Shorted Stock May Hint At Looming Merger
Hedge fund investors
have put Delta Air Lines Inc.'s pilots on alert, by shorting Delta
stock... just as CEO Richard Anderson (right) renewed speculation
the airline could combine with a rival.
Delta pilots -- who met recently to get an analysis of industry
trends, specifically on mergers -- are discussing rebuilding a $1
million "merger assessment" fund they could use to hire legal
representation in the case of new merger talks, according to a
story in the Atlanta Business Chronicle.
"Institutional investors -- including many hedge fund investors
-- see opportunity," Lee Moak, head of the Delta branch of the Air
Line Pilots Association, wrote in a September 24 letter to fellow
pilots outlining his concerns.
An investor who shorts a stock hopes to profit from slipping
prices. The investor borrows shares from a broker, agreeing to
replace them at a later date, and then sells them hoping their
price will decline.
The pilots have watched as institutional investors and hedge
funds helped grow their share of Delta stock by 39 percent in the
second quarter.
The airline's stock traded between $18 and $20 per share, and
trading volume declined, hedge funds shorting Delta stock increased
their holdings to 8.9 percent of Delta's more than 240 million
outstanding shares.
Instead of keeping the Delta properties together new investors
may be looking at breaking it up into pieces, according to the
story.
Those investors may be speculating that Delta's strong returns
after emerging from bankruptcy are temporary.
Moak wrote, these investors are looking for a "transaction" that
could include a "forced" sale of Delta's frequent-flier program,
reservation system or even a wholesale merger.
As of September 28, hedge funds shorted 8.9 percent of Delta
stock, for a total of 26.9 million shares. Bloomberg reports an 84
percent increase in the number of shorted shares since June 15.
"It's kind of like having a shark in your swimming pool in the
backyard," said Rick Miller, a corporate governance attorney with
Powell Goldstein LLP.
"At some point, the shark has to be fed," he said of the hedge
funds.
As ANN reported, last week
Delta reported better-than-expected profits with net income of $220
million for the third quarter, the highest in company history.
Delta's cost and debt structure was re-engineered during
bankruptcy, leaving the airline with a lean balance sheet.
Delta is now taking on more long-term debt by spending on
airplanes by adding employees and expanding its worldwide
presence.
CEO Anderson said last week consolidation could be in the cards
for the third-largest US airline, which is based in Atlanta.
"This industry, including Delta and candidly all network
carriers, are the products of consolidation," Anderson said. "We
firmly believe this evolution will continue."
He emphasized, however, that Delta wants to be "in control" as
an "acquirer."
That tune bolstered analysts who have long rallied for
consolidation in the airline industry as a means to take out extra
capacity, or airline seats, in the domestic system, and boost
airline profits by tempering low fares.
Industry analysts say Anderson's comments are peaking interest
and are, "rekindle investor confidence in hoped-for industry
consolidation," said Jamie Baker, an analyst with JPMorgan
Chase.
Baker wrote that he believes Delta would be looking for "larger,
more ambitious efforts, rather than smaller, more labor and
regulatory-friendly JetBlue [Airways] or Alaska [Airlines]-type
acquisitions."
Speculation that Delta and Northwest Airlines might try to merge
-- as their pilots unions and airplane fleets are similar --
erupted after Anderson was selected to succeed Jerry Grinstein as
CEO in August. Anderson is the former CEO of Northwest.
Hedge funds could apply pressure for a merger.
However, Anderson and President and Chief Financial Officer Ed
Bastian continually told investors October 16 they are considering
ways to strengthen Delta's cash flow... especially whether to sell
subsidiary Comair, one of the airline's regional carriers.
"It's the only one we own out of our nine regional carriers,"
Anderson said.
Moving forward, Anderson said Delta wants to pay down debt, and
will not order more jets, thus taking on more debt with aircraft
orders.
Proof of this is that Delta paid down $1 billion in debt, such
as bankruptcy obligations to the Air Line Pilots Association and
Pension Benefit Guarantee Corp in the third-quarter.
Still, Delta also invested $400 million in capital improvements
at its hubs in Atlanta and New York, as well as deposits on
aircraft, in the third quarter.
At some point, however, Delta will have to renegotiate a
contract with its pilots union, which could increase employee
costs. And fuel prices have been stubbornly high.
Delta spokeswoman Susan Elliott wouldn't comment specifically on
hedge funds, saying only that the airline has "ongoing discussions
with our shareholders, including hedge funds, about a variety of
topics, but we don't comment on specific conversations."
Delta's stock has not produced what it projected coming out of
bankruptcy.
Delta avoided the merger with US Airways Group Inc. by saying
Delta's value coming out of bankruptcy would be $9.4 billion to $12
billion, after an offer by US Airways of $10.3 million to buy
Delta.
"Frankly, having snubbed last year's cash-rich offer from US
Airways, it is no surprise that management and the Delta board are
beginning to feel the heat."