Federal regulators have recently thrown up roadblocks to the planned merger of US Airways Group Inc (NYSE:LCC) and AMR Corporation (OTCMKTS:AAMRQ), the parent company of American Airlines. The Department of Justice is worried that allowing two of the top five U.S. carriers to merge will hurt competition. DOJ lawyers also argue that the merger is unnecessary because AMR Corporation (OTCMKTS:AAMRQ) and US Airways Group Inc (NYSE:LCC) can be successful independently.
American Airlines and US Airways planes tail-to-tail. Photo: AMR.
Executives at both companies have staunchly denied the DOJ allegations. They claim that the merger will provide the best restructuring option for AMR Corporation (OTCMKTS:AAMRQ) and that it will improve competition. AMR and US Airways Group Inc (NYSE:LCC) leaders claim that by combining their complementary networks, they will be better able to compete with Delta Air Lines, Inc. (NYSE:DAL), United Continental Holdings Inc (NYSE:UAL) and Southwest Airlines Co. (NYSE:LUV): all the products of recent airline mergers.
Unfortunately, AMR Corporation (OTCMKTS:AAMRQ) and US Airways Group Inc (NYSE:LCC) executives have showed a distinct tendency to incriminate themselves. It’s becoming increasingly clear that an AMR Corporation (OTCMKTS:AAMRQ)-US Airways Group Inc (NYSE:LCC) combination will earn higher profits than would be consistent with vibrant competition. As a result, the DOJ — which is already taking a hard-line stance toward the merger attempt — is likely to become even more strongly opposed to the merger.
Full recovery
This week, AMR Corporation (OTCMKTS:AAMRQ) disclosed that it earned a record profit of $349 million before reorganization costs on revenue of $2.48 billion in July. That implies an adjusted profit margin of 14.1% and an adjusted operating margin of 16.6%. These figures are very high by the standards of the airline industry.
By contrast, Delta Air Lines, Inc. (NYSE:DAL)– which has been the top-performing legacy carrier recently — last month projected an 11%-13% operating margin for Q3. While that forecast also includes the seasonally weaker month of September, it’s still unlikely that Delta Air Lines, Inc. (NYSE:DAL) earned a higher profit margin than AMR last month.
In other words, despite having less scale than Delta Air Lines, Inc. (NYSE:DAL), AMR is already earning comparable or higher margins. That undermines the argument that AMR needs to merge with another carrier to remain viable.
Self-incrimination
Because of its ongoing bankruptcy case, AMR has to report results monthly. Thus, while AMR’s strong July results appear to bolster the DOJ’s case, releasing them was unavoidable. However, CEO Tom Horton aggravated matters with a triumphant memo to employees, in which he described AMR’s restructuring as one of the most successful in aviation history.
American is already profitable enough to easily earn returns in excess of its cost of capital. If a merger improves American’s profitability even further, it will be a clear indication that the company is benefiting from a dearth of competition.
Furthermore, AMR and US Airways have been pushing for a speedy trial to resolve the DOJ’s antitrust agreement. The two companies want the trial to occur in November so that they can complete the merger by year’s end (if they win). Part of their argument for a quick trial is that AMR is still under bankruptcy protection and that it would be “unreasonable” to prolong its stay there.
However, as AMR’s results show — and Horton’s memo emphasizes — American Airlines has never been in better financial shape than it is today. Not surprisingly, lawyers for the DOJ have already cited AMR’s record July profit in its request to set the trial for March 2014 — nearly four months later than the timeline AMR and US Airways Group Inc (NYSE:LCC) proposed. With AMR doing just fine in bankruptcy, it will be hard for the airlines to convince a judge of the need for an accelerated trial.
Foolish bottom line
AMR and US Airways can make a good case for why they should be allowed to merge. After all, DOJ allowed Delta Air Lines, Inc. (NYSE:DAL) to merge with Northwest, allowed United Continental Holdings Inc (NYSE:UAL) to merge with Continental, and allowed Southwest Airlines Co. (NYSE:LUV) to buy AirTran. Nevertheless, the case is not airtight. While it may seem unfair to prevent AMR and US Airways to follow in their competitors’ footsteps, some aspects of the merger would be clearly anti-competitive.
AMR’s management didn’t do itself a favor by highlighting how profitable it is as a standalone entity. It merely gave the DOJ further ammunition in its bid to delay the antitrust trial and ultimately derail the merger. Over the next several months, we’ll see just how much damage was done.
The article Is American Airlines Helping DOJ Make Its Case? originally appeared on Fool.com is written by Adam Levine-Weinberg.
Adam Levine-Weinberg is short shares of United Continental Holdings (NYSE:UAL). The Motley Fool recommends Southwest Airlines.
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