Northwest Airlines Corp (OTC:NWACQ) moved higher by another 20% today as speculation of a possible buyout continues. The runup began after Owl Creek - a fund that owns 4.4 million shares of the bankrupt company - said that Northwest shares could be worth between $18 and $33 per share in the event of a buyout. Now, when a company goes bankrupt, it is not uncommon for their shares to become worthless upon emerging from bankruptcy. After all, common stock shareholders are at the very end of the bankrupcty line. So, why would anyone buy shares of Northwest then? Well, if the company can orchestrate a buyout before it emerges from bankruptcy that satisfies the bankruptcy court and debtors, then common stock shareholders could see significant share appreciation. They outlined their argument in their most recent 13D/A filing with the SEC:

"Though it is early to value Northwest for recovery purposes, Owl Creek submits that, based on Wall Street analyst reports, the trading markets value Northwest's legacy carrier peers (American, Continental, United, and US Airways) at 5-1/2 to 6 times "EBITDAR."(3) Carriers like Northwest with a higher likelihood of being a merger candidate trade for more than 6x EBITDAR and carriers with a lower likelihood of being a merger candidate trade closer to 5.5x EBITDAR. Based on similar 2007 fuel price assumptions to those underlying the comparable company valuations, Owl Creek forecasts Northwest's 2007 EBITDAR to be $2,700,000,000. Given a valuation of 6.0x 2007 EBITDAR, Northwest should have a total enterprise value of over $16,200,000,000 at the time of its expected emergence from bankruptcy protection in September of 2007. With a cash build up of over $1,000,000,000 during the remaining pendency of the bankruptcy cases, this would result in an equity value of $19.75 per share AFTER covering all claims with interest and the preferred stock.

Furthermore, US Airways' hostile offer for Delta Airlines last week -- aside from signaling directly the consolidation trend in the legacy carrier market from which Northwest's value undoubtedly will increase -- demonstrates the inherent value, recoverable by Northwest's equity holders, that a merger of Northwest with a strategic partner will create. US Airways announced that it expects the combination to generate $1,650,000,000 of annual synergies, which is 6.2% of the combined Delta/US Airways passenger sales. Assuming comparable proportional synergies to a Northwest merger with Continental (Continental Airlines is the most logical partner, but this analysis would be equally applicable to another carrier), then the synergies generated by a combination of Continental Airlines with Northwest would be approximately $1,250,000,000 annually. Valuing the company at a post-merger multiple of 5.25x EBITDAR including one half of the synergies accruing to Northwest (the other half to the merger partner) results in an implied stock price of $33.50 per share.

This is not a "what if" analysis. Experts have been calling for consolidation for some time, and US Airway's offer for Delta Airlines suggests the starting point. SEE, E.G., Benjamin Silverman and Susan M. Donofrio, TWO EVENTS MAY TRIGGER AIRLINE CONSOLIDATION THIS FALL, Cathy Financial Industry Report, September 22, 2006; Jeff Bailey, A REVITALIZED US AIRWAYS IS CREATING A MERGER BUZZ, N.Y. Times, July 31, 2006, at C2 ("The surprising early success of
US Airways Group, the result of a merger last year, has led to some behind-the-scenes talks among investors and airline executives that could lead to more industry consolidation in the months ahead"); Susan Carey and Melanie Trottman, MERGER TALKS BRING OUT FEAR OF FLYING, Wall Street Journal, April 21, 2006, at C1 ("Most airline investors agree that consolidation would be great for an industry with too many airlines chasing too few dollars"). The value of the mergers becomes immediately apparent in the change in trading prices of Delta Airlines unsecured bonds following the November 15, 2006 announcement of US Airways' offer. The trading price of Delta Airlines bonds increased by fifty percent in the week after the announcement, and Delta's board has neither accepted nor closed that transaction yet. Owl Creek believes, in fact, that Northwest is a MORE strategic asset to an acquirer than Delta Airlines due to its strong international network and its "Golden Share" in Continental Airlines." (Read More)

Meanwhile, Owl Creek has also petitioned the U.S. courts to create a Shareholders Committee to represent preferred and common stock shareholders in bankruptcy court. If granted, this representation would greatly improve the chances of shareholders receiving something after the company emerges from bankruptcy. Owl Creek gave six reasons for this (which they elaborate upon in their 13D/A filing):

• the Debtors' cases are large and complex;
• the Northwest stock is widely held and actively traded;
• the interests of Northwest's shareholders are not otherwise adequately represented;
• the Debtors do not, under reasonable (non-strategic) valuations, appear to be "hopelessly" insolvent;
• Owl Creek's request is appropriately timed based on the status of the Debtors' cases; and
• the necessary costs do not significantly outweigh the concerns for adequate representation.

Combined, Owl Creek believes that the company has a good chance of being able to emerge from bankruptcy with enough capital to retain preferred and common stock. Moreover, they insist that in the event of further industry consolidation, the company could see a large enough premium to pay of debtors and have plenty left over for common stock shareholders. While the stock is obviously extremely risky at this point, any further news of a buyout or creation of an equity committee could give some meaning to the stock's current valuation. This makes Northwest a good stock to keep an eye on over the next couple of months.

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