50/50 Chance AMR Wins Merger Case, JPMorgan Says, Upgrades US Airways, Delta

The Department of Justice shocked the airline industry when it sued to block the merger of AMR Corp. (AAMRQ) and U.S. Airways (LCC), causing both stocks to plummet. JPMorgan’s Jamie Baker and Mark Streeter believe the odds are even that the two airlines prevail in court. They write:

AP

The industry dialogue has crescendoed, with airlines, pundits, bloggers, former CEOs, etc, all extolling the folly of DOJ's suit and  certainty of an airline win (we frequently hear 75% probability). But when it comes to  antitrust experts, we have yet to find any that believe the airlines face anything but a  steep, uphill battle, with most citing probabilities below 40%. We agree with the former, but we simply cannot ignore the latter, so let's call it 50/50.

Baker and Streeter also propose an option if the airlines lose the case:

LCC begins the process of extracting itself from the Star Alliance in favor of OneWorld. Senior management changes occur at stand-alone AMR, satisfying labor's desire for executive changes and assuaging investor concerns over excessive growth. AMR and LCC then pursue a high degree of domestic codesharing, with [Alaska Air (ALK)] potentially dropped as an AMR partner over time. Zero cost synergies, though LCC pilots don't get marked to market so costs remain intact. And oh, DOJ doesn’t have jurisdiction. Call it a near-beer, synthetic merger scenario. It’s not great – not by a long shot – but it beats the two airlines sulking and retreating into separate corners, in our view.

Either way, U.S. Airways is worth taking a look at, as the analysts upgraded it to Overweight from Neutral. Baker and Streeter explain why:

Delta is trading at roughly 10x 2014E earnings, LCC at 5x. Delta trades at a 16% premium on EV/EBITDAR. Granted, Delta is deploying capital to shareholders, joined the S&P 500, and appears to hold particular appeal for first-time airline investors. We get all that. But LCC makes money, consensus looks low, and the market's tendency to portray it as a handicapped network wannabe is highly misguided, in our view. We are raising our price target from $18 to $26 and rating from Neutral to Overweight.

Delta got an upgrade to Overweight as well.

Shares of AMR have dropped 2.1% to $3.73, while U.S. Airways has gained 3.2% to $18.64. Delta has gained 0.2% to $23.20 and Alaska Air has gained 0.9% to $62.17.  Southwest Airlines (LUV) has advanced 0.6% to $14.19.