American Airlines Retreats to Fight Another Day

Early this morning, American Airlines parent AMR Corp. (AMR) filed for Chapter 11 bankruptcy protection, listing total assets of $24.7 billion and debts of $29.5 billion.

Readers of my research service, Strategic Short Report, know that we’ve held a short position on AMR since mid-March. But that’s only part of the story here…

Many families of AMR employees will be impacted by this development, and it’s unfortunate that conditions forced this decision by the company. It’s a stressful day for loyal, hard working employees already suffering under a stagnant, inflationary economy.

The airline industry is deep into a painful but necessary restructuring process. Today’s bankruptcy is a big step toward a better future. We can all hope for a better, healthier airline industry on the other side of this restructuring, and hope that pilots, flight attendants and maintenance crews impacted by this bankruptcy find other opportunities with American or with other airlines.

Thankfully, AMR management and the board of directors did the right thing to avoid risking an even worse fate: liquidation. AMR is entering bankruptcy with several billion dollars in cash. Sustained high jet fuel prices, brought about by aggressive central bank money printing (and the prospect of even more printing) would have rapidly drained AMR’s remaining cash reserves.

The New York Stock Exchange has halted the stock several times today. Other than short sellers covering their positions, there are no natural buyers of AMR stock today.

AMR Share Price Since Dan Amoss's Short Recommendation

Few will want to embark on the long, uncertain process of owning AMR stock through bankruptcy, with the thesis that it will retain any value in a “new AMR” on the other side of Chapter 11. Most likely, creditors will own the vast majority of the stock after bankruptcy, diluting the value of a current AMR share to practically nothing.

This is all part of the process. Successful bankruptcy reorganization is as American as “Mom and apple pie.” American history and culture is all about renewal and fresh starts. While painful for many parties, it’s often necessary to restore soundness to an organization.

Corporations, like people, go through different stages of life: birth, adolescence, maturity, and death. In capitalism, corporate death frees up the capital and resources to fuel the next wave of company births. Trying to stop this process with bailouts and zero interest rates only guarantees that we’ll squander ever more resources on situations in need of restructuring.

Pain is a part of life, and trying to avoid it entirely is not healthy. Of course, that may be of little comfort to those affected by AMR’s bankruptcy at this time. We keep them in our thoughts and prayers.

We’ve published eleven Strategic Short Report commentaries on AMR since the March issue (when we first identified the stock as an attractive short) reiterating our case. Our readers had the opportunity to play a profitable part in the important process of aiding stock market efficiency.

Short sellers add to market efficiency by adding selling pressure to overvalued stocks.

In the case of AMR stock, it was overvalued the whole way down, because in hindsight, it was worth nothing…despite Wall Street analysts’ humorous attempts to value AMR as though it were a “call option” on recovery in the airline industry. We simply identified that there was a high probability the stock was worth nothing before the rest of the market. Sometimes it’s rational to panic, and panic early, ahead of the crowd.

In other cases — high-P/E momentum stocks, for example — short sellers add selling pressure where there otherwise would be none. Short sellers help keep bubbles from getting completely out of control and wasting oodles of capital — often sustaining heavy losses while holding short positions that move against them.

Sometimes, disagreeing with market prices is painful, but it is important to remember the vital role that short sellers play in the capitalistic process.

Short sellers add to the efficiency of the economy by acting to raise the cost of capital for companies that, with overvalued stocks, can raise capital on easy terms — easier than more deserving competitors.

It was very unlikely AMR shareholders could have salvaged any value (in the form of future free cash flow or dividends), and in fact, it’s better for employees and the entire organization that shareholders and creditors will lose some or all of their claims on company assets.

So in case you’re concerned that you “profited from the bankruptcy” of a storied American company in 2011: rest assured, you did not. In a very small way, you accelerated a painful but necessary process. Further operation of AMR in its current form would have simply squandered scarce resources in the hopes that shareholders and creditors would have some degree of return on their investments.

We all learn from each trading and investing experience (myself included). Profit or lose, we can get better by building a working knowledge of which strategies work, and which do not. After enough experience selling short, you begin to identify the telltale signs of a good, potentially profitable idea.

If we are still in the midst of a 15-20 year bear market — as I suspect — adding short sales and a sensible amount of put options to your portfolio is prudent. Hopefully, our ideas have helped your portfolio weather the recurring 2011 financial hurricanes.

Here’s hoping a revitalized, slimmed-down American Airlines comes back stronger than ever.

Best regards,

Dan Amoss,
for The Daily Reckoning

The Daily Reckoning