$5.65 target
AMR Corp, the parent company of American Airlines, recently announced the spin-off of its regional carrier, American Eagle into a separate company, and we believe the deal has the potential to improve American Airlines' valuation as a result of cost savings that would accrue with access to cheaper services on the regional routes than currently available on Eagle.
American Airlines is one of the largest passenger airline in the world by available seat miles and is the principal subsidiary of the AMR Corporation and competes with Delta Airline, Southwest Airlines, US Airways and United Continental.
We have a $5.65 price estimate for American Airlines, implying a premium of about 65% over the current market price.
Eagle Spins Off and Leases Back Aircraft
Under the deal, AMR will be spinning off AMR Eagle Holdings Inc., which operates regional carriers, American Eagle Airlines Inc. and Executive Airlines Inc., to AMR shareholders.
American Airlines will purchase American Eagle’s airplanes on the basis of their fair market value and take up all of its indebtedness, which is estimated at $2.2 billion. Subsequently, Eagle will lease the jets from American and offer regional flight services to the airline on a contractual basis for about 9 years.
Eagle will also issue a receivable note to American in case of difference between the total fair market value and debt burden assumed. The difference is estimated at $239 million as of end June 2011. (See AMR eyes American Eagle spin-off, 9-year contract)
How does American Airlines benefit from Eagle’s spinoff?
American Airlines derives ~21% of its value from its regional affiliates. These carriers increase the number of markets the company serves by providing connections at American’s primary markets. Eagle met close to 90% of American's regional flying needs and contributed about 10% in both operating revenues and expenses for the group (for the year ended December 2010).
The company believes that the spinoff would be beneficial for American Airlines as it would enable it to diversify its regional traffic with additional regional airlines to ensure access to the most competitive rates and services. Though no estimates were provided by the company on the cost savings, it expects to achieve by adding regional traffic from other players in the market.
Potential Impact on Valuation
Higher staff pay for Eagle employees than most peers
Eagle attributes the higher costs largely to the seniority of its work force. The average longevity for Eagle captains is about five years higher than for many other regionals because of Eagle's comparatively low growth rate. Other players in the market are therefore expected to be better positioned to give a more competitive price to American.
Aircraft maintenance expenditure to be borne by Eagle
Eagle's fleet consists of almost 280 aircraft averaging 9.9 years in age, though about 13% of fleet is aged on the higher side at 16.3 years.
Under the deal, these aircraft continue to be owned by American airlines though Eagle will be responsible for most of the maintenance of the jets, thereby curbing maintenance expenses for American. (See American Eagle Spin Off Poses Operational Challenges)
Cost savings due to the spinoff would lead to increased cash inflows from the American's Regional Affiliates division. As the division grows in value, American can command a higher valuation than under the current scenario, which has been built in with Eagle as a part of the group.
See our complete analysis for American Airlines’ stock
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