An American Airlines plane tail.  Image Source: American Airlines

American Airlines is one of the largest airlines in the United States.

History of American Airlines

• The origin of the modern company stem from mergers of over 80 different small airlines back in the early 1930s.  The brand American Airways was commonly used.
• Back then planes made money by delivering physical mail, not people.
• By 1933 they had a route network serving 72 cities.
• Businessman E. L. Cord purchased the business in 1934 and renamed it American Airlines, which him and CEO C. R. Smith ran.
• C. R. Smith was an interesting guy who apparently inspired a lot of trust in the organization.  When CEO he knew every employee’s name and was instrumental in getting Douglas Aircraft to develop the DC-3.  He picked up the phone and talked with Donald Douglas for a long time, eventually convincing him to develop the plane so that AA could replace their fleet of bi-planes.  Douglas finally agreed on the condition that AA purchase 20 planes.
• During this time, the famous Pan Am airlines had a monopoly in international travel.  By 1946 American began to push its way into this market, with American Overseas Airlines.  This eventually got sold to Pan Am just a few years later in 1950.
• They developed the first airport lounge (Admirals Club).
• The airline industry began to enter the Jet Age around the 1940s and 1950s.  Existing planes up to this time used spinning propellers to generate thrust (and then, lift, via the planes wings).  Jet engines were different in that they use a turbine and compressor to provide a significantly higher amount of thrust and power.  
• The jet engine was critical not just for American Airlines or the airline industry, but for transportation of humans in general, because it allowed flight over much longer distances with less stops.
• AA introduced Boeing 707s in 1959 which were transcontinental aircraft and invested heavily in aircraft with the new technology ($440 MM) over the next three years
• Throughout the 1970s they created computer reservation systems for tickets and invented the first frequent flyer program
• Up to this time in industry, airlines were heavily regulated by the government.  The government had significant control/influence over fares, which companies could/could not operate, and which routes could be operated
• This all changed in 1978 with the Airline Deregulation Act, which totally changed the game for the airline business and investors in the airline business.  With the free market at work, many airlines failed and only a few succeeded.  Air travel is largely commoditized, which tends to drive most entities within a market to drive prices lower and lower.  This is what happened, and with high expenses (oil, labor, etc.) many airlines failed.
• Profitability was generally good for American and for the industry throughout the 1990s, but by the end of the decade many more airlines had failed.  It is a tough business to be in.
• AA CEO Bob Crandell famously said, “I’ve never invested in any airline”, and “I’m an airline manager. I don’t invest in airlines. And I always said to the employees of American, ‘This is not an appropriate investment. It’s a great place to work and it’s a great company that does important work. But airlines are not an investment.'” Additionally, “A lot of people came into the airline business. Most of them promptly exited, minus their money.”
• AA made a series of acquisitions over the years, including purchasing TransWorld Airlines (TWA) in 2001
• AA was hit hard by the recession of 2008, but managed to survive…barely.  The parent corporation, AMR, ended up agreeing to a merger with US Airways, which was completed in 2015.
• Shareholders of the old company lucked out – shares went from a low of around $0.25 per share all the way up to around $26 per share in 2014 when the stock was relisted under the ticker symbol AAL.  They also lucked out because they got a decent exchange of equity from their shares of the old company – this was dictated by the bankruptcy courts.
• When the merger happened, AMR shareholders got 3.5% of the new company and also allowed for more share is the stock price increased (which it did).  AMR shareholders ended up getting about 1/3rd of the combined company (more than US Airways shareholders, who got 28%).
• This is NOT typical when companies go bankrupt…but this goes to show there is something to be said when a company is trading SO cheaply that it is essentially a “free lottery ticket” as investor Mohnish Porbrai has stated.

 Business Overview

• One of the world’s largest airlines (largest measured by fleet size, though Delta is the largest by revenue as of 2019 data)
• Being one of the largest airlines in the world, American serves over 61 countries, with 6,800 flights per day, and ultimately 215 million passengers per year (that’s a lot of people).
• They operate nearly 1,000 “mainline” aircraft as well as 600 regional aircraft (American Eagle subsidiary)
• American Eagle’s passengers connect people from “low-density markets” or rural areas, to the major cities in the hub and spoke system.  43% of passengers served by American connect in this way
• Helped found the oneworld alliance, which helps connect passengers to over 1,100 destinations in 180 countries – basically the whole world is covered
• Travel flown based on rewards from the loyalty program is not insignificant.  In 2019, 8% of revenue passenger miles flown were from redeemed award travel (point).
• Over 133,000 people are employed by American, and 85% of them are represented by a union of some type.  
• Labor is AA’s biggest expense, accounting for 34% of operating expenses in 2019.
• Fuel is the next highest expense, accounting for around 22% of operating expenses in 2019.  Keep in mind right now that fuel prices are historically low.
• Ok, let’s talk about the ‘Rona…
• The CARES act, signed in Spring 2020, provided more than $2 trillion in federal aid to Americans through various programs
• Several airlines, including American, applied for substantial government assistance since air travel quickly reached historic lows
• American Airlines’ piece of the pie consisted of $4.1 billion in grant money and $1.7 billion in a low-interest loan.  In exchange for the money, American cannot furlough or lower pay for its workers through September 30th, 2020.
• As of July they signed a term sheet with the government for an additional $4.75 billion, though the exact terms aren’t known yet b/c the deal isn’t finalized.  The government could potentially take some equity, but at the time of this writing that is speculation.

 Financials

Valuation and Closing Thoughts

• American is one the large American airline operators that will likely survive the pandemic, namely due to its size and the government’s need to stabilize the industry, not due to its financial health.
• American Airlines’ stock is so cheap precisely because of its balance sheet – it went into the pandemic with significant debt ($24B).
• Even before this pandemic, American was not doing all that great.  In a generally decent decade for aviation, sales barely budged and net income declined.  Even EPS didn’t grow positively in spite of the fact management used their cash/debt to purchase a significant number of shares.  It looks like those share purchases are going to go to waste because of future equity dilution.
• We know that AA just took on an additional $1.7 billion in debt and might take on billions more.  Let’s look for a moment at the terms of another announcement that management made in June.
• American Airlines announced an equity raise of about 74.1 million shares of common stock, as well as $1 billion in convertible preferred senior notes.
• Let’s examine the equity raise first.  When a company issues equity, it effectively goes to the public to raise more money.  Existing owners get diluted, so it’s the opposite of share buybacks.
• AA went to all the big banks, including Goldman Sachs, Citigroup, Bank of America, and J.P. Morgan, to underwrite the deal.  These banks get a piece of the action as well if they choose – getting 30 days to purchase up to 11 million shares at a discount to the price of the equity raise.
• The number of shares outstanding was about 426 million as we saw in the Financial section.  So this equity raise dilutes shareholders by 17% – ouch.
• The senior notes are bonds that American has to pay 6.5% interest on, which isn’t the best rate.  In addition, these notes are convertible to equity at a certain price.  The conversion price is $16.20 per share, a bit higher than it is as of this writing.  So if and when American’s share price increases above this level, note holders will be incentivized to convert their notes into common equity, diluting shareholders even further.  At that share price, the $1 billion in notes would become 61.7 million shares of common stock.
• 426 million + 74.1 million + 61.7 million = 561.8 million.  This is assuming the underwriters don’t get some shares as well.
• Effectively, if and when the share price exceeds $16.20 per share, assume 32% share dilution.
• For this reason alone, I am avoiding the stock.
• All of this does not even take into account the existing debt load that American has to deal with.  The way we come out of this pandemic is still uncertain, and future shareholders will have to pay for decisions being made today by American’s management.  They are just trying to survive, and are pulling out all the stops on what they need to do to meet short term liquidity needs.
• The stock trades at just under $12/share, but I wouldn’t touch it.  I don’t have any sense of what earnings will look like in the next few years.  I don’t have any sense of what revenue will look like.  What I do know is that the debt load is large relative to the size of the cash flows, that debt is increasing, and shareholders are about to take a massive hit due to this equity dilution.

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