. Since much of that regional flying is outsourced, they could probably shed it fairly easily. They say these problems are overwhelming (along with the usual “employees don’t want it” argument), but I just don’t see it being such a huge problem from a cost perspective.

* Depends on achieving “synergies” that are premised on faulty economic
assumptions;

There are some good points here. They say that US Airways’ synergy calculations don’t account for cost savings already implemented at Delta, so the projection is overstated. If that’s true, then I would agree that it’s a problem. Delta has made some good strides on the cost side lately, and those should be accounted for, but would US Airways really have overlooked that? Other arguments here are either vague (“inappropriate extrapolation of US Airways/America West merger estimates”) or not exactly proven (“impact of reduced customer service”).

* Saddles the company with a precariously high debt load;

It’s true that the company would have a high debt load, but is is precarious? I’m not a finance pro, so I’ll refrain from taking a stand here.

* Would reverse Delta’s progress and erode the value of the Delta
brand; and

This point is pretty “fluffy” and I don’t think it makes sense when considering US Airways perspective. Sure, Delta has done a good job of going more upscale lately, and they’ve started to rebuild some brand equity, but I don’t think that matters to US Airways. They are less emotional about the issue and more interested in just analyzing the numbers. Right now, the numbers make sense to them. In the end, it could lead to some intangibles coming out and biting US Airways in the a**, but it could also end up being insignificant.

* Would expose Delta to merger-related risks. US Airways continues to
experience significant integration problems and has not completed its prior,
much smaller merger with America West; it is not equipped to simultaneously
integrate a substantially larger company.

Now, this one very well may be true and it’s certainly concerning. Though US Airways and America West have merged from a branding perspective, there is still a lot to be done behind the scenes. Most notably, the airline needs to combine labor contracts and merge reservation systems. That is no small task, and it’s keeping the airline very busy right now. Do they have time to focus on a new acquisition? I suppose they just make it work if they need to, but it will be extremely difficult and will take a long time. I believe I remember US Airways management saying that they were comfortable going as slowly as necessary, so that may not be an issue.

Ultimately, with three diverse workgroups, a lot of route overlap, and a host of complex integration issues, this is far from the best possible merger around. I would argue that Delta and United or Delta and Northwest make a much more attractive couple on many levels, but sometimes you just try to do the best you can with what’s available.

I think US Airways saw an opportunity and jumped on it while Delta may be managing it more emotionally here. This PR campaign has been a massive effort to generate goodwill, happiness, and rainbows, but in the end it’s the unsecured creditors that matter. If they vote to take the deal that gives them the most cash, they’ll go with US Airways and run. If they think there’s a lot of potential upside to an independent Delta, they’ll go that way. Management thinks they can do better, but they need to convince the creditors of that in order to succeed.

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