Regional Airlines Mimic Major Counterparts

by: Davide Pavone
Major air carriers have obtained an interesting benefit through recent consolidation: greater bargaining power in the upcoming renegotiation of regional airline capacity purchase agreements. The greater bargaining influence is due to:
  1. an excessive supply of capacity in regional markets (brought about by consolidation)
  2. reduced counterparty risk. Delta (NYSE:DAL) and the post-merger United (UAUA) will play one regional airline off against another, and seek to obtain lower rates. However, recent developments in the regional sector suggest that regional air carriers are positioning themselves for the forthcoming round of negotiations.
Pinnacle Airlines Acquires Mesaba Airlines
Due to the somewhat high interest rate on the note (12.5%), analysts have questioned the profitably of Pinnacle’s (PNCL) acquisition of Mesaba Airlines, a $62 million transaction. Management has claimed that the acquisition enables Pinnacle to achieve a more efficient cost structure, and may lead to greater labor productivity. Delta’s planned discontinuation of turboprop operations also presents Pinnacle with the opportunity to replace its fleet of 30-seat turboprops with relatively newer aircraft. Ultimately, the turboprop operations of Colgan Air and Mesaba Airlines will be consolidated, and should be positioned nicely to compete with SkyWest (NASDAQ:SKYW) in the small turboprop sector.
ExpressJet Airlines to Merge with Atlantic Southeast Airlines
The current offer of $6.75 (in cash) per share of ExpressJet Holdings (XJET) is more than double the amount SkyWest bid in April 2008. A renegotiation of the Continental Airlines (NYSE:CAL) capacity purchase agreement (CPA), which will take effect once the merger is complete, explains the higher bid. The new CPA is scheduled to expire in 2020, and places SkyWest in pole position to benefit from the renewal and possible expansion of the Continental Express fleet. Continental also benefits from the new agreement as the major airline may take advantage of SkyWest’s balance sheet to acquire regional aircraft, and utilize the regional aircraft owned by SkyWest. Moreover, the new CPA puts an end to the uncertainty surrounding ExpressJet operations at Hopkins International Airport.
Due to the merger, it was suggested that service at Hopkins International Airport (Cleveland), a hub for Continental and ExpressJet, would be reduced drastically. Given that the new United will have hubs at O’Hare International Airport (Chicago) and Dulles International Airport (Washington), it was argued that major operations at Hopkins Airport would be redundant. Passengers who currently use Hopkins Airport to connect with another flight would be directed through either O’Hare Airport or Dulles Airport. A scaledown of operations at Hopkins Airport was permitted by the Continental CPA as it only required ExpressJet to operate a minimum of 190 aircraft on behalf of Continental, 16 aircraft less than the current 206 in operation. Under the new CPA, a minimum of 206 aircraft will be operated on behalf of Continental, a number which suggests that regional operations at Hopkins Airport will not be cut significantly.
Consolidation amongst major airlines has spurred regional operators to merge. Three competitors have been eliminated from the sector to date (in addition to the abovementioned acquisitions, privately-owned Trans States Holdings has purchased Compass Airlines from Delta), and the sales of American Eagle and Comair, as well as the bankruptcy proceedings of Mesa Air Group, are wild cards. Lastly, consolidation should lessen major airline bargaining power in the upcoming renegotiation of capacity purchase agreements.

Disclosure: No positions