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Questions surround American Eagle divestiture

Eagle pilots want to improve the air service agreement (ASA) between American Eagle and American before the divestiture of the regional operation is completed and have proposed a new plan to Eagle management which has yet to respond to the 18-Sep-2011 submission. Essentially, pilots want more time for Eagle to secure non-American Airlines business, according to a recent pilot briefing, indicating American said it would extend the agreements beyond the initial nine years if Eagle could guarantee attractive rates that would ensure its costs would not rise.

Unlike American, Eagle has a history of good labour relations which is expected to stand it in good stead as it becomes independent. Pilots, represented by the Air Line Pilots Association, have been very active in spin-off plans keeping its members informed.

Recently, it issued an update saying it has offered a counterproposal to the ASA but Eagle management has yet to respond. This could put off the divestiture date since there is much to be done if management agrees to the pilot proposal. In addition to hammering out a new deal and final contract language, it must be presented to rank and file and put to a vote making it a very lengthy procedure.

The divestiture guaranteed Eagle pilots spots on the American seniority list. Even so, pilots consider the air service agreement between American and Eagle to be “substandard.” Pilots noted the removal of Eagle’s ATRs as well as 40 jets per month beginning in Jan-2014. They are worried that the rapid deceleration of Eagle feed cannot be replaced in time to secure other feed contracts and ensure pilots are not laid off.

For Eagle, the divestiture comes at an opportune time given the many capacity purchase agreements set to expire between now and 2014. It will be going into a tough competitive battle for each one.

Pilots are also concerned that once American diversifies its feeder carriers, it will have not interest in keeping Eagle from failing, further jeopardizing jobs. The Master Executive Council noted several carriers have expressed interest in Eagle routes. Thus it wants Eagle management and American to hammer out a better agreement including the ability of Eagle pilots to transfer to any new operations.

Pilots suggested there are three possible outcomes -- Eagle management offering a counter-proposal, accepting the pilots proposal or saying it will not negotiate.

Apparently, the ASA published in the Form 10 submitted to the Security and Exchange Commission provided for a Plan B, an enhanced ASA that guarantees a market rate for American’s feeder costs in exchange for longer contracts. Pilots want to add two separate contract amendment rounds similar to those in the current contract with the first round in 2014 for effect in 2015 and one in 2017, effective 2018. However, the first round calls for a 150-day negotiating window which would open up all parts of the contract.

The transfer of aircraft from Eagle to American was set for completion by 15-Oct and it is unclear the impact the pilot proposals will have on divestiture. It is getting close enough to the target closure date that management will have to make a decision.

The proposal also calls for the creation of a financial bridge allowing Eagle pilots to transition to other mainline carriers, including American, with minimal, if any, loss in pay. Right now the company is offering either a “make-whole” loan or a lesser cash grant. The loan is interest free for the first three years during which the company will pay the interest. After that, the term of the loan will be seven years adjusted quarterly at prime plus 3.5%.

Pilots also want “first-dollar” profit sharing meaning pilots receive a profit percentage on a pre-tax profit equal to, or greater than a certain trigger. They want resolution of outstanding contract provisions on reserve pilot release, hotels and the company’s new Fatigue Risk-Management program.

The most complex provision centres on seniority-based wage scales because it will have more training costs owing to the pilot transfer provisions. This will force Eagle rates higher than competitors. In order to reduce the training burden, pilots proposed a captain’s wage rate be determined solely based on his seniority, regardless of the equipment.

Future prospects based on Eagle position in regional industry

There is no question American Eagle will be a significant player once it completes the spin off from AMR, expected by year’s end. Pilots also reported that several regionals are interested in bidding for Eagle routes once they become available in a few years.

It still retains a great deal of value for American with its profitability and the fact it accounted for 11% of American’s sales in 1H2011. Its USD2.3 billion in 2010 revenue for AMR was up 16%. Its market capitalisation, according to Dahlman Rose Analyst Helane Becker is estimated at USD485 million once it becomes publicly traded.

It will rival venerable SkyWest Airlines in revenues - USD2.7 billion compared to USD2.3 billion for Eagle.

The Eagle divestiture is the latest is such spin offs from mainline carriers. Continental sold its last stake in ExpressJet, since acquired by SkyWest, in 2007. Both Mesaba and Compass were spun out of Delta to Pinnacle and TransStates airlines, respectively. While US Airways continues to own many of its feeder operations, most are independent with the singular exception of Delta-owned Comair, which has suffered from the same lack of interest from other regionals

Eagle acknowledged earlier this year that both American and other mainline carriers balked at the carrier’s desire to expand its portfolio beyond American, making that one of the prime motivations for the divestiture. In addition, American wants to reduce its regional feed costs and its sweet-heart deal to acquire Eagle Aircraft and debt is designed to do just that.

Without the aircraft debt, American Eagle will likely be able to gain financing for the massive task of re-equipping its fleet although it may owe as much as USD293 million in notes to American once the divestiture is completed. Debt for its 263 aircraft is USD2.5 million, more than the aircraft are worth. If the debt is more than the market value, Eagle is responsible giving American notes to cover the difference..

The publicly traded regionals have all been working to upgrade fleets while American has only tweaked the Eagle fleet with first class seating. Currently its fleet contains only 47 CRJ 700s with the rest 50-seats or under.

But, the question remains as to whether the stand-alone carrier will be able to make it on its own despite its profitability. It is thought that if Eagle had any any real value or potential for grabbing business now flown by other regionals it would have been acquired.

SkyWest has long been known to want to increase its portfolio beyond its feeder services with Delta and United. It also has a small operation with Alaska. It has already acquired Continental Express ExpressJet only to end up increasing is United operations. American Eagle would add a that new client that ExpressJet couldn’t.

It is doubtful SkyWest has the capability to absorb Eagle as well given its change in fortunes from Delta that forced it into its first quarterly loss since 1987 earlier this year. Eagle has been on and off the market since 2008 and the St. George-based airline did not bite. SkyWest and United Express Air Wisconsin are Eagle’s major competitors.

Eagle’s first problem is the fact there is still too much capacity in the regional space and mainline consolidation has meant fewer legacies and a need for more innovation. Delta and United/Continental have already consolidated their regionals spinning them off to Pinnacle, TransStates and SkyWest, all of which are in the middle of a restructuring as a result. The industry must absorb these changes before Eagle’s future can be seen with any clarity.

To be sure, Eagle retains American’s business -- for now -- and that has yielded profitability for Eagle operations over the past four years. It is also the third largest regional in the industry with its main business out of the top airports -- Dallas, Chicago, Miami, Los Angeles, Kennedy and LaGuardia.

Ground handling -- which will enjoy at eight-year contract with American after divestiture - covers 100 airports and 13 airlines. Here again, however, it will face stiff competition as others look to ground handling to diversify revenue. Pinnacle, for instance, is also building its ground operations unit, PinnPro Professional Ground Services, now in 40 markets with 18 airline clients. 

It is doubtful the pilot proposal will derail divestiture but it could change the financial dynamics for an independent Eagle. Even so, pilots seem to be looking for more job security and wage guarantees. Its consideration of the coming training bubble prompted by the divestiture, something SkyWest and Pinnacle are also incurring, is a positive sign that it could be working to mitigate higher costs for Eagle. At least it shows that pilots see the impact of their actions to the future competitiveness of Eagle.

Still, Eagle faces the same issues that is causing the restructuring of the regional airline space which include lowering costs and taking on more risk from mainline partners. It also faces re-fleeting, in addition to the uncertainty surrounding the economy.

Indeed, while Eagle’s divestiture comes at an opportune time for it to compete on coming contracts, the uncertainties surround regionals means it will be tested sooner rather than later. That means its American contracts will be more important than ever.