At long last, divestiture for American Eagle

This is certainly is not the most auspicious time to be spinning the regional subsidiary off given the volatility of the regional space. However, it is probably better than late 2008 when American first announced its desire to be rid of the regional airline.

The problem is the move comes at a time when the regional industry is contracting not expanding which means one of the main benefits of the spin off - acquiring other capacity-purchase contracts - comes at a time when competition is already fierce and Eagle's costs are known to be much higher that its peers. Indeed, its peers are struggling to lower costs further as legacies pressure them for lower capacity-purchase rates. This is being compounded by the fact that regional costs are on the rise with new regulatory requirements and higher maintenance costs driven by older aircraft.

2010 USD	Horizon*	Republic	Pinnacle**	SkyWest***
Profit	NA	Consolidated (22.4m) down 38.6% CPA NA	(2.9bn) vs 1.6bn	(11m) vs 15m
Op Revenues	176.5m vs 76.1m	Consolidated 659.1m up 8.3% CPA: 236.7m up 0.1%	298.1m vs 208m	865.9m up 37%
Total Expenses	94.6m vs 66.4m	Consolidated 659.7m up 4.9% CPA: NA	291.9m vs 196m	865.7m up 44.9%
ASMs	742m down 6.4%	CPA 2.6bn down 2.2%	2.8bn up 68%	8.6bn up 52.6%
Load Factor	75.6% vs 73.5%	67.8% down 3.6 pts	68.4% down 1.8 pts	74.9% down 2.2 pts
Yield cents	NA	NA	NA	13.10 down 8.4%
PRASM cents	23.25 vs 20.62	NA	NA	RASM 10.1 down 9.8%
CASM cents	CASM ex fuel 12.16 vs 15.69	8.96 up 4.2%	NA	10.30 down 4.6%

Source: Centre for Asia Pacific Aviation

While it is proceeding with the spin-off, CEO Gerard Arpey said the company remains open to a sale but offered no details except the fact that all would be explained in a Form 10 filing with the Securities and Exchange Commission in August.

The move closes its fourth and fifth big initiatives for American's turn around along both the 460-aircraft order of narrowbody aircraft from Boeing and Airbus. Its cornerstone strategy and its joint business agreements across the Atlantic and Pacific were the first three. The divestiture is expected to stem the flow of losses incurred by the parent company from the regional operation. Such a move would lower American's passenger and maintenance costs and free up Eagle to acquire other capacity-purchase business.

"After a great deal of analysis, we have concluded that it is in both carriers' best interest to separate American Eagle from AMR, and thus today we are announcing our intent to move forward with the divestiture of American Eagle," Mr Arpey told employees. "We believe this will enable us, over time, to ensure that we maintain market rates for the feed traffic to AA through Eagle or other regional airlines, while also providing Eagle with an opportunity to compete for new business and grow."

AMR Eagle Holding Corporation will file Form 10 with the Securities and Exchange Commission covering the divestiture and will provide more granularity in to the plan as well as more information about Eagle and its historical consolidated financial statements.

Since American began acquiring regionals in the mid-1980s and formed Eagle as a wholly owned subsidiary of the company, American's financial statements have shown that Eagle expenses have always exceeded revenues.

In 2010, American Eagle/Connection operations yielded a 15.7% increase in revenues to USD2.3 billion. Expenses dropped for the year from USD2.7 billion in 2009 to USD2.5 million in 2010. For the fourth quarter regional revenues rose 17.9% to USD611 million but not enough to overcome regional costs of USD696 million compared with USD675 million a year ago.

Connection, Eagle and Express programmes

2010 USD	Alaska	AMR	Delta	United/CO	US Airways
Profit	167M	(144M)	100K	827M	(85M)
Revenues	176.5M vs 76.1M	577M up 16%	1.4B up 9%	1.4B up 10%	685M up 13.8%
Expenses	9.46M vs 66.4M	721M vs 629M	1.3B up 42%	573 down 1.9%	770M vs 650M
ASMs	759M vs 369M	3.1B up 13.8%	NA	7.8B up 1.1%	3.4B up 6.5%
Load factor	75.6% vs 73.5%	67.7% up 0.5 pts	NA	73.1% down 1.8 pts	69.8% up 0.6 pts
Yield	NA	NA	NA	24.99 up 11.5%	28.08 up 6%
PRASM	23.25 vs 20.62	NA	NA	18.27 up 8.8%	19.60 up 6.9%
CASM x fuel	NA	NA	NA	NA	ex fuel & spec items 15.10 up 3.2%

Source: Centre for Asia Pacific Aviation

Despite this, the spin-off came with no details except to wait for the SEC filing. As with its mega aircraft order, the announcement did little to influence analyst views of American. Legacies are moving away from the regional model given Delta's downsizing of its regional fleet. While American continues to want the feed provided by Eagle, it also wants a more competitive CPA price, thus the reason for the spin-off.

Dahlman Rose Analyst Helane Becker, in her research note on all the news at American yesterday, said she is forecasting Eagle will generate USD2.7 billion in revenue this year. She views SkyWest as its closest competitor in terms of revenues with a forecast of USD3.6 billion in revenues anticipated this year. However, SkyWest's market capitalisation is approximately USD660 million, which is ~18% of total revenue, she said.

"A similar percentage of revenue for American Eagle Airlines would value it at approximately USD485 million," she concluded, adding the question becomes whether American will retain some Eagle debt to make it more attractive. American would not say yesterday when prompted by analyst questions.

"We believe the decision to divest Eagle now is, in part, due to American's decision to acquire narrow-body aircraft and engage in a replacement programme," Ms Becker wrote. "American Airlines and American Eagle Airlines currently operate a joint fleet of approximately 900 aircraft. Today's order and options (and the existing order and options) will take the fleet to more than 1000 aircraft. This is a staggering amount of aircraft in an environment of almost no domestic passenger traffic growth."

Eagle serves 185 cities with 265 aircraft and flies 20.6 million passengers annually. It now employs 12,000 and is the seventh largest airline based on the number of departures at 1600 daily.

Eagle pilots weighed in on the plans, since its grievance over the spin-off has been settled and noting the transfer could not be stopped. American Eagle Master Executive Council said the current contract would require that pilots and their contract be included in the transfer of any aircraft.

Pilots and American settled the grievance guaranteeing employment opportunities for Eagle pilots at the mainline carrier as long as they were on the Eagle seniority list on 11-Oct-2011. It exempts them from a pre-employment interviews or medicals prior to transfer to American's seniority list. Eagle pilots will also be offered a minimum of 35% of any new-hire class. Should such a class be greater than 25 pilots per month, Eagle would be required to release at least 25 pilots per month for the class.

If American Eagle were to lose flying resulting in a furlough, American would be required to increase the percentage of Eagle pilots in new-hire class to a minimum of 50%. American will also try to get the airline acquiring the flying to give preferential treatment to Eagle pilots.