The parent of Air Canada Jazz plans to spin off the Canadian regional carrier this quarter in a deal that may value the airline in excess of $826.3 million.

However, Montreal-based ACE Aviation Holdings [ACE] will not be setting Halifax-based Jazz free as has been the practice in the United States. Instead, the spin-off will be seen as an investment vehicle, not as an operational move.

In its announcement, ACE Aviation revealed few specifics about the proposed initial public offering (IPO). Instead, the company said it would issue a prospectus later this quarter, the company's third quarter.

When Air Canada restructured its operations last year in Canadian bankruptcy court, it set up an umbrella holding company, ACE Aviation, that either controls its units directly or controls them through limited partnerships. The company exited bankruptcy last September. Air Canada Jazz was one of the partnerships that was created. Another was Aeroplan, the company's frequent flyer program. In the spin-off, ACE will be selling a minority stake in the Jazz limited partnership.

Air Canada Jazz was created in January 2001 when a newly merged carrier, called Air Canada Regional, took to the skies. A wholly owned subsidiary of Air Canada, this company combined four regional airline brands - AirBC, Air Nova, Air Ontario, and Canadian Regional. In 2002, the carrier was renamed Air Canada Jazz.

The spin-off is "another step in our ongoing strategy of maximizing the value of our business units to the benefit of our shareholders," said ACE Aviation CEO Robert Milton.

Jazz is likely to be spun-off in the same way the Aeroplan was shed in June (RAN, June 27). In the Aeroplan IPO, ACE Aviation sold just 14.4 percent of the shares to the public and retained 85.6 percent of the interest. About 25 million shares were sold for $200 million. The transaction valued the Aeroplan limited partnership at $1.6 million. Aeroplan held onto $81 million while $101 million was forwarded to ACE Aviation.

"Based on that good story, we would envisage doing something similar," Milton told stock analysts during a recent company earnings conference call.

"I think it is a move by ACE Aviation to realize some value from some of the assets it has," said Cameron Doeksen, an analyst with Dloughy Merchant in Montreal. "I have a feeling they will only sell a small minority position in Jazz, and perhaps sell more off later."

"It is not an operational thing, but instead they are trying to realize some value for their shareholders. What they are doing here is a little different than in the U.S.," he said.

Instead of being structured as a stock company, Jazz will be structured as an income trust just as Aeroplan is.

An income trust is a corporate structure that is available in Canada, but not in the United States. The only similar corporate vehicle in the U.S. is the real estate investment trust, Doeksen said. "It is a corporate structure that is designed to be tax effective. The trust will pay significant dividends in monthly distributions. The shareholders will receive an income stream from the excess cash that Jazz produces."

A number of Canadian companies are converting to the income trust structure, particularly if they have a steady income stream and do not have "huge cash" requirements for growth.

Investors buy income trust shares for the dividend income and not necessarily for the appreciation in share value. The market values the shares based on the cash flow yield from the investment, Doeksen said. The shares are traded based on expectations that the size of the distribution will grow in the future.

Faced with multimillion-dollar tabs for new aircraft, an income trust may appear to be the wrong structure for an airline. However, Doeksen said the spin-off could be structured so that ACE Aviation or Air Canada would buy any future aircraft for Jazz and then lease the planes to the regional unit. The regional jets now on order, he said, are coming with an operating lease so the carrier does not face a huge capital outlay. "There are methods for them to grow and still pay out hefty distributions."

Jazz officials were not available for comment.

The last regional airline spin-off was Pinnacle Airlines [PNCL] in November 2003 (CRAN, Nov. 22, 2003). Once 100 percent owned by Northwest Airlines [NWAC], Northwest and its pension funds sold the Memphis-based carrier for about $330 million. Northwest continues to own 11.4 percent of the company.

In 2002, Continental Airlines [CAL] sold about 40 percent of ExpressJet [XJT] in a deal that netted Continental about $137 million (CRAN, April 22, 2002). Continental has gradually shed the bulk of the stock, but it still owns 19.7 percent of the company.

In both the Pinnacle and ExpressJet deals, the former parents have an element of final control over the sibling. Pinnacle cannot fly for another carrier without Northwest's blessing and the same holds true for ExpressJet. Consequently, neither carrier owns its own fleet and both have been limited to flying small RJs. In Pinnacle's case, it is limited to the 44-seat Bombardier [BBD] CRJ 200 and ExpressJet is limited to the 50-seat Embraer [ERJ] 145.

As Air Canada and Jazz restructure their fleets, Jazz has ordered 15 CRJ 705s, a CRJ 900 configured to seat 75 in a two-class cabin. Four of the planes, which include in-seat audio and video, have been delivered. As Air Canada takes possession of its 15 new Embraer 175s, with 73 seats in two cabins, the mainline carrier will begin to transfer its fleet of CRJ 200s to Jazz. Air Canada has also ordered 45 Embraer 190s, configured to seat 93 passengers.

Jazz's fleet also includes 42 Dash 8 100s, seating 37 passengers, and 26 50-passenger Q 300s.

By Oct. 30, Jazz will convert the following routes from Dash-8 to CRJ 200 service: Vancouver-Prince George, Vancouver-Fort St. John, Calgary-Saskatoon, Calgary-Regina, Calgary- Fort McMurray, Edmonton-Saskatoon, Edmonton-Regina, Winnipeg-Saskatoon, Winnipeg-Regina, Winnipeg-Thunder Bay, Toronto-Baltimore, Toronto-Detroit, Ottawa-Boston, Montreal- Charlottetown, Halifax-Boston and Halifax-Goose Bay.

The CRJ 705 is being deployed to: Calgary-Houston, Toronto-Houston, Toronto-Dallas, Toronto-Newark, Toronto-Atlanta, Toronto-Boston and Toronto-Chicago.

>>Contact: Cameron Doeksen, Dloughy Merchant, (514) 845-8111.<<