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Analyst Note From Avondale Partners Re AA Distribution, 1-6-11

Analyst Note From Avondale Partners Re AA Distribution, 1-6-11

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Published by Tom Johansmeyer

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Published by: Tom Johansmeyer on Jan 06, 2011
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Important Disclosures on Page 6
AMR Corporation
AMR - The AMR Ticket Distribution Fights Continue
Airline January 6, 2011
Bob McAdoo, Senior Research Analyst bmcadoo@avondalepartnersllc.com 913-766-9884
Price ($) 8.5752 Wk Range ($) 5.86-10.50Price Target ($) 12.00Market Cap ($mil) 2,860.0Enterprise Value ($mil) 9,590Avg. Daily Vol. (000s) 9,937Price / Book (0.8x)Cash Per Share ($) 13.67Insider Ownership 0%Shares Out (mil) 333.3Shares Short (mil) 28.7Float (mil) 328.0Short % of Float 8.8%Div($)/Yield(%) NM/NMFYE - Dec
2009A 2010E 2011E
1Q (1.30)A (1.36)A (1.19)2Q (1.14)A (0.03)A 0.513Q (0.93)A 0.39A 0.504Q (1.25)A (0.19) (0.04)FY EPS ($) (4.63)A (1.15) (0.09)y/y % chg NA NA NAFY EPS Consensus ($) (4.63)A (1.23) 0.38FY EBITDA ($mil) 100.0A 1,451.0 1,866.0FY EBITDAR ($) 605.0A 2,006.0 2,426.0FY REV ($mil) 19,917.0A 22,163.0 23,874.0y/y % chg -16% 11% 8%CY EPS ($) (4.63)A (1.15) (0.09)CY P/E NM NM NM
Recent press accounts regarding AMR's dispute with Expedia and Orbitz, the Online Travel Agents or OTAs,confuse the relationships of the players and miss the underlying economics driving the dispute.The underlying issue is not about limiting consumers' choices. It's about potentially eliminating up to $9 perticket fees for no longer needed services.We believe the dispute likely continues and spreads. Sabre jumped in yesterday. AMR eventually prevails.As the situation evolves, AMR will likely lose some OTA customers to competitors. AMR's lost traffic willbump some low fare business from the other airlines. But AMR should pick up the spilled traffic, givencurrent loads.A new equilibrium? AMR with unchanged traffic and lower net costs.Other airlines silently watch. They'll surely follow suit. OTA shares should continue to suffer from the press,their results not meaningfully weaker. Travelport and Sabre, both private, have the most to lose.
Key Details and Summary Perspectives
At first, the dispute was publicly with Orbitz and Expedia... –
Although Orbitz and Expedia have been thenames in the forefront in the fights over fees and travel agent displays, two private companies, Travelport andSabre (the GDSs, see below), are behind the issues AMR is really fighting.These disputes are fundamentally between the airlines (for now, only AMR has surfaced) and entities knownas Global Distribution Systems (GDSs). The OTAs provide a service that the airlines use and value. Asexplained below, the GDSs are in the background and much of what they were designed to do is no longerneeded. Much of the original functionality and need for the GDSs has been made obsolete by the internet.However, quite a number of independent systems and websites, including the OTAs, still flow data throughthe current GDS systems rather than use modified systems that could avoid the GDSs and thus the GDS fees.The GDS fees, set years ago when there were few alternatives to the GDSs, are largely and indirectly drivinghow the OTAs operate. GDS fees are much of the impetus for the current disputes.
...and now Sabre fires a shot across the bow. –
Press accounts now indicate that Sabre, whose GDS has thelargest subscriber base and which owns OTA Travelocity, will be raising fees on AMR and adjusting howAmerican's flights are displayed. Which fees will be increased and the exact amounts have not beenannounced. We view this as a weak shot across the bow, as Sabre, although announcing today, apparently isnot moving on this immediately, but rather waiting until August. This August date is one month before theend of the current agreement and before a new agreement is to be renegotiated.By announcing now with a quiet August effective date, Sabre gets the press and puts informal pressure onAMR. However, by not pulling all American listings, Sabre keeps Travelocity as the largest OTA that stilloffers full schedules for all airlines, including American's schedules.
An Interesting Observation:
In reviewing the various press accounts of these disputes, one European serviceprovider sums up the situation quite well: "So here we are in a world where technology is ready to beimplemented but progress and innovation are slowed down by political forces. It is as we have this brand-newairplane that produces 50% less atmospheric pollution, but you are not allowed to use it as the revenue streamof the oil lobby would be cut in half as well."We couldn't have said it better ourselves.
Beyond the fees, the changing marketplace is fueling AMR's push for change.
A second aspect to thedispute is AMR's desire to display its product in various unique ways to the consumer. The OTAs strive tocompare all the airlines on a single screen. With that, the fares, flights, etc. all need to be comparable. Thus,you see only the lowest fare for a coach seat.AMR wants flexibility in how it sells and prices seats with ancillary services. As Southwest Airlines sellsBusiness Select fares, combining the seat with early boarding, free drinks and extra frequent flyer credit,AMR would like the ability to package its fares with these or other services. Such bundling is not possiblethrough the OTAs or any other distribution outlets that flow transactions through the GDSs. AMR can offerthe bundled product on AA.com. However, less than 30% of AMR's customers buy through AA.comAMR's very vocal push to move OTAs to the AA.com Direct Connect, thereby bypassing the GDSs and theGDS fees, would give AMR the ability to create special packages and deals that could be displayed to thewide population of customers using the OTAs.
Some background, definitions and explanations. What's a GDS?
GDS systems, companies and contractshave evolved over the years from a time when:1.Every passenger had to have a paper ticket to board a plane.2.There was no internet to enable consumers' viewing of flight schedules, availability, or fares.3.The only way to provide access to fares, schedules, and availability to every travel agent office,corporate travel department, or other major user of the airlines was to connect special purpose terminalswhich travel agents leased from the GDSs. They could not use a PC, as the dedicated special purposeairline networks did not talk to PCs. This required huge investments in dedicated networks, anddedicated repair and support personnel, as these networks had thousands of terminals all over the world.American, United and TWA each created one of the current three GDS networks within their own ITdepartments. These operations, together with the related central main-frame systems housing the airlines' ownreservation and passenger service systems were separated from the airlines in a series of varying transactions.The Sabre GDS, once part of American Airlines, is now owned by Sabre Corp. Travelport owns the other twoand still operates them as two separate networks. Sabre, now private, is owned by Silver Lake and TPG.Travelport is owned by a group led by Blackstone.
Who still uses a travel agent? –
Travel agents once printed tickets and collected funds in every town,neighborhood and office building around the world. They did more of this than did the airlines themselves.Travel agents also assisted the travel management departments of major companies in accumulatinginformation supporting travel budgeting and cost control. Travel agents were paid commissions from 7% to10% of the ticket value for printing the ticket and serving the public.Those commissions were eliminated several years ago and most local mom-and-pop travel agents ceased to
 AMR Corporation - January 6, 2011Avondale Partners, LLC
exist.Large corporate travel agents and travel organizers still handle a substantial portion of business travel, muchof it through the GDSs.OTAs were developed in the 1990s as the internet opened the airlines' databases to the general public. OTAsearlier received commissions. At one point, the major OTAs were owned by the airlines themselves andcreated to sell the lowest priced tickets direct to the public as a lower cost outlet. In turn, OTAs collectedcommissions from other airlines when those airlines were selected by the consumer.Once commissions disappeared, and OTAs lost their direct commissions, GDSs shared their fees with theOTAs to keep the business flowing.
Separately, airline consolidation impacts the GDS companies. Travelport to take a hit.
The GDScompanies still operate the main-frame computers that keep passenger reservation records and drive theairport passenger processing systems. Mergers and consolidation reduce the number of systems that arerequired. The Delta/Northwest merger eliminated the Northwest systems from Travelport's book of business.The recent Continental/United merger is going to further reduce Travelport's business. Continental neverowned a GDS. Its in-house reservations have been handled by SHARES which has been part of EDS and wasrecently purchased by Hewlett-Packard. The combined management of Continental and United has selectedthe prior Continental system to be the new standard for passenger processing and reservations. Thus,Travelport will soon lose that business to Hewlett-Packard as the United data is transferred to the Continentalcomputers.
Company Description
AMR Corp. (AMR) is the parent company of American Airlines and American Eagle Airlines and is based inFt. Worth, TX. Before recent consolidation, American Airlines was once the world's largest carrier. It serves250 cities in over 40 countries. The combined network fleet numbers more than 900 aircraft.
Investment Thesis
Structural changes and continued discipline leave airlines highly leveraged to economic recovery
Over the last 20+ months, most airlines have significantly downsized their business through capacity cuts. Justas importantly, many of these airlines have been very successful removing capacity-related costs at the sametime. As such, the airline industry today looks much different structurally than just a few short years ago. Webelieve most airlines are now managing for profitability rather than market share. If the airlines can maintainthe capacity and cost discipline shown over the last few quarters, and we have no reason to believe that theywill not, most should see greatly improved earnings with economic recovery. Over the next several months,airline stocks will likely trade on investor perception of economic strength and how close the economy couldget to pre-recession levels. As the economy improves, investor interest in airlines will likely increase and pushshares up from current levels.
Price Target Justification
It is now clear that at the measured pace at which the economy is strengthening, and given current airfares andfuel prices, AMR will likely still lose money in 2010, albeit much less than was lost in 2009. Most airlines arepointing to signs of recovering business and international demand. The outlook for near-term yields andbookings remains strong. As such, we have set our AMR price target at $12 to match the high achieved inearly-January '09 when the demand for air travel had just started to weaken on economic recession. We think that AMR shares could trade back up to this level over the next several months.
Potential Catalysts
Stable oil prices near current levels, and capacity discipline, combined with early signs of modest economicrecovery, should significantly improve earnings power. As investors and analysts become more convincedthat this will occur, estimates should rise and sentiment will likely shift in favor of this group.With limited numbers of new aircraft orders, it appears to us that airlines are finally chasing earnings ratherthan just growth for growth's sake.
 AMR Corporation - January 6, 2011Avondale Partners, LLC

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