How Good Companies Use Bankruptcy to Their Benefit

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By now you're aware that American Airlines parent company AMR (NYS: AMR) filed for Chapter 11 protection. As the latest major U.S. carrier to file for bankruptcy protection, American faces significant challenges to keep its business flying. Let's look at rival carriers and how their respective restructuring plans helped them become more competitive after emerging from bankruptcy.

Before we delve in, it's important to understand that shareholders at the time of bankruptcy usually lose everything. Businesses operating under Chapter 11 protection will generally be delisted from major stock exchanges.

When these companies go public after bankruptcy, new stock is issued as part of their reorganization plan. It's essential to understand that the old stock and new stock usually have no relation, even if they share the same ticker symbol.

An industry trend
American joins competitors Delta (NYS: DAL) and United Airlines in seeking help from the bankruptcy courts. United filed for Chapter 11 protection in 2002, after the company was unable to secure a government loan guarantee to avoid bankruptcy.

At the time of filing, United's assets totaled $25.1 billion. In 2006, United emerged from what was the most expensive airline bankruptcy in history. The carrier was able to reduce its average annual costs by nearly $7 billion -- putting it back on the path to profitability. United parent UAL then merged with Continental in 2010 to become United Continental (NYS: UAL) .

Over the past 12 months, United Continental has reported more than $33 billion in revenue, with a profit of $653 million. Compare that to American's $23.6 billion in revenue, and bottom-line loss of $982 million. Clearly, American needs to become more cost competitive if it wants to survive in the long term.

Delta flies into bankruptcy
Delta Airlines filed in 2005. One of the largest airlines in terms of passengers carried, Delta's assets totaled $21.8 billion at the time of its filing.

Two years later, the American Airlines rival emerged from bankruptcy stronger and more profitable. By restructuring much of its $20.5 billion hole of debt, Delta was able to remove unprofitable routes, reduce its fleet of aircraft, and lower expenses -- eliminating about $2 billion in annual costs.

Additionally, by capitalizing on international routes with the highest profit potential, the carrier was able to successfully expand its global business. Delta now offers service to 351 destinations in 64 countries on six continents.

Clear for landing
In 2007, the airline emerged from bankruptcy having posted four straight quarters of profits. By the end of that year, Delta was able to reduce its net debt from $17 billion to $7.5 billion.

The airline left bankruptcy with $2.5 billion in exit financing from six leading banks including JPMorgan, Goldman Sachs, and Bank of America's Merrill Lynch. Delta used the financing to make payments for exiting bankruptcy and to boost its cash balance.

By taking these steps, Delta was able to lower costs and improve its capital structure -- issues that American Airlines hopes to tackle through the Chapter 11 process.

An unfair advantage
American Airline's costs have dramatically outgrown the costs of its rivals. Both Delta and United Airlines used the courts to reorganize their debt, while American was left at a disadvantage.

As American looks to restructure, the company could reduce its workforce and minimize travel on unprofitable routes -- similar to other airlines before it. However, it is business as usual for the airline, as operations remain on schedule heading into the holiday travel season.

Blue skies or a crash landing?
Luckily, the company had $4.1 billion in cash and short-term investments when it filed for protection. This cash hoard may help American retain more leverage during bankruptcy, as it won't have to rely as much on outside financing to keep its business flying.

The money is more than double the $1.5 billion Delta had when it filed in 2005, as well as the $800 million under United Airlines when it sought protection in 2002.

American hopes bankruptcy will help strengthen its balance sheet and build a foundation for long-term success. Tim Horton, the new CEO of AMR, has little doubt about the airline's eventual recovery. In fact, Horton confirmed a jet deal with Boeing (NYS: BA) and Airbus to deliver American's new narrow-body aircrafts.

But don't worry; the contracts for new planes are hardly a splurge. The jets come equipped with General Electric's (NYS: GE) new Leap X's engines, which should boost fuel efficiency by 15% -- ultimately cutting down fuel costs for the airline.

AMR faces significant challenges and tough competition going forward. However, it wouldn't be the first U.S. airline to exit bankruptcy as a stronger version of its former self. Click here to track AMR's journey to profitability with My Watchlist, a free Motley Fool service.

At the time this article was published Fool contributor Tamara Rutter does not have a financial position in any of the companies mentioned in this column. Follow her on Twitter, where she uses the handle @TamaraRutter. The Motley Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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