Putting the Pieces Together

Airline Focus Channel

Putting the Pieces Together

Republic has moved beyond contract flying to become a buyer of troubled airlines.

By Sandra Arnoult
Indianapolis
Air Transport World, November 2009, p.49

For more than a decade, Republic Airways Holdings has proven its mettle as a consistently profitable, highly reliable provider of outsourced lift to the US major airlines through its three regional subsidiaries: Republic Airlines, Chautauqua Airlines and Shuttle America. The carriers operate in codeshare agreements with US Airways, Delta Air Lines, Continental Airlines, American Airlines and United Airlines with a fleet of 230 Bombardier and Embraer regional jets.

But during the past year Republic has stepped beyond its core competency by acquiring three standalone carriers in various stages of financial distress. Over the next few months, its challenge will be to capitalize on the best qualities of its newly acquired assetsMidwest Airlines, Frontier Airlines and Hawaiian carrier Mokulele Airlineswhile not neglecting the fee-per-departure regional flying upon which its past success was built. In the mind of CEO Bryan Bedford, who oversees this new aeronautical empire, it is a task that is eminently doable.

The decision to branch out was based in large measure on Bedford's conviction that the North American regional market had matured and would offer limited opportunities for new partners or growth going forward. Perhaps the epiphany occurred when Frontier filed for Chapter 11 bankruptcy protection 19 months ago and cancelled the contract under which Republic operated 11 E-170s on its behalf, leaving Republic with the unwanted aircraft and a large unsecured IOU.

"It was a sobering experience for us to pull aircraft out of the partnership operation," Bedford recalls. "At some point, the [regional business] model is just going to start to become a melting ice cube." For that reason he began to take a serious look at other options, including branded flying. But he was certain he would not go down the rocky path trod by ExpressJet, which ended its branded flying experience in September 2008 not long after it was launched, and the overly ambitious Atlantic Coast Airlines, a regional that tried and failed to transform itself into a low-fare airline. Renamed Independence Air, it burned through millions of dollars before shutting down in January 2006.

"We are not starting from scratch," he says, referring to Frontier and Midwest. "We are buying companies that have been in business for 15 and 25 years. They have multiple members in their frequent-flyer programs and deep loyalty in their core markets. We aren't building anything. Hopefully, we can make it better and more economical. It's a comfort to have a place to put aircraft."

Republic's initial involvement with the three carriers it subsequently would acquire began with contracts to provide lift and cash investments to shore up the airlines and protect its contracts. But as the three fell deeper into crisis, it made the decision to double down and acquire them. "Bryan sees a bigger picture and I applaud him for pursuing it," says aviation analyst Doug Abbey, who has followed the regional airline industry closely for more than two decades. "The bigger picture is the need to diversify his revenue stream and his operations stream in general. He was an opportunist in a downturn environment. In principle and in theory, I like it."

Frontier Rescue

Frontier has been Denver's hometown airline since 1994. It billed itself as an LCC but was never mistaken for a no-frills carrier. Its fleet includes 51 Airbus narrowbodies featuring seats with 33-in. pitch and seatback IFE with DirecTV and pay-per-view movies. Despite a distinct market identity, however, it never has been able to achieve sustained profitability in a market in which United is the proverbial 800-lb. gorilla. In 2008, UA had a 36.9% market share at DEN, Frontier had 22.6% and Southwest Airlines, which returned to the market in 2007, had 9.3%, according to statistics from the airport.

Hard hit by the dramatic escalation in fuel prices last year and lacking a sufficient cash cushion, Frontier filed for Chapter 11 bankruptcy reorganization in April 2008 and quickly cancelled its air service agreement with Republic. In March 2009, Republic committed $40 million in post-petition debtor-in-possession financing. At the time, Bedford saw the investment as a win-win proposition.

"First and foremost, what we saw there was the potential for this business to successfully restructure. It was a pure financial exercise at that point," he recalls. "We could do nothing, in which case our ability to have a satisfactory recovery on our claim is compromised, or we could get engaged and make a DIP loan to Frontier like any other investor might make. That turned out to be a very positive investment for us. But it also gave us the option to go to the next level if we thought there was a business there that we wanted to buy."

In July, a US Bankruptcy Court judge approved Republic's proposal to purchase Frontier for $108.8 million. A counteroffer for $170 million from Southwest threatened to unwind the deal, but SWA had made its bid contingent upon the two airlines' pilot groups reaching agreement on integrating seniority lists and work rules. When they couldn't, Republic prevailed. On Sept. 10, the court approved Frontier's plan of reorganization, clearing the final hurdle for the acquisition. The deal was finalized on Oct. 1. As part of the purchase agreement, Republic agreed to waive its $150 million general unsecured claim against Frontier.

"We always saw Frontier as an opportunity," Bedford says. "We could win by buying a great business at a very good price. Or someone was going to write us a big check. There was simply no way to lose . . . Now that we've got it, we feel pretty good about what we have." He is not certain if Southwest will step up the competition at DEN in reaction to the takeover, but he says, "Frontier Airlines has no place to go and we're not leaving Denver. There is nothing that could cause Frontier to capitulate."

"This is an extremely proud day for everyone in our company," said then Frontier President and CEO Sean Menke when Republic's winning bid was announced. "Upon consummation of our plan of reorganization with Republic, we will be a successfully restructured airline, well positioned to be a competitive, successful, sustainable airline for years to come."

Bedford sees Menke, who joined Frontier from Air Canada in September 2007, as a key player in the newly constituted airline conglomerate, saying he will rely on the Frontier CEO's acumen with branding and marketing to make the merger succeed. Interestingly, only a week after Republic completed its takeover of Frontier Menke relinquished his role as CEO and took on the new position of executive VP and CMO of the parent company. No new CEO of Frontier was named, raising a question as to whether Bedford will be the de facto head of the airline.

Frontier's regional subsidiary, Lynx Aviation, remains a big question mark, Bedford admits. It operates a fleet of 11 Q400s, the only turboprops anywhere on Republic's property. "Lynx is still something we have to figure out," he says. "Clearly it's going to continue to operate as a branded Frontier product for the foreseeable future. We will have to figure out if having a subfleet of 11 aircraft makes sense for us."

Saving The Cookie

In an earlier era, Milwaukee's Midwest Airlines rightly could have been described as a boutique carrier, with a service product that set it apart from all comers. Upscale meals prepared by its in-house catering arm and served on tablecloths with china place settings and free-flowing wine and champagne were standard features on Midwest flights for much of its existence. Following 9/11, that service was scaled back to reflect the new reality of heightened security (no metal knives and forks) as well as drastically reduced revenues and impinging low-cost competition. Still, it managed to hang onto its last vestige of exclusivity, the baked-onboard chocolate chip cookies.

In 2006-07, Midwest fought off a hostile takeover effort by AirTran Airways, which had entered MKE a few years earlier and also operated 717s, the mainstay of the Midwest fleet. In rejecting AirTran, shareholders chose instead to sell the airline to an investment group led by TPG Capital and including Northwest Airlines. But the buyout did nothing to staunch Midwest's rising losses in a market that no longer would support its cost structure.

In September 2008, Republic forged an agreement to operate 12 E-170s for Midwest Connect and offered the parent company a one-year, $15 million loan as part of the deal. Midwest grounded its fleet of 12 aging MD-80s and obtained an agreement to return its 717s to Boeing as part of a restructuring effort. By August 2009, Republic had acquired 100% of the equity of Midwest, paying TPG $6 million in cash and issuing a $25 million five-year note that can be converted to stock at $10 per share.

The reconstituted Midwest fleet will be made up entirely of E-190s and the carrier will operate under the Republic certificate, Bedford says. He has assumed the role of CEO, but he insists that the Midwest brand will be continue to be marketed heavily. And he confirms that the signature chocolate chip cookies still will be featured on Midwest flights. "We can manage the cookie," he says with a smile. "The aircraft configurations are a lot more challenging."

In mid-October, Republic announced it would acquire 10 E-190ARs from US Airways, applying the full balance of its October 2008 $35 million loan to US toward the purchase and assuming the remaining debt on the jets. Four of the 99-seat aircraft are expected to enter service in November and December to replace the Midwest 717s. The remaining six are expected to join other Republic-owned carriers during the first half of 2010. They bring the number of E-190s in the Republic fleet to 145.

Bedford is focusing on the strengths of both Midwest and Frontier. Over the past year, the former has had to retrench, paring back its workforce and ending service from Milwaukee to the West Coast. Frontier now can enter MKE with its Airbus fleet and reestablish those important markets under codeshare, he explains. Also, both carriers enjoy strong brand recognition in their respective markets, established marketing and distribution channels and long histories of quality customer service.

Going Hawaiian

As with Midwest and Frontier, Republic initially became involved with Hawaii's Mokulele Airlines as a vendor. Last fall it agreed to operate four E-170s on behalf of the two-year-old inter-island carrier (which previously had flown nine-seat Cessna Grand Caravans) under a 10-year capacity purchase agreement. It also issued an $8 million convertible line of credit to Mokulele. With Republic's mainline partners downsizing and returning aircraft to their regional partners, Bedford figured it would cost less to operate the aircraft in Hawaii than to remove them from revenue service and park them.

After Mokulele defaulted on the line of credit, Republic took control in March 2009. Bedford admits he never set out to take over the tiny company. The Hawaiian Islands are a hotbed of competition, with main carrier Hawaiian Air squaring off against Island Air, Mesa Air Group subsidiary go! and Mokulele.

But in mid-October, Republic struck a deal for a joint venture with MAG under which go! and Mokulele will operate inter-island service under both names. Under terms of the agreement, Mesa will own 75% of the JV's units and Mokulele shareholders will own 25%. The JV will be the second-largest inter-island air transport operation behind Hawaiian Airlines, which still controls around 80% of the Hawaiian market.

For now, Bedford is trying to assemble his new family members into a workable entity that shares synergies of size, operation, administration and fleet diversification. A major challenge will be integrating the workforces, which are represented by various unions. He also cautions that the next few quarters likely will see a drop in Republic's earnings. "You will see our earnings diminished as we go through all of the integration issues," he admits. "Our belief is the integration will be completed by March 2010."

While the task is complicated, he breaks it down into three core business units: Operations, administration and branding. Republic is an old hand at the first two and will rely on its new hand, Sean Menke, to manage the third. "We will have the best resources on the brand side," he allows.

"I think Bryan has a vision," Abbey observes. "It's a credible, logical and well-thought-out game plan." For Bedford, it's game on: "It's all about managing risk. It's a lot better strategy than sitting on our hands."

ATW

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