Determined occasions name for determined measures. That’s the conclusion that the administration crew at American Airways Group (AAL) should have provide you with that led the agency to challenge a major quantity of shares and debt securities. The transfer by the agency was in all probability vital and shouldn’t have been thought of a shock by anybody listening to the enterprise. Having mentioned that, the transfer will finally show to be extremely dilutive to shareholders within the agency, and this might scale back the upside potential of the corporate in the long term in comparison with a state of affairs the place these dilutive steps wouldn’t have been crucial. A variety of ache There’s little doubt that American Airways has been experiencing quite a lot of ache these days. Within the first quarter this yr, the corporate’s income got here in 19.6% decrease than the place it was the identical quarter final yr. The agency generated a web lack of $2.24 billion, in comparison with the $185 million acquire seen within the first quarter of its 2019 fiscal yr. Its working cash circulate within the newest quarter was -$168 million, in comparison with the prior yr’s first-quarter influx of $1.65 billion. If this weren’t unhealthy sufficient, it’s worthwhile to think about that the second quarter, due to the timing of shutdowns, was forecasted to be worse by the enterprise. In all, American Airways anticipated its cash burn within the second quarter to common round $70 million per day, with a dip to as little as $50 million per day occurring within the month of June. Altogether, this suggests web cash burn in the course of the second quarter of between $4.55 billion and $6.37 billion. For many firms, this could in all probability sign the top. For American Airways it nonetheless may, nevertheless it’s essential to think about the agency’s liquidity. Regardless of ache within the first quarter, the corporate’s cash available (together with $157 million in restricted cash) was $3.73 billion. That is solely marginally decrease than the $3.98 billion seen on the finish of its 2019 fiscal yr. Due partially to the issuance of $1.70 billion in gross debt, the agency’s liquidity remained sturdy. Even with the painful cash burn projected for the second quarter, administration mentioned that by the top of that interval it anticipated to take care of liquidity of round $11 billion.
A take a look at current strikes This sizable liquidity place may need left some traders within the firm feeling snug, nevertheless it’s essential to take into account that maintaining the enterprise working is extra than simply about liquidity. It’s additionally in regards to the notion of the enterprise’s skill to stay afloat. Though liquidity may be ample, if debt is simply too excessive and/or if liquidity drops low sufficient that it’d make future capital contributors anxious in regards to the agency’s prospects, it may be troublesome, and even unattainable, for American Airways to lift cash down the highway. It’s seemingly that, mixed with fears that COVID-19 circumstances are on the rise, that led the agency to behave pre-emptively to bolster its stability sheet additional. As a part of this, the corporate introduced plans to challenge $1.5 billion worth of Senior Secured Notes that may come due in 2025. That is on prime of tapping a $500 million Time period loan B Facility that may come due in 2024. If it have been simply these debt issuances, although, there wouldn’t be a lot to write down about. What’s actually fascinating, and for shareholders painful, is what else administration determined to leap into. As a part of its capital elevating efforts, the agency determined to lift $750 million from the issuance of frequent shares, plus $750 million from the issuance of Convertible Senior Notes that mature in 2025. Initially, underwriters acquired the appropriate to speculate an additional $112.50 million for frequent stock, plus $112.50 million for much more Convertible Senior Notes. Since issuing this announcement, although, the image modified. On June 23rd, administration revised its goal, now aiming for roughly $1 billion in frequent stock and $1 billion in Convertible Senior Notes. Underwriters now have the appropriate to obtain $150.1 million in frequent shares, plus $150 million in further Convertible Senior Notes. Let’s start, first, with the frequent stock, since that’s the best. In all, American Airways is issuing 74.10 million frequent shares of itself to traders at a price of $13.50 per unit. This represents a reduction of 15.6%, in comparison with the $16 that shares closed at on June 19th. Underwriters may additionally obtain 11.115 million frequent shares in the event that they train their 30-day possibility, with these items receiving the identical price that the bigger frequent issuance is receiving. After factoring in underwriting reductions, American Airways is projected to obtain web proceeds of between $966.Eight million and $1.112 billion (relying on whether or not the underwriters’ possibility is exercised).
This alone is painful for shareholders. With 422.9 million frequent items excellent as of this writing, the deal values American Airways at $5.71 billion on a pre-money foundation. It will end in dilution for current shareholders of between 14.9% and 16.8%. That is painful within the respect that when shares have been at their 52-week excessive level of $34.99 earlier than the COVID-19 disaster, the corporate’s valuation was $14.80 billion. Dilution there would have been much more modest at 7.2% on the worst. Whereas the frequent share issuance is painful, the Convertible Senior Notes are even worse doubtlessly. The precise rate of interest on the $1 billion in notes, at 6.5%, just isn’t all that top. Actually, given the present surroundings for American Airways, it’s in all probability very cheap. To know why the Convertible Senior Notes are so harmful, although, we have to dig into the weeds extra. Upon first look, they don’t seem so unhealthy. The notes may be redeemed on or after July fifth of 2023, or on or earlier than the 20th scheduled buying and selling day earlier than the Maturity Date of the notes. This second case is provided that the frequent exceeds 130% of the conversion price, which is pretty beneficiant at $16.20 per unit. This 130% threshold, then, is $21.06 per unit. Even so, holders in these notes may elect as an alternative to transform them into frequent stock within the enterprise. This can be carried out topic to an preliminary conversion charge of 61.7284 frequent items per $1,000 in principal. With out the underwriters’ possibility, this suggests as much as 61.7284 million frequent items being issued. With the underwriters’ possibility, this provides 9.26 million items to the pie. Within the occasion that the notes get redeemed by American Airways, although, the holders of the notes which might be being recalled have one thing tough up their sleeve: a make-whole premium.
*Taken from American Airways Group The make-whole premium is organized in order that after a discover of redemption is acquired however earlier than the notes are literally redeemed, the holders may elect to transform their notes into frequent stock. The desk above illustrates the efficient variety of shares, per $1,000 in principal, that might be added (based mostly on date of redemption) that the holders of the Convertible Senior Notes would obtain on prime of their preliminary conversion charge. Within the worst-case state of affairs for current shareholders, this, mixed with the already sizable frequent stock issuance, would end in 170.Four million new shares of American Airways being issued. This may translate to dilution of as much as 28.7%. Takeaway Proper now, it’s clear that American Airways is making an attempt to shore up liquidity due to how unhealthy the market is and due to uncertainty over what it’d appear like sooner or later. If this isn’t a vital step at the moment, it’s at the very least prudent. Having mentioned that, the phrases of the share and Convertible Senior Notes issuance are unattractive, and the top outcome will seemingly be vital dilution for current shareholders. To place this in perspective, if frequent traders are ever to see the identical market capitalization of $14.80 billion that the corporate peaked at up to now yr, the price per unit at the moment, within the worst case, can be as little as $24.95, versus the $34.99 items traded for as an alternative. This transfer may finally show vital for American Airways down the road, nevertheless it’s not with out quite a lot of ache for current shareholders.
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Disclosure: I/now we have no positions in any stocks talked about, and no plans to provoke any positions inside the subsequent 72 hours. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (apart from from Searching for Alpha). I’ve no enterprise relationship with any firm whose stock is talked about on this article.