American to Purchase AirCal for $225 Million : Stronger Competition Expected on West Coast as Airline Beefs Up Its Nationwide Operation
American Airlines, the nation’s second-largest carrier, said Monday that it will buy the parent company of AirCal for $225 million in a deal that will give American the West Coast routes it has lacked and make it a nationwide airline.
The deal is also expected to turn AirCal’s operation under American into a much stronger contender in the highly competitive and lucrative Los Angeles-to-San Francisco flight corridor, although probably without triggering another bloody fare war.
AirCal, which flies its 39 airliners to destinations in six states and British Columbia from its hub at John Wayne Airport in Orange County, competes heavily with PSA and United Airlines in the corridor.
Second in Corridor
Each year, 8 million passengers, most of them business people, are shuttled up and down the coast on 450 daily flights by AirCal, PSA, United and smaller airlines. According to 1985 figures, the latest available from the Department of Transportation, AirCal had almost 33% of the corridor business, trailing PSA, which had 48.7%. In third place was United, with 8.1%.
Officials of American said they will use AirCal’s corridor traffic to feed passengers into American’s transcontinental routes. John Hotard, a spokesman for American, said that even before the merger is complete, AirCal passengers will be eligible to participate in American’s frequent flier program, so that the credits they earn by taking West Coast flights can be used for flights to the East.
Hotard said it is “premature” to discuss American’s marketing strategy on the West Coast corridor but said the competition probably will not take the form of discount fares. “American is a fare leader, but we don’t always have the lowest fares,” he said. He added that, like AirCal, American has a reputation for service and has traditionally operated at a relatively high cost.
The transaction is the latest move in what has become a frenzy of merger activity in the airline industry since it was deregulated in 1978. The trend has picked up steam in the last 18 months. Since deregulation, there have been 32 airline mergers, 22 of them in 1985 and 1986.
It seems clear that there will be more. George James, president of Airline Economics, a Washington consulting firm, predicted in an interview Monday that the 98 carriers still in operation will shrink to six large airlines and about 20 smaller ones.
The American-AirCal announcement, made at a news conference at American’s Dallas headquarters, came as something of a surprise, however, because officials of American had said consistently that, rather than acquiring other airlines, they planned to expand from within.
Robert L. Crandall, chairman and president of American, which has 325 airliners, annual revenues of $6 billion and $1.3 billion cash in its treasury, said in an interview Monday that the AirCal acquisition does not change that internal growth strategy.
“To assure American’s success,” he said, “we must have a West Coast presence soon, and we simply cannot do that (while) simultaneously developing our new hubs at Nashville, Raleigh-Durham and San Juan and continuing to develop our established hubs at Dallas-Fort Worth and and Chicago. Therefore, we have decided on this relatively small acquisition as a means of supplementing the growth plan and solving the West Coast problem.”
Timing provided part of the explanation for the surprise announcement, analysts maintained. AirCal was up for sale and, if American had not acted quickly, someone else might have gotten there first. “The principals had been shopping the airline around,” said Greg Kieselmann, an airline analyst with the Los Angeles brokerage Morgan, Olmstead, Kennedy & Gardner Inc.
Crandall said the two airlines had been talking in recent weeks about completing a joint marketing agreement. “It was about as close to merger without actually being a merger agreement as you could get,” he said. “Other people were courting AirCal. (So) it translated into merger talks.”
William Lyon, chairman and chief executive of AirCal’s parent company, ACI Holdings Inc., headquartered in Newport Beach, said Monday that in the course of those talks “it became clear to both sides that there was a good fit.
“There have been so many changes in the airline industry that is is harder for a smaller company to aggregate capital to buy new equipment and to compete,” Lyon went on. “There’s a tremendous amount of capacity that’s not being used now. We’re competing against that. It becomes more and more difficult.”
The proposed merger was viewed by analysts as an excellent deal for both airlines. “For American it is a relatively modest investment, and it gets them up and running with a West Coast system,” said Edward Starkman, who follows airlines for the Paine Webber brokerage in New York. “And the AirCal shareholders get a good price.”
By acquiring AirCal, American is expected to get a bonus of more prized flights at John Wayne Airport, where the entry of new airlines is greatly restricted by airport noise considerations. Both AirCal and PSA have fought to get a bigger piece of the pie at John Wayne by spending millions to purchase the latest in quiet jets.
If the Orange County Board of Supervisors agrees to let American assume all of AirCal’s 28.5 average daily departures at John Wayne, it will have a total of 34 departures, compared to PSA’s 25.
$15 Cash a Share
Under the agreement between the two companies, American will initially pay $15 cash a share for 6 million shares of stock in ACI Holdings. The purchases will be made from ACI’s two principal shareholders, Lyon and George L. Argyros, and will represent slightly more than 70% of the holding company’s outstanding common stock. ACI has also granted American an option to purchase up to 10 million unissued shares of its common stock.
Pending regulatory approval, the ACI shares acquired by American will be put into a voting trust. ACI’s convertible preferred stock and and other debts will be converted to common stock by their holders before completion of the merger. Once this is done, American said, the total value of the transaction will be $225 million.
The deal has been approved by the boards of both companies and has been submitted to the Department of Transportation, which has six months to issue a decision. Observers predicted that there will be no opposition on antitrust grounds because the two airlines overlap on only about half a dozen routes.
American said it hopes that the transaction will be completed by mid-1987. AirCal will then cease to exist and its planes will be painted with American’s colors. Most of AirCal’s roughly 3,500 employees will be retained, American said.
Some analysts contended that American is paying too much for AirCal, about twice the book value.
Crandall said, however, “We have valued the company based on what we think it can contribute to American. When operated in conjunction with American, we believe that AirCal’s assets will produce stronger earnings and larger cash flows than AirCal has been able to earn as an independent company. Thus we think the price per share is fully justified when compared against anticipated earnings.”
ACI Holding’s stock, traded on the American Stock Exchange, closed Monday at a 52-week high of $14.375, up $4. The stock of American’s parent, AMR Corp., closed down 25 cents at $56.125 in trading on the New York Stock Exchange.
Newport Beach-based AirCal was founded by five young California businessmen in 1965 and began operations with two Lockheed Electra propjet aircraft two years later. AirCal had net earnings last year of $9.3 million on revenues of $344.5 million. In the first nine months of this year it lost $6.2 million on revenues of $271.5 million.
Wait and See
San Diego-based PSA, AirCal’s major competitor, took a wait-and-see attitude toward the merger. “I guess we got a little more than we bargained for today,” said PSA spokesman William Hastings. He was commenting on the American-AirCal merger and an announcement Monday that United Airlines plans a major increase in the frequency of its flights in and out of Los Angeles.
“Obviously American has more resources than does AirCal,” Hastings said. “It all depends on how they plan to use those resources. Will they use the planes on the San Francisco-Los Angeles corridor or will they take the planes elsewhere?
“There is no doubt about it. American Airlines will be a tougher competitor. We will just have to work all the harder,” he added.
Robert E. Dallos reported from New York and Leslie Berkman from Orange County.
AirCal workers react to takeover. Story in Business.