Novice Investing - US Airways Wants Delta

Date: Monday 01st 2008f December 2008 04:23:08 PM

US Airways Wants Delta - 11/15/2006

By: Novice Investing Staff

In the airline industry, US Airways Group Inc. (LCC) made an $ 8 Billion bid for the now bankrupt Delta Airlines (DALRQ.PK). US Airways will pay Delta secure creditors $ 4 Billion in cash and 78.5 Million US Airways stocks worth $ 4 Billion. US Airways content that by merging with Delta, it would save $ 1.65 Billion annually. This is a return on investment of 20.6%, mind you. However, something odd is happening here. Note that US Airways market capitalization is 'merely' $ 4.52 Billion. How can it pay for an $ 8 Billion acquisition? Further, Delta stock is trading at $ 290.1 Million market capitalization. Why pay 27 times higher?? Are they out of their mind?

Well, actually not. While Delta is trading at $ 290.1 Million valuation, remember that it is operating under bankruptcy law. In bankruptcy, shareholders is in the mercy of its creditors. How much did Delta owe its creditors? It is normally in the balance sheet section under liabilities, most specifically, long term debt. Now, we know that Delta had a huge pile of debt. Our writer has talked about Delta's high bankruptcy chance back in late 2004. At this point, Delta has $ 14 Billion more debt than it has assets. In other words, shareholder equity is negative.

So, what does this all mean? Simply said, US Airways is buying Delta's creditors for $ 8 Billion. Delta currently has $ 9.69 Billion in outstanding debt. Therefore, the $ 8 Billion proposed deal does not look so crazy after all. All told, Delta's bond soar 32% after the deal was announced. Our guess was that the $ 8 Billion tag represents a 32% premium over current trading price of Delta's bond.

Wait a minute, why didn't Delta bond trade at $ 9.69 Billion face value? The reason is that bond too, trades up and down just like shares. Doing a reverse calculation, Delta's bond was worth $ 6.06 Billion before the deal. This is because creditors are not sure that they will recoup their investment by investing in Delta's debt.

So all in all, paying up $ 8 Billion for Delta is not that insane. However, we still have no clue on how US Airways can pay up for the acquisition. It will issue 78.5 million shares of its own shares, which will dilute existing shareholders by two fold! Also, we understand that US Airways has lined up financing to come up with another $ 4 Billion cash. If that is the case, we would then see smaller companies gobbling up its bigger competitors. Some did that. Latest example was Boston Scientific's (BSX) purchase of Guidant (GDT). That type of acquisition seldom works well for the acquirer. This one would not be any different, if the deal is done.

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Disclaimer: The sole purpose of this article is educational. This article is merely the opinion of the writer and is not in any way a buy/sell recommendation regarding US Airways Group Inc. (LCC) or any other securities.

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