Partly Cloudy Forecast for Airports After AMR-US Air Approval

Morningstar

AMR (AAMRQ), the parent company of American Airlines, and US Airways Group (LCC) announced last week that they have settled the litigation brought by the U.S. Department of Justice, Arizona, Florida, Michigan, Tennessee, Pennsylvania, Virginia, and the District of Columbia. The merger, proposed in early 2013 and initially estimated at $11 billion, will create the world's largest airline and is now closer to an $18 billion deal. In August, the federal government sued to block the merger, claiming it would restrict competition and significantly increase consumer prices.

Under the terms of last week's settlement, the airlines will divest from 52 slot pairs at Washington Reagan National Airport and 17 slot pairs at New York LaGuardia Airport, as well as certain gates and related facilities to support service at those airports. The airlines also will divest two gates and related support facilities at each of Boston Logan International Airport, Chicago O'Hare International Airport, Dallas Love Field, Los Angeles International Airport, and Miami International Airport. The divestitures will occur through a Justice Department-approved process following the completion of the merger. As part of the deal, the slots will be filled by low-cost carriers such as JetBlue Airways (JBLU), Southwest Airlines (LUV), and Virgin America, which traditionally have faced challenges increasing their presence at these key airports.

"This agreement has the potential to shift the landscape of the airline industry," U.S. Attorney General Eric Holder said in a statement announcing the deal. "By guaranteeing a bigger foothold for low-cost carriers at key U.S. airports, this settlement ensures airline passengers will see more competition on nonstop and connecting routes throughout the country."

Despite the divestitures, the new American Airlines is still expected to generate more than $1 billion in annual net synergies beginning in 2015, as was estimated when the merger was announced in February.

In the settlement agreement with the state attorneys general, the new American Airlines has agreed to maintain its hubs in Charlotte, N.C., New York (Kennedy), Los Angeles, Miami, Chicago (O'Hare), Philadelphia, and Phoenix for three years. With limited exceptions, the new airline will also continue to provide daily scheduled service from one or more of its hubs to each plaintiff state airport that has scheduled daily service from either American or US Airways for a period of five years.

Last month, officials from both airlines came to an agreement with the Texas attorney general concerning the proposed merger, as well. The settlement resolves the state's objections by American agreeing to maintain daily service to rural airports across Texas. Additionally, the airlines entered into a binding agreement to maintain the merged company's headquarters in the Dallas-Fort Worth metropolitan area. That settlement is expected to be amended to make it consistent with last week's settlement with the headquarters remaining in the Dallas area.

Completion of the merger remains subject to the approval of the settlements by the U.S. Bankruptcy Court, and certain other conditions. The companies now expect to have American Airlines exit bankruptcy in the coming weeks and complete the merger in December 2013.

Morningstar expects the overall impact of the merger on individual airports to vary based on a combination of factors, including carrier concentration, scope of operations, and market position of the airport. Those with significant concentration in either or both the two airlines are subject to the potential risk of the new airline condensing routes over the longer term. However, in the shorter term, because of the specifics of the agreement, we don't expect significant disruptions in revenue or service levels at major airports as a result of the merger.

Will These Airports' Bonds Be Grounded?
Below we comment briefly on the airports covered by Morningstar's municipal research group, noting any potential effect from the merger.

Miami International Airport is exposed to potential long-term risk from the merger because of its carrier concentration and position as a major international hub for American. American Airlines and its subsidiaries currently account for over 68% of the airport's total market share. US Airways has a minimal 2% presence at Miami. This risk is partially offset by the airport's diverse operations, with significant volume in both passengers and cargo. Additional long-term credit strengths include its strong market position and area economy, which are expected to result in continued airport demand. Miami has a broad and diverse economy and a unique niche as an economic anchor for southern Florida and a hub for international trade, particularly with Latin America and South America. The new airline will be required to give up two gates at MIA, but those gates are expected to be filled with a competing carrier. Cash on hand is significant, which could aid the airport through a temporary service disruption.

Dallas/Fort Worth International Airport is similar to Miami in many ways. It is also a major international airport and a hub for American Airlines, which accounts for 84% of total enplanements. AMR leases 100% of the terminal space in three of the airport's five terminals and 60% in a fourth, and it paid a significant portion of the airport's operating and debt service costs in fiscal 2012. Any significant reduction in operations from the new airline could have a material effect on airport revenue. However, the new airline will be based in Dallas, probably ensuring that the new airline will remain a significant presence in the airport. The airport has a sizable scope of operations, serving a broad 12-county area in north-central Texas with a strong economy. The strong area economy should continue to fuel origin-and-destination-related travel. Cash levels are satisfactory and expected to remain so in the near term.

Chicago O'Hare International Airport also has carrier concentration related to the merger but to a lesser degree than Miami or Dallas/Fort Worth. O'Hare serves as a hub for American, which accounts for over a third of all enplanements. US Air represents less than 3% of traffic. Exposure risk is somewhat offset by the fact that United Airlines (a subsidiary of United Continental Holdings (UAL)), including its regional commuter airlines, is the largest airline operator for the airport, with almost half of total passenger enplanements. The service area is an economic anchor for the Midwest as well as an international economic center. The new airline will be required to give up two gates at O'Hare, but those are expected to be filled with a competing carrier. Cash levels are sound, albeit lower than the previously discussed airports.

The merger is expected to have almost no impact on Hartsfield-Jackson Atlanta International Airport. American Airlines accounts for a minimal 1.6% of air traffic, while US Airways is an even lower percentage. Delta Air Lines (DAL) accounts for roughly 70% of total enplanements. The airport also benefits from its preeminent market position as the world's busiest airport.

Overall, the merger emphasizes investors' need to look at concentration risk when analyzing airport revenue bonds. For those airports with concentrations in American Airlines or US Air, investors should pay close attention to its service plans in the next several years.

We believe larger airports with strong market position and area economies that support current enplanement levels will likely not experience a material long-term decline in origin-and-destination enplanements resulting from the merger. Some disruption in service levels is possible over the long term, though, if the new airline finds certain routes redundant or cannibalistic. Of greater concern would be if, after the three-year period stipulated by the current settlement, the new American consolidates its connecting hub airports, as this could lead to a decline in connecting traffic. Smaller regional airports with market concentration in the two airlines may also see a measurable impact. We will continue to monitor the merger and its impact on the credit quality of affected airports.

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