Fitch places UAL & United Airlines on watch positive following merger announcement

Fitch places the following ratings on Rating Watch Positive:

--Issuer Default Rating (IDR) for both UAL and United 'CCC';

--United's secured bank credit facility 'B+/RR1';

--United's senior unsecured rating 'C/RR6'.

An upgrade of the IDR to 'B-' could follow later in 2010 or at the time of the merger's closing if continuing revenue strength and a benign jet fuel price environment leads UAL to report consistently positive stand-alone free cash flow (FCF) and declining debt levels. If merger integration issues are successfully addressed and the operating outlook remains encouraging at or before the time of closing, Fitch would likely upgrade UAL and United's ratings to the 'B-' level, in line with CAL's current IDR.

The Rating Watch Positive reflects Fitch's view that a merger between UAL and CAL, if ultimately closed under terms similar to those outlined today, will eventually support sustainable improvements in margins, positive FCF generation and stronger liquidity in a post-merger scenario. Significant execution risk exists, however, and the terms of new labor contracts could have a substantial impact on the economics of the merger. Fitch will remain focused in particular on regulatory risks related to the antitrust review by the U.S. Department of Justice (DOJ) and the inevitable complexity of labor integration for unionized work groups at UAL and CAL.

Absent major asset disposal requirements in a future antitrust decision, the combined UAL-CAL route network would offer clear opportunities for the post-merger carrier to deliver a sustainable revenue per available seat mile (RASM) premium to the industry. The two stand-alone networks are very complementary, with United's notable strength in trans-Pacific routes meshing well with CAL's strong market position in New York and into Latin America via the Houston hub. The depth and breadth of the post-merger route network, together with the premium product focus of both carriers, should put the post-merger carrier in a strong position to deepen penetration in key high-fare business markets.

Revenue-related synergies will ultimately be more decisive in determining the long-term financial success of the merger. Recognizing immediate cost saving opportunities associated with the elimination of duplicative operations (in particular, headquarters and certain overlapping airport operations), unit costs for the post-merger carrier could eventually move higher if pay rates and benefits for United employees are moved up to match CAL contracts. Cash integration costs, moreover, are likely to be significant, and will put some pressure on FCF for both UAL and CAL this year and into 2011.

Although the proposed stock swap agreement limits the need for additional debt to support post-merger liquidity, the new airline's lease-adjusted leverage will remain very high in Fitch's base case forecast scenario. Post-merger balance sheet debt for the new airline will likely exceed $14 billion, in addition to approximately $10 billion in capitalized aircraft leases. Combined unrestricted liquidity will likely approach $7 billion (over 20% of pro forma post-merger annual revenue). The new airline will face heavy and steady scheduled debt maturities. Combined maturities total $2.1 billion in 2011 and $1.3 billion in 2012. CAL also faces rising cash pension funding obligations for its frozen but substantially under-funded pension plans.

Assuming modest global economic growth and solid RASM growth moving into 2011 and average jet fuel prices at $2.40 per gallon, Fitch expects the combined carrier to generate positive FCF in 2011 with pro forma lease-adjusted leverage exceeding 6 times at the end of next year. Fitch's forecast assumes that the transaction would be closed by early 2011.

On a stand-alone basis, UAL's credit profile has strengthened considerably over the last several months as consistently improving unit revenue trends, positive FCF and more reliable access to the capital markets have pushed unrestricted liquidity substantially higher. United's current unrestricted cash and investments balance of $4.5 billion provides the airline with substantial flexibility should the industry operating environment worsen. In addition, the airline's fixed obligation burden is relatively light through at least 2012, reflecting the successful refinancing of near-term maturities and the absence of defined benefit pension funding obligations. Unlike other legacy carriers, moreover, UAL has no fleet capital commitments until widebody replacement aircraft begin arriving in the middle of the decade. Capital spending levels, as a result, are expected to remain modest (below $500 million in 2010). Combined 2011 capex for the post-merger airline will likely exceed $1.5 billion, driven by CAL's heavier spending on new aircraft.

All of these factors should put UAL in a position to continue de-levering its balance sheet, albeit at a modest pace, over the next several quarters. Factoring in increased cash flow impacts linked to merger integration costs and potentially higher post-merger unit labor rates, UAL and CAL together can generate positive FCF in excess of $500 million during 2011 if industry demand and yield trends continue to strengthen.

Signs of an improving demand and fare environment were clearly evident in UAL's first quarter results, with consolidated RASM growing by 19% year over year. The recovery in high-fare demand has been most apparent in international markets, with trans-Pacific RASM increasing by 30%. Capacity constraint during the recession has put the carrier in a good position to report solid RASM gains in 2010 as passenger yields continue to trend significantly higher across all regional markets. UAL and CAL are both reporting material improvement in revenue as a result of better feed within the Star Alliance since CAL joined the alliance last October.

Fuel price volatility remains a major concern for UAL and the entire industry in light of the steady run-up in crude oil and jet fuel prices since early 2009. United has ramped up 2010 fuel hedge protection over the last few months following a period of large hedge losses in 2008 and 2009. For the remainder of 2010, approximately 54% of projected fuel consumption is hedged via swaps and call options with average crude oil equivalent price caps of $79 per barrel. Protection beyond 2010 is limited, however, and the carrier remains vulnerable to a sharp spike in energy prices as global energy demand picks up.