United Airlines Stock Decline Doesn't Hurt Employees

Finally, a drop in stock price that doesn't hurt United Airlines employees.

An odd thing to say, since the stock is down more than 40 percent since the first heady days of February, before the company emerged from Chapter 11 bankruptcy.

But most of the rank-and-file, unionized employees of United didn't get big packages of stock options and restricted stock like CEO Glenn Tilton and his top executives.

Instead, they got a promise of convertible debt, so-called because the bonds can be converted into United stock at a fixed price.

Convertibles have been described as debt with a stock option thrown in. Because of that feature, the bonds usually pay lower interest rates since the noteholders can profit handsomely when the stock rises.

The only problem for the bondholders occurs when the market price of a stock sinks and the conversion price is too high. Then they lose the value of that "stock option" feature.

According to the bankruptcy terms, the conversion price on the notes was supposed to be 125 percent of the common stock's average closing price from the first 60 days of trading - about $47.

But the bankruptcy plan also included a provision that the notes be issued so that they traded on the open markets at "par," or the issuance price. Simply, this means the interest rate on the notes had to be set to compensate investors for any discrepancy between the conversion price and the market price.

By July, this was a problem. United stock had sunk significantly, trading in the mid-$20s. United realized the interest rate on the notes would need to be "significantly higher than 4.5 percent," according to the company's quarterly report, to compensate the employees for the gap between a conversion price of about $47 and the market price.

So United struck a deal with the employee groups. The conversion price was reset to 125 percent of an average price of United's common stock over the two trading days ending on July 25, the days the notes were issued to employee trusts. The market average was somewhere around $28, meaning the new conversion price is about $35.

Here's what this meant: There were $726 million of notes which were originally convertible into about 15.5 million shares. Under the revised terms, the notes are convertible to 20.8 million shares.

Since United parent UAL has just 115 million shares outstanding, the extra 5.3 million shares represent nearly 5 percent of the company that could be given away to employees, just to avoid the higher interest rate.

"While the resetting of the conversion price increased the option component value of the notes, we and our financial advisers believe the significantly lower coupon more than offsets this," spokeswoman Jean Medina said.

United disclosed the debt change on the same day it pre-announced its second-quarter earnings, which featured the company's first profit since 2000 (a bankruptcy-related gain in the first quarter notwithstanding).

United's stock closed up the day of the profit announcement but then fell five days in a row, shedding more than 10 percent. Perhaps investors realized the relaxed convertible pricing is good news for the employees but bad news for the common shareholders.

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