Legacy carriers find it isn't so easy to sell their regional subsidiaries
Regional Airlines
Legacy Airlines Look for Sweetheart Deals
Aviation Week & Space Technology
05/16/2005, page 58
James Ott
Cincinnati
Legacy carriers find it isn't so easy to sell their regional subsidiaries
No Sweetheart Deals
Divesting of regional airline subsidiaries would offer at least temporary relief for financially strapped legacy operators, but the path to merger and acquisition is strewn with formidable obstacles.
Need for cash is driving Delta Air Lines to look for a buyer of its wholly owned subsidiaries, Comair and Atlantic Southeast Airlines (ASA). A recent contender, SkyWest of St. George, Utah, the number three regional, ultimately decided against acquiring them.
"The key is for Delta to find a buyer that will pay a reasonable price," says Raymond E. Neidl, an analyst with Calyon Securities Inc. of New York. He estimates that price to be $600-800 million, a far cry from the $1.8 billion paid by Delta to fully acquire Comair alone in 1999 (AW&ST Oct. 25, 1999, p. 30).
SkyWest pulled out from discussions because of Comair's high cost structure, says airline consultant Robert Mann of R.W. Mann and Co. He thinks Atlantic Southeast didn't appear to be a good prospect for SkyWest either. Delta acquired ASA before the Comair transaction for the purpose of improving ASA's service quality, and it still needs work on operational performance, says Mann.
If Comair and ASA are sold, "I don't think you'll see a sweetheart deal," adds Brooks Holtom, a management professor at Georgetown University. "[Delta] will be looking for the highest bidder, the person who thinks he can manage it best and produce a return for the shareholders."
Comair and its primary unions just completed a round of contract revisions that represent the equivalent of a pay freeze. The pilots, represented by the Air Line Pilots Assn., annulled a 4.5% pay raise. The flight attendants will get pay raises, but future hires will be paid a 20% lower B-scale over five years. Mechanics are getting a small raise. Mann points out that Comair's costs are still the highest in the industry. A captain with one year of experience receives $60 per hour, or $66 if the aircraft is the CRJ700, about $5-10 more per hour than rival carriers.
Because of that high cost structure, Delta in 2004 held back growth aircraft from Comair while it added capacity for ASA and other low-cost operators affiliated with the Delta Connection system. Starting in June, Delta is rewarding Comair for the new labor contracts with delivery of the first of 10 CRJ200s. In 2006, Comair is promised 25 larger 70-seat jets that could be either Bombardier or Embraer aircraft.
Over the years, alliances between mainline and regional airlines have fallen into three separate types. The jury is still out on what is the best course, says Alan Sbarra of Roach and Sbarra Airline Consulting. Some legacy operators, such as United Airlines, avoided ownership. United stresses business relationships with carriers that feed traffic to its hubs. American Airlines prefers ownership. It acquired Executive Airlines and put together the American Eagle network. At first, Delta took a financial interest in its regional feeds and later turned to full ownership, along with a cast of affiliated independent carriers.
Sbarra believes the impetus to sell is financially driven. "A company may be under pressure from shareholders to get back to the core business."
In recent years, Continental managed to sell off most of Continental Express, now ExpressJet, and Northwest Airlines sold the larger portion of Pinnacle Airlines. Public offerings were "an above-market deal," Mann recalls, "and the result was they were able to do the transactions."
When business turns sour, that means trouble for any airline associated with reorganization under the bankruptcy laws. In reorganization, United pressed former Atlantic Coast Airways for cost savings in their capacity purchase agreement, and the relationship ended. Now as Independence Air, former Atlantic Coast is on its own. Air Wisconsin, another former United Express carrier, also couldn't manage under United's cost-cutting plan.
Going on its own for an airline that once relied on a mainline partner is not an easy transformation, says Mann. In 2000, American Airlines was looking to sell its Executive subsidiary, part of its Eagle network. Several potential buyers performed due diligence, yet there were no takers.
"The first impediment was that even then the view was that independent entities are really not stand-alone capable," the consultant says. "Secondly, the mainline-regional relationship had changed since the mid-1990s. Then quality operators were in short supply and majors were willing to offer lucrative contracts."
Today, with several mainline carriers in reorganization and perhaps more heading that way, the relationship between mainline and feeder regionals is changing again. Now, profitable regional carriers are exploring investments to support mainline carriers and to protect their capacity agreements for the future.
Mann says it is "an odd turn of fortune" that Air Wisconsin and Republic Holdings, parent of Chautauqua Airlines and Shuttle America, may invest $125 million each to keep their regional services for US Airways and America West.
Mesa Airlines, which launched a partnership in recent weeks with Delta, is considering an investment to protect its feed services for the mainline merger partners. Mesa gains up to two-thirds of its revenues from US Airways and American West under separate contracts currently. It is the only regional carrier flying the 90-seat CRJ900s for America West, which AmWest's pilots permitted under their contract scope clause, the industry's most liberal.
If Mesa lost its America West contract, the independent could have a hard time finding an airline to serve that would not be restricted by pilot scope clauses.
The regional airline business appears to be patterning itself after developments in the cargo field, where carriers, known as ACMI operators (Aircraft, Crew, Maintenance and Insurance), are proliferating. These airlines provide basic lift for a contract price and leave the marketing, administration and support operations to the buyer. Chautauqua and Mesa are good examples of these near-ACMI operators.
Thus far in this time of change, labor unions have demonstrated cooperation, revising contracts, taking pay cuts and simplifying work rules, so that mainline and regional carriers can endure economic shocks. Continued focus on easing scope clause restrictions is expected as regional carriers begin operating 100-seat-plus aircraft. Currently, the demarcation line for scope restrictions starts at 70-seat aircraft.
