Mesa Air Group: "We Need to Fit Capacity to Demand"

On February 5, The Wall Street Transcript interviewed Jonathan G. Ornstein, Chairman and CEO of Mesa Air Group, Inc (MESA). Key excerpts follow:

TWST: Would you give us a brief historical sketch of the company and a picture of the things you are doing at the present time?

Mr. Ornstein: The company was founded by Larry and Janie Risley in 1982 in Farmington, New Mexico, with a single-engine, six-passenger airplane flying from Albuquerque to Farmington three times a day. Larry was really one of the great airline entrepreneurs and built a little company up in New Mexico. At one point Larry was competing against 13 different competitors within the state; fortunately for Mesa, Larry's success was long lasting and the company grew and prospered. I joined Mesa in 1987 after meeting and interacting with Larry in the lease of an aircraft for a small airline that I was working with in LA. With Larry's operational expertise and the little bit of financial background that I had, we rapidly grew the company, acquiring bankrupt and near-bankrupt airlines. Between 1988 and 1994, we grew the company from revenues of about $10 million annually to $500 million annually. In the process, we acquired Aspen Airways, Air Midwest, WestAir and Crown Airways, all commuter airlines operating under codeshare agreements with various major airlines. Throughout this period, the company continued to progress.

One of the last deals I had worked on at Mesa was the attempted acquisition of Continental Express. Unfortunately at the last minute Mesa's Board decided not to move forward with the transaction. Shortly after the deal fell apart, David Bonderman, Continental's controlling shareholder and Chairman, asked me to join Continental and run Continental Express. I left Mesa in July 1994. It was a difficult decision but I always maintained a good relationship with Larry. And in 1998, after I had left Continental and I worked over in Europe with Richard Branson forming Virgin Express, Larry called me and asked me if I was interested in coming back to work at Mesa. Without a doubt it was the best opportunity in my life and I came back to Mesa in April 1998. I have joked that the easiest decision I have ever made was moving back to Farmington, New Mexico, to rejoin Mesa. Unfortunately, Mesa had fallen on some hard times after the change in regulations by the FAA that resulted in smaller aircraft becoming significantly more expensive to operate. In order for the company to survive, we knew it was imperative that we develop a new business plan - very quickly!

We recognized the great potential offered by regional jets and worked to transform the company from a turboprop operator to a jet operator. Over the last 10 years, we have reduced the number of 19-seat aircraft we operate from 122 to 20 and have increased the number of regional jets from five to 155. This year, we should do about $1.4 billion in revenue and the consensus on the Street calls for $70 million in pretax income. Mesa operates codeshare partnerships with United, USAirways (LCC) and Delta (DALRQ). We also have an independent operation in Hawaii operating as go! and an operation in Albuquerque under Mesa Airlines.

As we execute our plan, we are looking to continue to expand our regional jet operations and have taken a worldwide view. We just signed an agreement with Shenzhen Airlines to operate regional jets in a joint venture in mainland China. We will be the first US carrier to operate within the People's Republic. With a population of 1.2 billion people and GDP growing at over 10%, there is a tremendous opportunity in China for regional jets. There are currently fewer regional jets in all of China than there are in United's Chicago hub operation! We think the potential upside in China as the first carrier in the market is significant. We also continue to look at ways of expanding our business domestically. We are continually working with our partners to grow and expand with our current partners as well as continually looking for opportunities to forge partnerships with new partners.

TWST: You acquired a number of companies that weren't doing too well and you made them work better. What were the keys?

Mr. Ornstein: At the time of those acquisitions, the majority of regional flying was based on what is referred to as a "pro-rate" model. Under this model, the regional carrier had complete control over scheduling, planning and fleet size. As a result, many carriers had over-saturated markets and poorly allocated staffing and aircraft. We developed a formula where we basically looked at carriers and said, One of the big issues historically for the airline industry has been overcapacity. We also were able to closely control costs and there is no doubt that in a commodity industry like the airline business, cost is king. When we evaluated a potential acquisition, we developed a model to adjust capacity to meet demand and at the same time developed savings targets needed to successfully turn around the business. We were very successful in this regard and greatly benefited from the further expansion of our codeshare partners through these transactions. In a way, this is similar to what is happening today at the major airline lever. Through the bankruptcy process, major airlines have reduced capacity while at the same time adjusting their costs to manageable levels.

Fortunately, we never had to use the bankruptcy process in any of our acquisitions nor have we done it here at Mesa. We are very careful about our costs and there are some things you can and can't do. You have to work very closely with your workforce to explain that distinction. But I think long run, we feel that by doing that, we serve not only our company and our shareholders, but our people. For example, Mesa has no one on furlough. We've never furloughed a flight attendant and we've never furloughed a mechanic. I think that those kinds of achievements are almost unheard of in the airline industry, and result from the fact that we run our business from a standpoint that we have to be able to retain profitability and we have to be able to effectively compete for new business opportunities. To achieve that, you have to have industry-leading cost structure, which we do have. The benefit of this exchange for the employees is tremendous job security.

TWST: What would be the two or three best reasons for the long-term investor to look closely at Mesa?

Mr. Ornstein: Right now, I would look at it as a value play. We are trading at a significant multiple discount to the market; we are trading at a discount to the industry. We have a very strong financial position. I think there is some uncertainty out there and that once that gets resolved, it should give people more confidence. The fact that we have now unlocked what could be one of the biggest opportunities in aviation with our China joint venture provides the possibility of significant growth. I think these factors combined make Mesa very interesting over the next few years.