On June 22, Reuters reported that Republic Airways Holdings Inc. (RAH) will sponsor Frontier Airlines’ exit from bankruptcy, noting that the “US regional carrier” would pay $108 million for 100 percent of the equity in the reorganized entity. The next day, Republic announced that it will buy the remains of Midwest Airlines for a mere $31 million (only $6 million in cash), from TPG, the private equity group that has had some success in the US airline industry. While the story got some play in the mainstream press, the possibilities are much bigger than many may realize.
Think About It
Prior to these announcements (and keeping in mind that the Frontier deal is subject to Bankruptcy Court approval), Republic Airways Holdings was soley in business as a provider of “regional airline” capacity. The holding company offers potential purchasers three brands: Chautauqua Airlines, Shuttle America, and Republic Airlines. Under this model, Republic Airways Holdings operates under the flags of its contractual partners, including United Express; US Airways Express; Delta Connection; AmericanConnection; and Continental Express. Therefore it has its fingers into each of the five legacy carrier networks
RAH’s CEO, Bryan Bedford has been in this industry a long time. And he is smart, really smart. Bedford makes this move in an environment in which it is increasingly clear that the legacy carriers do not – and cannot – now operate under a cost structure that will support the number of airlines trying to survive in the hypercompetitive domestic US airline business.
Through May of 2009, airlines have cut capacity another 11 percent. At the same time, passenger revenue is down 21 percent versus the first five months of 2008. When compared to the heyday of 2000, mainline capacity is down 28 percent in the domestic market and passenger revenue is down 33 percent. Despite all of the work done by the legacy carriers to reduce costs – whether through the hammer of the bankruptcy court or not – these revenue trends illustrate an industry all but unsustainable in its current form. And while much has been made of the shift of capacity from domestic to international markets, those revenue trends are even worse in recent months.
Back to Republic
So what‘s behind Republic Airway’s maneuver? Consider this. Chautauqua is a carrier with relatively senior workforce and a fleet that offers little in terms of improvement in technology or scale. Shuttle America is much the same. And parts of Republic Airline’s fortunes are tied to United and US Airways where it operates the latest and greatest 70-seat technology. Happily for Republic, no other carrier is better positioned to capture this flying, in part because it owns its fleet rather than leases it from its mainline partner.
RAH’s structure allows it the necessary flexibility to provide a range of services for a range of clients. It has the flexibility to move from one segment of the business to another. The holding company is designed to work around pilot scope agreements. Nobody does it better. As a result, Republic and Bedford have built a business that provides them with a capital base that allows them to “pay to play.”
Indiana Hold 'em
Bedford “played the river” and now, in this observer’s view, has won enough chips to move to the final table. Providing debtor-in-possession financing is among the safest bets in restructuring. It results in little to no loss of capital in return for increased business. The result is a widely diversified portfolio of flying at increasing revenues as aircraft have gotten larger. Based on the cash flows, Republic has a fleet of aircraft well suited for tomorrow’s US domestic market. For Republic, the next move is building fleets in the 90-120 seat range and that will only augment its cost advantage.
The Frontier Card
Now Frontier provides Republic with something it previously lacked: a technology infrastructure that gives it long-term viability in the market. A technology infrastructure not tied to a legacy system. Today’s “regional carriers” are merely a wet lease of capacity to fly to small markets where mainline aircraft and crews cannot operate economically. They don’t sell tickets. Their purchased capacity merely moves people onto a mainline aircraft at a hub. With Frontier, Republic could change the game.
When it comes to changing the way consumers buy airline tickets, few see Air Canada as the bellwether - they were. But Frontier’s CEO, Sean Menke, came from Air Canada and brought with him the concept and a blueprint of giving consumers a choice of the services and amenities they want at a price they were willing to pay. There, he was recently joined by Air Canada’s Daniel Shurz, a marketing/strategy visionary wunderkind who has further strengthened the Frontier management team.
Frontier may well be the next new thing in the market. It’s not the Independence Air model or just another regional carrier. It is tomorrow’s solution for outdated domestic capacity. Bedford could now buy an Airbus fleet for a song. Bedford could now buy Milwaukee at a bargain. Who cares about Milwaukee? Only Southwest and AirTran and each and every legacy carrier that depends on Milwaukee traffic to feed operations at their hubs.
Imagine This Scenario. . .
- Republic continues to collect revenue per departure for the feed it provides to each of its five current clients.
- Republic maintains a financial interest in cities with three carriers trying to maintain or obtain market dominance. There is little evidence to suggest that many cities can support three aggressive carriers vying for market share. It’s been tried at DEN and it sure as hell cannot work at MKE.
- Come Fall, as mainline carriers realize that previously announced capacity cuts are not sufficient, they turn to Republic and attempt to renegotiate their contracts. Republic says “Hell No” and instead makes a move to turn to develop its holding company portfolio into an airline that will compete for the very same traffic.
- Maybe it then becomes apparent to one of those competing airlines that flying to DEN– largely reliant on feed traffic –no longer makes sense and it negotiates with Republic to replace its capacity there? Certainly, labor issues abound, but economic realities could prove persuasive.
All of this comes at a time of seachange for the big players in the US market. Ultimately, there is little left for the legacy carriers to restructure. There is no way to restructure zero demand. There is no way to restructure free-falling fares. There is no way to restructure rising fuel costs. And under current labor contracts, there is no way to restructure labor costs other than to get rid of minimum employment requirements.
That given, and with liquidations possible if conditions don't begin to quickly improve, Republic is well positioned to take advantage of vacuums in the domestic market. And we all know that nature abhors vacuums.
We’re entering a new era in the US airline industry. Change likely won’t depend on the kind of calamity or crisis that triggers the “force majeure” clause that allows airlines to suspend or break contracts. Instead, new market economics may force a restructuring of the industry in which the victors are those, like Republic, which simply have a better business model - a flexible and agile model. The top domestic airlines of tomorrow might be Southwest, jetBlue, Republic and maybe two of the five current legacy carriers.
Hubs will remain in the largest metro areas because that is where the population is gravitating. Thus, the focus of air service providers is no different today than it was in the early 1990’s when we lost Eastern and Pan Am. And once again, the industry will discover that presence in all the big markets doesn’t give them pricing power anywhere. Republic’s move demonstrates that the major carrier’s reliance on feed markets to cross subsidize this fact could be over. Air travelers want low fares and, time and again are showing they’ll drive to whatever airport – and airline -- offers them.
In the very near future, it might be a very different set of carriers that dominates the US domestic landscape.