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Avro Article Wall Street Jornal

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Mar 7, 2005
MESABA:Avro Article Wall Street Jornal

Feeders Facing Dish of Northwest's Pain
By Ross Snel
TheStreet.com Staff Reporter

9/21/2005 7:18 AM EDT

Northwest Airlines' stock isn't the only airline equity getting hammered by the carrier's descent into bankruptcy.

Two companies operating regional feeder flights under contracts with Northwest -- Pinnacle Airlines and Mesaba Airlines' parent MAIR Holdings -- have seen their stocks fall about 17% and 25%, respectively, over the past week and a half. Investors are worried about payments Northwest owes the two small airlines, as well as the fate of their partnerships with the nation's No. 4 carrier.

The situations highlight the risks regional carriers face as their legacy partners undergo wrenching restructurings necessitated by record-high fuel costs and competition from nimbler, low-cost discounters.

Last week, Northwest skipped an $18.7 million payment to Mesaba and a $22 million payment to Pinnacle. Northwest's filing last Wednesday for Chapter 11 bankruptcy protection gives it relief from creditors, creating uncertainty about when and if it will make those payments. Both regional carriers also have expressed concern about other big payments due toward the end of the month.

Because Pinnacle's only customer is Northwest, it warned in a regulatory filing Friday that the interruption in its cash flow will be material. Helane Becker, airline analyst at the Benchmark Co., a New York-based brokerage firm, expects Pinnacle shares to remain under pressure because of the company's now-murky outlook. Her firm does no investment banking.

Meanwhile, Northwest is seeking to use the bankruptcy process to reject leases on 35 British Aerospace Avro regional jets it subleases to Mesaba. Although analysts say the move is hardly surprising -- the planes are starting to get long in the tooth and are less efficient than newer models -- it does raise uncertainty for Mesaba, and Becker advises investors to sell the stock.

What's more, analysts expect Northwest to imitate other bankrupt legacy carriers US Airways and United Airlines' parent UAL , which used Chapter 11 to extract contract concessions from regional partners.

Feeders Facing Dish of Northwest's Pain
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That could mean less lucrative payments to the two regional carriers going forward. Northwest reimburses Mesaba based on each hour it flies the Avro planes and each seat it flies one mile in its Saab 340 jet-props. Pinnacle earns an operating margin of between 9% and 11%, but Becker notes Northwest may try to lower that to the midsingle digits.

Northwest might even shop around its regional business to other regional operators such as Mesa Air Group (MESA:Nasdaq - commentary - research - Cramer's Take) and Republic Airways (RJET:Nasdaq - commentary - research - Cramer's Take), giving it bargaining leverage over Mesaba and Pinnacle, says Douglas Abbey, a partner with Velocity Group, a Washington-based consulting and market research firm. Still, Northwest would likely give Mesaba and Pinnacle first dibs on new contract offers, he adds.

In a conference call last week, Northwest's CEO, Doug Steenland, said that while he anticipates having discussions with Mesaba and Pinnacle carriers over issues such as fleet changes, the "nature" of the regional carrier relationships and the services they provide will remain unchanged for the foreseeable future.

Analysts offer different forecasts for what might happen to the 35 Avro jets Mesaba flies. Roger King, airline analyst at CreditSights, an independent New York research firm, says one optimistic possibility is that Northwest renegotiates the lease rates lower and passes the savings onto Mesaba.

Another scenario, according to Becker, is that Northwest cancels its leases on the planes, leaving Mesaba in a position where it must re-lease the planes from their original owners, a prospect that could prove expensive.

A hearing on Northwest's request to reject the leases is set for Oct. 7.

As Northwest seeks to benefit from the flexibility of Chapter 11, it also may try to embrace a broader trend sweeping the airline industry: the conversion of some mainline -- or large-jet -- flying to next-generation regional jets seating between 70 and 110 passengers.

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Feeders Facing Dish of Northwest's Pain
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Switching smaller flights to those regional jets can save large carriers money because regional jet pilots typically have much lower salaries. The obstacle has been contract provisions with unions representing mainline pilots.

In Northwest's case, all planes with more than 60 seats must be flown by mainline pilots, with an exception: Mesaba can operate the 85-seat Avro jets, as long as they are modified to carry only 69 passengers.

Of course, Northwest likely will try to press its mainline pilots to change those rules so as to allow its regional partners to fly the next-generation 70- to 110-seat regional jets. Another possible change would be to have mainline pilots fly those jets, but at a lower pay rate. A spokesman for the pilots union acknowledged that Northwest has proposed changing the provisions since early 2003, although no changes have been made. The union says it has yet to see Northwest's post-bankruptcy proposal.

If Northwest can clear the runway for the large regional jets, it could provide growth opportunities for Mesaba and Pinnacle, says Abbey at Velocity Group, which does no business with Northwest or the regional carriers. The problem is that neither Mesaba nor Pinnacle have the planes in their fleets. Getting them would take time.

In the meantime, Northwest might seek to make the switch by contracting some flights out to other regional carriers like Mesa and Republic that either have the larger regional jets in their fleets or have ordered them. According to Abbey, such contracts might be temporary, giving Mesaba and Pinnacle time to take delivery of the larger jets.

Still, such scenarios will take a while to play out, and in the me
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Someone please enlighten us on what happened at tonight's fist pounding ALPA meeting. I'm sure it's all speculation but any rumors/news is welcome. thx

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