ANALYSIS: American pilots ruling paves way to merger decision

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Bankruptcy court judge Sean Lane removed what many have said was the last remaining barrier to a restructuring plan at American Airlines, when he approved a new contract between the air carrier and its pilots.

The agreement along with those reached with its other employee workgroups established a clear cost structure for the airline when it exits chapter 11 protection. This structure will prove invaluable as it evaluates whether to emerge as a standalone carrier or merge with US Airways.

"[The collective bargaining agreement] achieves significant cost savings and work rule flexibility necessary for [American's] long-term viability," says US Bankruptcy Court for the Southern District of New York judge Lane in his ruling to approve the contract at a hearing on 19 December. The airline can begin implementing the contract immediately.

The six-year contract with the Allied Pilots Association (APA) includes allowances for up to 120 large regional aircraft or 25% of the mainline narrowbody fleet through 2014 and increasing to 40% by 2016, expanded domestic codeshares with Alaska Airlines, Hawaiian Airlines and other carriers, and numerous additional cost savings and flexibilities that the airline has said are necessary for it to compete with other US mainline carriers. A large regional aircraft is defined as one with 66- to 76-seats.

American said that the savings from the agreement would be about $315 million per year, in a court filing earlier this month. This is part of $1.25 billion in annual savings from labour that it outlined earlier this year.

"[The contract] sets the cost structure and handling on the APA side, which makes it easier to both define the cost and the cash issues and, maybe, the seniority integration in the case of a merger," says Robert Mann, an airline industry analyst with RW Mann & Company.

American has outlined clear goals to cut costs by $2 billion annually while incrementally increasing revenue by $1 billion by 2017. The new pilot contract was critical in achieving these goals, including the cost savings and new revenue achievable by "right-gauging" its fleet to include more large regional aircraft.

"It's kind of like the final step," says Helane Becker, airline analyst and a director at Dahlman Rose. "They had to get this contract done. They [now] have something for the unsecured creditors committee to compare against the US Airways offer."

Tempe, Arizona-based US Airways reportedly made an offer to American management in November. While details of the proposal are not known, the two sides have been in discussions over a possible combination since they signed a non-disclosure agreement in August. In addition, American's labour unions all agreed to contract term sheets with US Airways and announced their support of a merger in April.

The APA says that it is participating in four-party talks with American management, US Airways management and the US Airline Pilots Association (USAPA), which represents US Airways East pilots, to craft an interim agreement in the case of a merger, in a statement on 19 December.

Bob McAdoo, an airline analyst at Imperial Capital, says that by bringing the respective pilots unions to the negotiating table may be a sign that a deal is near. "The only reason I can imagine them bringing the two unions into the room is they are serious about a transaction," he says.

Becker said that she anticipates a merger announcement around "yearend", in a report on 17 December. Shareholdings in the new company will likely range American bondholders with 65% to 75% and US Airways shareholders 25% to 35%, she said.

American's pilots ruling leaves one major issue hanging. Judge Lane says on 19 December that the rights of two pilot groups at the airline - supplement B (those hired after 1983) and supplement CC (former TWA pilots) - to oppose the new agreement ended when he approved its section 1113 motion to reject its previous collective bargaining agreement in September. However, these groups would likely have the opportunity to revoice their issues, including seniority integration and protected flying, in the event of a merger with US Airways.

The fact that USAPA only represents US Airways East pilots and not the so-called West pilots adds to the potential woes. East pilots are those from the former US Airways and West from the former America West, which merged in 2005.

"We could see four pilot claims groups at the table," says Mann. "It would be convoluted to say the least."

But first, American has to decide on whether it wants to merge or not.

"We don't know if [American is] going to have a merger or not, so we don't know if it is the contract that they're going to operate under," says McAdoo on the impact of the new pilots contract on American's restructuring. It is also an apt reminder of how American's future remains very much up in the air.