Northwest Airlines Shares Could Debut Overvalued

Northwest Airlines is hoping for the highest valuation in its history when it emerges from bankruptcy protection May 31. But there are signs that it may be a little rich for some investors.

Creditors were offered new Northwest shares at $27 each, but more than 90% of them went unsold. Underwriter JP Morgan Securities, which has to buy anything unsold from the $750 million offering, believes they're more likely to trade closer to $24 a share, according to a bankruptcy examiner's report issued last week.

Northwest shares are set to begin trading on the New York Stock Exchange on a when-issued basis Monday and begin regular trading May 31.

In addition, several investors lost interest late last year when climbing prices for Northwest's debt suggested a market value of $7 billion, according to the examiner's report. Northwest no longer plans to seek $150 million in private investment it had once considered.

After 20 months under court protection from its creditors, Northwest Airlines got approval Friday to emerge from Chapter 11.

Northwest's lukewarm reception by investors is hardly unique. Interest in airline stocks has cooled, with shares in other airlines off 10% or more since the year began, while the rest of the market sets new records. Analysts say the decline was driven by cooling merger speculation, rising oil prices, and a warning from Southwest Airlines that it was seeing a soft patch in demand. New shares in Delta Air Lines have drifted 13% lower since they began trading earlier this month after it emerged from bankruptcy protection.

Calyon Securities analyst Ray Neidl said it's no surprise that Northwest debt holders declined to buy additional shares. Their debts are already being paid in shares, and they probably don't want to add to their exposure, he said.

He said he would expect Northwest to command a premium versus other airlines because it is newly reorganized. Its labor contracts run through the end of 2011.

"They've got a reduced cost structure, a reduced balance sheet" and restructured routes, he said. Their cost per available seat-mile should be about a penny lower than competitors, he said.

Eagan, Minn.-based Northwest has said it has reduced its costs by 10.8% not counting fuel, for a total of $2.4 billion in savings, including $1.4 billion from labor. It's still hoping to cut another $250 million in non-labor costs this year.

The examiner's report issued last week said Northwest at first hoped to raise $750 million to $1.25 billion in equity for the reorganized company. The idea was to inject additional cash as it emerged from bankruptcy. Northwest's advisers got 15 private equity and hedge funds to sign confidentiality agreements in November so they could take a close look at the airline's books.

"These institutions included very sophisticated investors in the airline industry," examiner Richard Nevins wrote.

But on Nov. 15, US Airways Group made a hostile bid for Delta, which was most of the way through its own reorganization. Airline values soared.

Northwest's common stock, which the airline had said would be canceled when it emerged from bankruptcy, zoomed from 90 cents before the bid to more than $6 per share in mid-December.

Trading in Northwest's claims began to imply that the airline was worth $6 billion to $7 billion, Nevins wrote. Most of the institutions that had been looking at injecting cash lost interest at that point, Nevins wrote.

Not everyone has been scared away, though. Trading has continued to be brisk in Northwest's claims, which are to be exchanged for new shares in the reorganized company.

Prudential Equity Group analyst Bob McAdoo said that with the economy strong, there's no reason demand shouldn't stay strong, too.

"I think that as we get into the summer, I think a lot of these companies are going to see that demand continues to be strong. I quite frankly expect all of the airline shares to go up meaningfully as we go through the summer," he said.