Thanks Brent!

Analyst Note 02-10-2006 

UAL Corporation UAUA, parent of United Airlines, has emerged from bankruptcy, and its newly issued shares of common stock are trading on the Nasdaq under the ticker UAUA. We are removing our $0 fair value estimate because it applied to the firm's old shares, which were canceled, as expected. We anticipate assigning the new shares a nonzero fair value estimate shortly.

Thesis 08-03-2005

Even if United emerges from Chapter 11 bankruptcy, the firm will almost certainly cancel its equity stock. Our fair value estimate of these shares is $0.

Despite massive and ongoing improvements, business at United remains difficult. The industry has undergone a fundamental shift whereby air travel is practically a commodity. Low-cost carriers control more than one fourth of the total U.S. market, and with help from the Internet, they've benefited the most from improved price transparency. Ultimately, United and its legacy peers cannot count on a return to the high airfares of yesteryear--even for business travelers, their historical lifeblood. Success is now based on a low cost structure, which allows the carrier to charge less than its competition and turn a profit. United has significantly closed the gap with industry standard-bearer Southwest Airlines LUV, though its unit costs excluding fuel remain about 20% higher.

Another reason to be wary of investing in United is its significant leverage, both operating and financial. With fixed costs representing a large portion of total operating expenses, United has substantial operating leverage--which is a very good thing when business is booming but has the opposite effect when business is in the dumps. More importantly, with a massive debt load, United is highly levered financially. The firm took on significant debt to buy newer, more efficient aircraft, and recently, United has been using this debt to fund losses in its operations. The effect of this financial leverage is to exacerbate the poor operating performance of the airline, resulting in enormous net losses.

Another issue we have with United is the volatility of its operating results. This uncertainty is directly a function of the business cycle and multiplied by the firm's leverage. Between 2000 and 2002, for instance, the company's annual revenue fell $5 billion, or 26%, and its net profits plunged from a meager $50 million to a loss of $3.2 billion. This continues a pattern of large profits and losses that has persisted every decade since the 1940s. Since deregulation in 1978, the airline industry as a whole has lost more than $11 billion. Given the current structure of the industry, we don't see this pattern ending anytime soon.

Low-cost competition, hugely underfunded pensions, record high fuel prices, war, and terrorism are together expediting the natural selection process in the airline industry. We think United will emerge from bankruptcy, but success beyond that will require further adaptation to the fundamentally more difficult environment. As for now, United stock is worthless.

Valuation

We believe the shares are worthless, and the company has issued statements to the same effect. Any shares currently outstanding will be canceled if and when United emerges from bankruptcy.

Risk

Though Chapter 11 does not necessarily mean United will cease operations, the risk of liquidation and complete capital loss for shareholders and creditors, albeit remote, overshadows other considerations for the time being. Sky-high fuel prices and continued pressure from low-cost carriers are making exiting bankruptcy more difficult.

Strategy

Exiting bankruptcy is management's most fundamental mission, and to attract the necessary financing, cost-cutting has been relentless. Labor concessions, route restructuring, right-sizing its fleet, and further negotiations with lenders and lessors are all priorities. The firm's defined-benefit pension plans are being handed off to the Pension Benefit Guarantee Corporation (PBGC), which will relieve United of substantial cash obligations.

Management & Stewardship

Glenn Tilton joined United in September 2002 as chairman, president, and CEO. A career Texaco man, he rose to become chairman and CEO--vice chairman after the merger with Chevron CVX--and briefly was interim chairman of Dynegy DYN before joining United. Tilton and the management team have had their hands full responding to repeated crises and working through the carrier's bankruptcy, heated labor negotiations, and restructuring the airline. We still don't see a coherent strategy emerging for the carrier that tried to be all things to all people and ended up costing the most to run. Before bankruptcy, the firm was 44% employee-owned, and thanks to multiple classes of supervoting shares and designated director seats, outside shareholders had little or no say in corporate affairs.

Profile

Chicago-based UAL Corporation owns and operates United Airlines, the world's second-largest airline. United provides passenger and cargo transportation to more than 120 airports in 26 countries through its major hubs in Chicago, Los Angeles, Denver, San Francisco, Washington, D.C., London, and Tokyo. The firm operates about 450 airplanes with about 60,000 employees.

Growth

In 2004 United reversed a shrinking trend as it increased capacity by more than 6%. Capacity will be down again in 2005 and relatively flat for a few years, though sales should show mild growth as United moves planes from domestic routes to more lucrative international flying.

Profitability

Things have been abysmal in recent years. The firm lost about $10 billion from 2001 to 2004. Despite substantial cost cuts, high fuel prices are preventing more than marginal operating profits.

Financial Health

Soaring debt and continued losses forced United to seek bankruptcy protection as it restructures. The airline continues to struggle to improve its cash flow and balance sheet to attract exit financing.