My Account Menu

CAPA Login


Register to trial CAPA Membership!

Republic entering uncharted territory

21-Jul-2009

WEEKLY REFLECTIONS WITH RON KUHLMANN AND THE CENTRE. Recently, we have looked at the proposed launch of JetAmerica by examining the history and conditions that accompany its (now cancelled) start up. One of the unique features of the proposed airline was its virtual nature, with the “carrier” being merely an assembly of components.

We now have another variation on the airline theme with a regional airline holding company purchasing two small airlines and deviating considerably from its past operational model. UPI reported on June 24 that “Republic Airways Holding said it would take over two struggling airlines, Frontier, based in Colorado, and Midwest, based in Wisconsin.”

The combined airlines would be the 11th largest US carrier, based on first quarter 2009 results (Chart 1) and MIT’s William Swelbar notes that  “The world is changing. New market economics may force restructuring in the industry, where the winners are those, like Republic, with flexibility and agility.” And, we might add, money.

Chart 1:

Sked Pax, Q1 2009

Republic

1,841,581

Frontier

2,159,374

Midwest

228,302

Total

2,229,257

So the pattern is reversed with the regional moving into the big tent rather than being created by the larger entity.

Supplemental Flying

To fully understand the implications, we must first have a quick look at the way in which regional carriers have become ever more important in the US. Every legacy carrier has for some time operated short-haul or regional routes using either contracted services or through their own subsidiary.

Of late, the US carriers have elevated this practice to new heights and just who flies what for whom is anything but transparent. This was made abundantly clear in February 2009 with the crash of Continental Flight 3407 in Buffalo, New York. First reports all reported the crash as a Continental aircraft. Only subsequently did it become common knowledge that the aircraft belonged to Colgan Air, a regional airline owned by Pinnacle Aviation, and operated on contract with CO.

Following this incident, the differences between “mainline” flights and contracted flights have made headlines with the latter said to be operating with different training and vastly different pay scales and experience. The substitution of smaller aircraft with lower costs has been a primary tool of legacy carriers as they reduce capacity and cut expenditure.

Fairly New…

This extraordinary outsourcing of flights is fairly recent. In 1998 every flight operating between Dallas and Knoxville was a mainline aircraft. In 2009, every flight is operated by a regional RJ. Between Dallas and Cleveland, a distance of over 1000 miles, all the nonstop service on either American or Continental is on an RJ.

The phenomenon is also prominent in major markets as well. Much of the service between St. Louis and both New York and Washington, important business and tourist destinations, is now operated on regional jets. A similar pattern is evident between Salt Lake City and many major cities in the west including Los Angeles, San Francisco and Seattle. Traveling even on a flagship route may involve travel on a smaller aircraft that has been contracted or is operated by a regional subsidiary.

As both CRJs and ERJs have gotten larger, they can accommodate roughly the same number of passengers that fit into early 737s and DC-9s. And unlike the earlier 50-seat RJs, these newer aircraft are full-sized, allowing passengers to walk upright when boarding and deplaning. The difference, however, is that these aircraft are often neither owned nor operated by the carrier whose logo they bear, but flown contractually by a number of airlines that exist solely for that purpose.

And pretty much a US thing.

Contracted or regional or short haul flying can certainly be found in many places. In Europe, Air Nostrum supplements Iberia’s routes and Lufthansa City Line operates on Lufthansa’s behalf. The regional partner is used much in the same way as they are in the US, but with a major difference: they are linked to only one carrier and often fully owned.

A quick look at chart 2 shows that this kind of exclusivity is not present in the US market with each legacy carrier having multiple suppliers even if, as is the case with Comair or American Eagle, the major owns a subsidiary. While these subsidiaries are wholly dedicated to the parent, the reverse is not true.

Nor is the lineage of these companies easily deciphered at first glance. Going back to the Buffalo crash, remember that while the aircraft in question may have been painted in Continental colors, it was operated by Colgan Air, a subsidiary operation of Pinnacle Aviation.

Certainly most travelers have no clue as to these complex interconnections that result in carriage from A to B. Nor need they. Nonetheless, it is interesting to note that Chautauqua has a “client “ base that consists of four of the five remaining US majors.

Chart 2

US Majors regional connections

Holding/Parent

Carrier

Op for

Aircraft

Fleet

American Airlines

American Eagle

AA

CRJ/ERJ

226

Pinnacle Aviation

Pinnacle Airlines

DL

CRJ

141

 

Colgan Air

US/CO/UA

340/Q400

48

Republic Airways

Chautauqua Airlines

AA/CO/US/DL

ERJ

91

 

Republic Airlines

US/YX

ERJ/CRJ

67

 

Shuttle America

DL/UA/5Z

ERJ

60

Air Wisconsin

 

US/UA/NW

CRJ

70

Mesa Air Group

 

US/UA/DL/YV

 

156

 

Air Midwest

 

B1900

20

Delta Air Lines

Comair

DL

CRJ

110

Delta Air Lines

Compass

DL

ERJ

37

Delta Air Lines

Mesaba

DL

340/CRJ

109

US Airways

Piedmont

US

DH8

51

 

PSA

US

CRJ

49

SkyWest

 

DL/UA

EMB/CRJ

280

Executive

 

AA

ATR

39

Cape Air

 

CO

Cessna/ATR

55

Champlain Enterprises

CommutAir

CO

DH8

16

It is also interesting to note that a given aircraft, like a footballer or US baseball player, may wear numerous competing jerseys over its lifespan.

Good Business

While contracts surely differ, making a “standard” difficult to define, most of the regionals contract on the basis of set reimbursement per trip. This provides the contracting legacy carrier with predictable costs for contracted operations. It has also meant that the regional carriers and their parent companies, with contracted, guaranteed income, have done fairly well financially, even as their legacy partners struggle.

This disparity has not escaped the notice of their patrons and the rules are beginning to change with the contracting carriers insisting that the regionals assume a greater percentage of the market risk.

Republic Airways Holdings

The corporate webpage introduces the company as follows:

Republic Airways strives to be the premier solutions provider of regional jet capacity to a diverse group of network airlines.  We work closely with our partners to provide low cost high quality regional jet capacity.  Republic Airways aircraft are deployed under our network partners brand to provide service to existing markets, open new markets and schedule convenient and frequent flights for our major airline partners.

This is a fairly straightforward definition of the business plan and operating philosophy until very recently. And, as is shown in chart 3, this has been done very profitably even in a down market.

Chart 3

Republic Airways Financial Performance

 

2008

2007

2006

2005

Total Net Income(millions)

84.58

82.76

79.51

60.65

Basic EPS from Total Operations

2.43

2.05

1.89

1.69

But recent decisions show that Republic is aware of fundamental shifts in the industry and a willingness to foray into new ventures.

In August, 2008 Republic emerged as one of the DIP (debtor in possession) partners proving funding for the bankruptcy reorganization of Frontier Airlines. Later in the year the company saw fit to loan partner US Airways $35 million.  Part of the press release stated, “Our investment in US Airways’ today simply reaffirms our commitment to US Airways and its ability to continue managing through uncertain economic times for our industry.”

And also in 2008 there was further proof that business as usual might be under assault as American successfully amended its service agreement with Chautauqua that,

  • allowed a reduction in the number of aircraft operating
  • reduced by about 3% the reimbursement rates to Chautauqua
  • extended the early termination date by American by 3 years

Small changes, but indicators that the legacy carriers were likely to take a much harder negotiating stance, given the disparity in financial performance between the partners. George Hamlin, president of Virginia-based Hamlin Transportation Consulting observed that  "the regional business is becoming more difficult, and there will be a shakeout."

Branching Out

A far more substantive change in direction came last month, in June 2009, when Republic announced two significant developments.

The first was the announcement that it had agreed to be the equity sponsor of Frontier’s reorganization plan. If approved, Republic would have a 100% equity stake in a stand-alone carrier with a broad domestic network as well as an international presence.

Frontier’s operation consists of the mainline operation operating Airbus 320 variants and its subsidiary Lynx, operating Q400s.

A day later the airline announced its intention to acquire 100% of the equity of Midwest Airlines, based in Milwaukee. The airline currently operates a fleet of Boeing 717s which are to be replaced with E190s across its network.

These are monumental deviations from the company’s stated goal to be a “provider of regional jet capacity to a diverse group of network airlines”.   Republic now will have a portion of its future operations in the always-scary realm of direct airline operations, making it a competitor with, as well as a partner of, other US carriers. Whether or not this new positioning will draw blowback from the majors is yet to be seen.

Especially United, currently dominant in Denver, might have some misgivings that the supplier of some of its contracted capacity is also a powerful hub competitor. If Republic profits, made by contracts with United, are reinvested in Frontier and its competitive edge, there is good reason for some angst at UA.

More News, More Questions

On June 29, Frontier announced a comprehensive codeshare and mileage program agreement. This will allow passengers to be exchanged at the hub cities of Denver and Milwaukee for onward network carriage to destinations previously not included in the two separate networks.

Furthermore, Midwest currently has a broad based codeshare agreement with Delta over Atlanta, Memphis, Minneapolis and Detroit, some of those flights doubtless operated by other Republic Airways subsidiaries. The operational overlap is less complex with Frontier but the international service adds a complexity to the mix.

Some Questions

Will Republic Airways be able to operate its own airlines profitably? Both Midwest and Frontier have had problems maintaining positive results and Frontier has had to resort to bankruptcy, though it has had several months of positive results.

Not everyone believes the experiment will work. On July 6, Avondale Partners cut its price target for Republic Airways Inc from USD19 to USD4 a share because of the announcements involving Frontier and Midwest. "A riskier business model and investor doubts will likely drive Republic shares downward until the likely outcome of recent acquisitions is clearer."

Current industry conditions are the most trying in decades and even Southwest, the perpetual money machine, is encountering difficulties. Furthermore, Republic will inherit a fleet of Airbus aircraft that are incompatible with its currently operated aircraft. Will the expertise gained in its past model make the transition to own-operations easier or more difficult?

Denver presents competition from both United and Southwest, making for a very crowded marketplace. And Southwest recently announced its intent to begin Milwaukee service, with Air Tran expanding and directly challenging with nonstop service between Milwaukee and Denver. Again, a crowded market with lots of fare competition. Unlike the established contract pattern, there will be no guaranteed coverage of trip costs in either hub.

With its new venture, Republic is entering uncharted territory and the outcome will be closely followed. We will be a part of that observant group.

Late addendum. A Federal bankruptcy judge has approved Republic’s intention to acquire Frontier, but allows Frontier to exit the agreement in the case of a higher offer. This process, however, has a strict time schedule in that initial proposals must be received by 03-Aug-2009 and finalised by 10-Aug-2009, with all offers being considered on 11-Aug-2009.


Want more analysis like this? CAPA Membership gives you access to all news and analysis on the site, along with access to many areas of our comprehensive databases and toolsets.
Find out more and take a free trial.