Description

DALRQ

Delta Airlines was previously written up by rosie918 in December, 2004.  Rosie provided a great overview of Delta’s problems, correctly predicting that Delta would file for Chapter 11, which took place in Sept., 2005. 

A year later, Delta is still in bankruptcy and is expected to file a plan of reorganization by the end of the year.  Under any realistic scenario, there will be no room left for the equity and eventually the stock will be cancelled.  Despite this, the equity still trades as if it has value, making it an excellent short candidate.

Recent events

Airlines have been doing quite well as of late and the stock price of both DALRQ and NWACQ (also in bankruptcy) have spiked along with their improved performance and decline in oil prices.  I can only speculate that daytraders/retail investors have somehow linked the recent operating strength to thinking that the current stock might actually be worth something.  This is not realistic.  It is next to impossible to imagine any scenario where the current equity is not cancelled.

Why the equity is worth 0

1)  As the company itself states in its filings (see most recent 10Q):

On September 14, 2005 (the “Petition Date”), we and substantially all of our subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). No assurance can be given as to what values, if any, will be ascribed in our bankruptcy proceedings to our various pre-petition liabilities, common stock and other securities. We believe that our currently outstanding common stock will have no value and will be canceled under any plan of reorganization we propose and that the value of our various pre-petition liabilities and other securities is highly speculative. Accordingly, we urge that caution be exercised with respect to existing and future investments in any of these liabilities or securities. In addition, trading of our common stock on the New York Stock Exchange was suspended on October 13, 2005, and our common stock was de-listed from the New York Stock Exchange on November 30, 2005. Additional information about our Chapter 11 filing is available on the Internet at www.delta.com/restructure. Bankruptcy Court filings and claims information are available at www.deltadocket.com.

Supporting this view, insiders have been selling.  The non-executive chairman of the board sold his remaining stake in DALRQ at $.77 on Sept. 11.  The chief operating officer sold his remaining stake in the company at $.74 on Sept. 6.

See filings:

http://www.sec.gov/Archives/edgar/data/27904/000130104006000012/xslF345X02/edgar.xml

http://www.sec.gov/Archives/edgar/data/27904/000130104006000011/xslF345X02/edgar.xml

2)  The primary reason for the lack of value to DALRQ’s equity is its underfunded $11b pension plan. 

If a plan is not fully funded, an employer may apply to the Pension Benefit Guaranty Corp (PBGC) for a distress termination.  For the PBGC to take over the plan, the company must prove that it cannot remain in business unless the plan is terminated. 

Delta has sought approval from the Court to transfer its plan to the PBGC.   As the company argues in their motion to terminate the plan:

“In order to replay the DIP loans, maintain minimum liquidity, and satisfy its financial obligations to the Pilot Plan and otherwise in the first 12 months following its emergence from bankruptcy, Delta would require between $5.2b and $6.6b of exit financing, an amount that vastly exceeds what Delta could obtain under any conceivable scenario….Delta pledged substantially all of its assets as collateral in order to secure the $2.2b in DIP financing that it obtained.  Delta has virtually no unencumbered collateral against which to secure an additional $3b to $4.4b in financing above the level of its DIP financing.”

(http://www.deltadocket.com/delta_downloads/delta_downloads_root/pilot_motion.pdf)

Recently on Sept. 5, the Bankruptcy Court granted Delta’s motion.  In doing so, the Court agreed that it would be impossible for Delta to reorganize under Chapter 11 without first terminating the plan.  While the PBGC still must formally agree to take over the plan, their approval seems certain given the Court’s decision.  See:

(http://www.nysb.uscourts.gov/opinions/ash/133662_3178_opinion.pdf)

(http://www.bizjournals.com/atlanta/stories/2006/09/04/daily12.html?b=1157342400%5E1341022)

The main thesis here is that the pension plan for a corporation is considered an unsecured creditor (which is senior to equity) so when a company impairs the pension plan, more than likely, the equity is worth nothing.  On top of that, Delta’s plan (~$3b in cost savings) includes $970m in savings from “restructuring under the bankruptcy code.”  This category explicitly includes debt relief (and once again, debt would be senior to equity, implying little value for equity).  See p18:

http://deltadocket.com/delta_downloads/delta_downloads_root/bastian_declaration.pdf

A similar situation occurred with United’s recent bankruptcy.  Their pension was also impaired, the equity eventually went to zero, and the PBGC later became one of the main shareholders of the newly restructured company (they were given shares since they took on the pension liabilities):

3)  Financials

You could probably construct a short thesis from 1) the company’s own declaration that the equity is worth nothing and 2) the fact that the pension plan is being impaired.  But to be comprehensive, let’s take a look at some of Delta’s finances as well:

From its most recent Q, Delta has $20.7b worth of assets on its books and $28b worth of debt ($7.9m long term debt and capital leases, plus $20.1b “liabilities subject to compromise,” which includes the $11b pension).

Delta hasn’t generated any profit since 2000.  Depending on how you want to estimate it, Delta’s EBITDAR (EBITDA before aircraft rent) was -187m for 2005 and -1.3b for 2004. 

No doubt, operations have improved in ’06.  Delta has reduced its fleet by 118 planes and cut significant costs from its business.  Through the first six months of this year, EBITDAR was about 690m, and from April through July, Delta generated positive monthly EBITDAR figures of 208m, 202m, 360m, and 308m, respectively.  Note:  the June and Sept. quarters are Delta’s seasonally strongest quarters due to increased vacation travel.

Delta’s DIP covenants require it to achieve $1.988b in EBITDAR for 2007 and $2b annually thereafter.  As I try to construct a best case scenario and look back to the 1999/2000 timeframe, Delta was able to generate about 3.6b in EBITDAR in 2000.  If we assume Delta could get back there, that would imply a debt/ebitdar ratio of 7.7x. 

From looking at the comps and Delta’s projected ebitda, we can get a sense of how the market is valuing the company.  Note:  projected ebitda numbers for AMR, CAL, and UAUA come from consensus estimates.

As this table demonstrates, for Delta to trade in the neighborhood of AMR and CAL, the market is already implicitly assuming that Delta can reach $3.6b in ebitda for ’07!  With this kind of valuation, there would seem to be little downside to a short.

While oil has come down and the outlook for the airline industry in general is much more positive now, it is difficult to foresee Delta’s business improving so dramatically.  Competition is fierce with the low cost carriers and with cheaper oil will come lower ticket prices (also as a result of greater price transparency for the consumer from the internet).  Furthermore, there’s a lot to be concerned about out there with the economy/housing/consumer potentially slowing.

Upon exit from bankruptcy, Delta’s latest forecast is for $2.3b in unrestricted cash and short-term investments for March 30, 2007.  They project liquidity needs at emergence of:

-         $2.14b (payment on GE and AMEX DIP of $2b and $142m of misc. priority claims and expenses)

-         $2b (required operational liquidity)

See: p10 (http://www.deltadocket.com/delta_downloads/delta_downloads_root/coleman_declaration.pdf)

To summarize, even making optimistic projections, with $28b in debt, there does not seem to be much logic for the current $200m in equity value.  The company itself does not believe there is any value to the equity and the pension plan (which again is senior to equity) is very close to being officially impaired.

Timing

Delta is targeting to file its plan of reorganization by the end of the year and from speaking with the company, it seems like everything is on track for them to do so.  Afterwards, other creditors will have the opportunity to propose their own plans and it could take some time to sort out everyone’s claims.  Eventually, the bankruptcy court will have to approve a plan.

Catalyst