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Monday, April 28, 2008

XJT Rejects SkyWest Buyout Offer

ExpressJet Holdings, Inc. rejected an offer by SkyWest to acquire the company for $3.50 per share in cash but held out the possibility that a higher per-share offer could do the trick. For now, it is investigating all its options. The announcement results from considerations of a Special Committee composed of independent outside members. The current share price for XJT is $3.05, according to its web site.
The Special Committee began a full review of strategic and operational alternatives available to ExpressJet. The strategic review will include, among other options, immediately engaging in discussions with SkyWest and other potentially interested parties to evaluate a merger at a higher price, as well as entering into discussions with Continental Airlines, Inc. regarding a new capacity purchase agreement.
The Special Committee reached the decision to reject the SkyWest proposal after careful consideration, including a thorough review of the proposal with Goldman Sachs & Co., its independent financial advisor, and Abrams & Laster LLP, its independent legal advisor. In making its determination to reject the SkyWest proposal, the Special Committee considered a number of factors, including the belief that the fair value of the company's stock is substantially higher than the current SkyWest proposal. The special committee indicated the $3.50 per share price proposed by SkyWest does not fully and fairly reflect the inherent value of ExpressJet or its prospects, whether as a stand-alone company or part of a larger entity.
“While the Special Committee recognizes that a combination of ExpressJet and SkyWest would likely produce meaningful synergies, SkyWest's current proposal does not deliver the value of these synergies to ExpressJet's stockholders,” said the company in its release. “Therefore, the initial SkyWest offer is inadequate and represents an opportunistic attempt by SkyWest to acquire the company at a price well below the true value that ExpressJet would bring to a combination.”
The committee reaffirmed its confidence in management's ability to successfully execute the company's current strategic plan.
"The ExpressJet Board and management are committed to taking all appropriate and necessary actions to enhance value for ExpressJet stockholders,” said Chair Pat Kelly. “As the Special Committee reviews the strategic alternatives available to the company, we have a solid management team and employees dedicated to providing our customers with exceptional service and conducting business as usual."
In making today's announcement, ExpressJet cautions its stockholders and others considering trading in its securities that there can be no assurance that any definitive offer will be made, any agreement will be executed, or any transaction will be approved or consummated. The company does not intend to disclose developments relating to this review unless and until the Special Committee and its board approves a specific agreement or transaction.

SkyWest Active in Regional Acquisitions
While SkyWest remains skeptical of consolidation benefits at mainline carriers, its entire history has been one of aggressive acquisitions as a means to grow. Indeed, it has always made a success out of acquiring other regional airlines, having built itself up with the acquisition of Sun Aire in the 1984 and with its latest acquisition in 2005 of fellow Delta Connection Atlantic Southeast Airlines. The acquisition of ExpressJet would add another code-share partner – Continental – to its current stable of United and Delta, something SkyWest has consistently said it has wanted and, given the volatility of the industry in which increased diversity is critical, it needs. XJT also flies in a pro-rate operation for Delta out of Los Angeles.
But it also brings in more 50-seaters, something the industry will move away from especially with the price of oil. SkyWest, meanwhile, is acquiring larger regional jets and a scope clause that caps out at 50-seat aircraft. It also means the acquisition of ExpressJet’s troubled branded operation. Launched a year ago, when demand was much stronger and oil much lower, the point-to-point branded service has struggled and management said during is rationalizing the system.
ExpressJet is currently in negotiations with Continental to lower the price of its capacity purchase agreement but the regional’s executives think that Continental should pay a premium for having a golden share in its regional partner, which resulted from the spin off of Express Jet a few years ago. Indeed, Continental pointed to its contract negotiation in its first quarter press release saying its planned reductions in regional capacity, slated for the fall, is fluid given the XJT negotiations and the fact that Chautauqua’s contract is set to expire. It wasn’t long ago that Continental terminated 25 percent of XJT’s contract. That prompted the development of XJT’s point-to-point operation as it tried to make use of the 69 aircraft once used in the terminated portion of the Continental contract. In addition to the branded, Continental and Delta operations, XJT has about 10 aircraft in corporate shuttle service.
XJT serves over 150 destinations as a Continental Express in the United States, Canada, Mexico and the Caribbean. While its current contract is scheduled to terminate on December 31, 2010, Continental can reduce flying after December 28, 2009.
While such airlines as SkyWest and Republic have strong long-term contracts with their partners, it is those contracts with early termination, such as ExpressJet’s with Continental that puts companies at risk with mainline consolidation. Those contracts take on a new meaning with bankruptcy, however, as Republic learned only too well last week when its 12-year contract with Frontier was terminated as part of its bankruptcy reorganization. See related story, this issue.
“Consolidation is good for regionals,” said SkyWest Chair Jerry Atkin. “However, it also creates risks. Whoever has a contract up this year or next may have a problem because the major network carriers are reducing network capacity as well as regional capacity. It also has to do with who you are partnering with. If it happens to be in a hub that is being rationalized, however, it doesn’t matter how good the contract, there is going to be a challenge. The impact of consolidation is so situation oriented. Who is consolidating? What kind of a fleet do they have? What shape is the contract in and what is the relationship between partners? Is the partner panicking or is it one that will just play things out? All those factors are what makes the difference.”

Some Skeptical of Mainline Consolidation
“Consolidation is only one of several devices that some people think is a way to deal with rising costs,” said SkyWest Chair Jerry Atkin in a recent interview with Regional Aviation News before the XJT announcement. “Fuel prices have a reached a point that the ability to pass them along is gone. It was amazing that up until about three or four months ago they could keep passing those increased costs along. Consolidation may hold some short-term benefits but I’m not sure they are worth what you have to go through.” While that may hold for the majors, SkyWest has always been successful at growing – either through acquisition or on its own – and has managed to merge disparate companies into the single largest independently owned regional in the world.
Still, now that Delta and Northwest have announced their deal, others are sure to follow including the oft-mentioned United/Continental combination. Despite the benefits of consolidation, investors remain unenthusiastic continuing to stay away from airline stocks battered by fuel prices that have now reached $118 per barrel.
In response to a question as to what lessons regionals could take from the America West/US Airways merger, Atkin questioned whether they had actually merged given the failure to merge the pilot rosters. Only last week, US Airways pilots formed its own pilots union, rejecting the long representation it has had with the Air Line Pilots Association. Even so, one of the America West/US Airways lessons is the de-hubbing of Pittsburgh in network rationalization.
In the Delta/Northwest case at risk hubs include Memphis which could hit Pinnacle very hard and Salt Lake, which one of SkyWest’s largest hub operations, Cincinnati, Detroit and even New York City. Memphis and Salt Lake could be scaled back in favor of Northwest’s Detroit and Minneapolis hubs. Indeed, Pinnacle and Comair, which serves Cincinnati, are seen at most risk in the merger, at a time when Pinnacle is just now growing its Continental Connection operation with newly acquired Colgan Airways. Pinnacle also has some Delta Connection routes. However, that is unlikely to balance what may be coming down the pike for it at MEM.
The merging carriers are, for now, insisting there are no plans to cut back on hubs, which may help the proposed merger pass federal muster. The New Delta will likely focus on Atlanta, Salt Lake, Detroit, Minneapolis and JFK, according to pundits. However, opportunities could emerge for low-cost carriers which have gone into former mainline hubs as happened with PIT, Nashville, St. Louis and Raleigh, the latter three impacted with American rationalized its route system in the post 9/11 period.
Press reports indicated that Memphis origin and destination passengers are far lower than Nashville, which may derail its chances for low-cost carrier service. Local press indicated that Memphis was largely a regional jet operation for Northwest and had some of the highest fares in the region. However, Memphis Commercial Appeal Reporter Jane Roberts reported that NW CEO Doug Steenland assured Memphis leaders that the hub was central to the merged carrier, immediately upon the announcement of the merger. Delta CEO Richard Anderson followed suit shortly thereafter.
Roberts quoted Larry Cox, president and chief executive of the Memphis-Shelby Airport authority as telling members that Memphis increases in importance with every increase in fuel prices. In her report, he cited the average six-minute taxi time from gate to takeoff, compared to an average of 26 minutes in Atlanta. He also cited lower landing fees at Memphis, where there are plans to decrease them again next year. U.S. News & World Report rated it No. 2 behind San Jose International as the least stressful major airport in America in its annual Airport Misery Index in February, according to Roberts, who also pointed out that it is the nation’s smallest hub.
Others cited the close relationship Anderson, who, as a Northwest exec, built strong relationships at MEM where he pushed for more international connections and restoration of service after 9/11.

Capacity Reductions Required
“Consolidation is only an attempt to deal better with the price barrel crude,” said Atkin. “Whether it comes in form of consolidation or not, in either case you have capacity reduction requirements. The theory is if carriers are bigger, they can manage a broader base of markets and revenue and monopolize them better and charge more for it. But that’s only good for the short term. It doesn’t really last.”
The real concern, he said, is fuel costs and, while regionals are doing all they can to minimize fuel usage, it will remain a difficult problem. “Fuel is the driving force,” he said. “While airlines could point to forward bookings, they are not a real indicator of anything. With fuel this high, it is going to be a difficult year for everyone. Although we regionals have contracts that seemingly buffer us, we won’t escape because capacity is being reduced.”
For its part, SkyWest is doing everything possible to manage fuel burn and has been doing so for more than a year. It is changing climb and descent profiles to minimize fuel burn and maximize efficiency. In addition, it is attacking ground operations as well. “This challenge, for me, goes beyond squeezing costs out on the edge,” he said. “Fuel is 40-45 percent of the total cost and that is huge. Nothing’s going to make up that difference so it is a lot more complicated than lowering costs.
“We’ve reached the point in the cost of the airline ticket where there are a lot of people who are not going to continue to pay for it,” he continued. “And the airlines can’t afford not to charge what it costs to fly. So you don’t carry those people or charge less than what it costs. So I think what you are going to see is shrinking capacity by “x” amount because of the traffic that just isn’t going to pay for the next fare increase.”
Aktin pointed out that only those who provide the best service at the most cost-competitive price to the mainline partners will survive. “Those factors – taking care of your customers and your employees better than anyone else does, financial strength and being more cost competitive than anyone else – are more important than ever,” he said. “In the past, difficult times created some opportunities for SkyWest but it is not clear what will happen in today’s environment. I’ll bet all the regionals in business today won’t be here five years from now. Anyone who doesn’t have a top operation will be at risk. When things get tough, only the very best are kept around. This isn’t business as usual. We are well prepared to deal with that. There will be some bumps, but I also think we’ll have some business out of it.”
Atkin noted that every airline – regional or mainline carrier – has routes to shed. “Every network carrier has some basket of unprofitable routes right now and they’ve got to do something about them.” he said. “But if you take the worst markets served by 737s, they work really well on a 76-seat airplane. We can carry the traffic that is able to pay the higher costs and you don’t have to carry the traffic that can’t, so it works out. The same thing happens at regionals, we have some unprofitable routes. This environment provides a challenge on the bottom end and opportunity on the upper end.”
He also predicted there might be some regionals who just throw in the towel because of the increasing difficulty of operations and rising costs. However, he did not say who, although even informal conversations between regional airline reporters have indicated one might be Air Wisconsin and another Trans States. The most at risk, however, is Comair, which Delta slashed during bankruptcy and which Atkin categorically stated SkyWest is not in the market for Comair. “You have to wonder if a company would want to reinvest whatever they are making in the next [partnership] contract,” he said, “because the competition is stepping up. With our [critical mass] we could purchase a lot cheaper than they and how do you compete with that.”
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