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Monday, November 24, 2003

Atlantic Coast Launches Low-Fare Carrier, 'Independence Air'

Mesa Vows to Continue Its Takeover Bid, Despite ACA's Order for Airbus Jets

DULLES, Va. -- The transformation of Atlantic Coast Airlines (ACA) [Nasdaq: ACAI] from a regional carrier to a low-fare airline has begun, despite the negative views of pundits, financial analysts and Mesa Airlines [Nasdaq: MESA] chief Jonathan Ornstein, who say it will not work.

In a ceremony Nov. 19 at ACA's maintenance hangar at Washington Dulles International Airport that had all the atmosphere and showmanship of a rock concert, ACA kicked off "day one" of its new low-fare airline, Independence Air.

The dimly lit hangar, packed with more than 2,000 raucous and screaming ACA employees, as well as government officials, stockholders and media, featured two large video screens to display the new carrier's budding commercial message, a very loud sound system, and lighting effects that resembled disco balls casting dancing beams around the hangar.

At the climax of the hour-long event, the curtain behind the stage dropped to reveal a regional jet painted in the new light blue and purple on white Independence Air livery. Amid flickering strobe lights, the crowd went wild.

When he took the stage, ACA Chairman and CEO Kerry Skeen joked, "I feel like a rock star," and added, "I'd like to freeze this moment and carry it around with me."

"Today is the first day," he later added. "We're out there gaining traction [in the marketplace] ... We think the right place to be is in the low-fare platform. Those are the [airlines] that are succeeding."

ACA is moving forward with its plans to establish a low-fare carrier based at Dulles, the fifth largest air market in the nation, despite a hostile takeover attempt by Ornstein and Mesa, who are trying to convince ACA's stockholders that the safest, most profitable route is for ACA to remain a United Airlines [OTC: UALAQ] code- share partner under the control of Mesa (CRAN, Nov. 17). ACA intends to implement its new independent low-cost carrier strategy as soon as its existing contract with United has been terminated.

The night before the unveiling ceremony, ACA announced it had entered into agreements to acquire 25 Airbus aircraft in the A320 family, with options for more. The first of these aircraft are due to arrive in September 2004 and will be ready for revenue service as early as November 2004.

ACA, which has been in business 14 years, entered into a binding memorandum of understanding with Airbus for a firm order of 10 new A319 aircraft configured with 132 seats, and five new A320 aircraft configured with 156 seats, including full conversion rights. It has also entered into leasing commitments from operating lessors for 10 additional A319 aircraft. Each aircraft will be equipped in a single-class configuration. The binding deal could make Mesa's takeover bid problematic.

Independence Air plans to operate a fleet of at least 112 jets, including 87 Bombardier [Toronto: BBDb] CRJs along with the 25 Airbus A320/A319 aircraft. The Airbus family will give the carrier transcontinental capability, and the expanded route structure to West Coast cities brought wild cheering when the map was displayed on the video screens during the launch ceremony. Independence Air is planning more than 325 daily departures to 50 destinations by 2006.

People in the Washington region would like to use Dulles more, Skeen said, but don't because of the high-priced fares and inconvenient schedules. "We plan to change that," he said. To fly from Dulles to Ft. Myers, Fla., for example, it costs $472 for a connecting flight. Independence plans a direct flight on the route priced at $130, he said.

The "biggest risk" to the entire venture is establishing the brand, and Skeen said the company would work hard to do that. He also told the employees that the new carrier would employ a "customer first" attitude that would permeate all business operations.

The new carrier's logo features an "i," as in "Independence," within a light blue circle. The marketing campaign is sure to focus on this, as the hangar featured numerous blue circles beamed onto the walls with spotlights containing sayings such as, "i am enthusiastic," "i am genuine" and "i am innovative." The carrier's new Web site is http://www.flyi.com . Its marketing campaign also will feature the catch-phrase "Go Your Own Way."

Tom Moore, ACA's president and chief operating officer, said these "i" statements represent the values of the new company. "Values drive behavior. Behavior drives results," he said.

ACA needs to "see past the legacy carriers. I believe we should be leaders, not followers, today."

The pundits and analysts who are predicting that the new airline will fail are "wrong" because "we're smarter than they are," Moore said.

To rowdy applause, Moore bellowed, "I want to get out from underneath the thumb of United -- right now ... We're going to write our name on the next great American business story."

One of the biggest assets the new carrier has is its Terminal A at Dulles, where ACA controls 36 parking slots. Dulles, which earlier in the week celebrated its 41st year in operation, currently has no low-fare carrier based there. The area has one of the highest per capita incomes in the country, and passengers will enjoy the wide seats and wide aisles of the Airbus family, Skeen said. ACA has also ordered a new type of leather seat for its RJ fleet, at a cost of $6 million, which will offer passengers an inch more of leg room while not reconfiguring the number of rows, he said.

Despite what many analysts say, the RJ is a good product for a low-fare carrier, Skeen said. They can reach 70 percent of the U.S. population from Dulles and they can provide a high frequency of flights to destinations that often go unserved by larger aircraft.

One needs only to look at JetBlue Airways' [Nasdaq: JBLU] order for 100 Embraer [NYSE: ERJ] 190s, and AirTran's [NYSE: AAI] increased the use of the CRJ through its regional partner Air Wisconsin, to see that the RJs work, Skeen said.

To become a low-fare carrier, the company must increase its aircraft utilization, Skeen said. While a major carrier might operate its Airbus fleet for 10 hours each per day, Independence Air plans to operate its fleet for 14 hours per day.

Independence also will be instituting simple and flexible work rules for its employees to take on the extra load.

Skeen contrasted the startup of Independence Air with that of another successful low-fare carrier, JetBlue. JetBlue started with $140 million in capital, while Independence will have $300 million in cash on hand by the end of this year. "We can't wait to get started," Skeen said.

Before the curtain dropped revealing the newly painted Independence Air CRJ in the hangar, ACA spokesman Rick DeLisi took to the podium to deliver a David Letterman-like "Top 10 Rejected Names" for the new airline, as supplied by employees through an online voting poll.

They included names such as "Kerry Air," after CEO Kerry Skeen, "Kitten Air," "Pacific-Midwest Airlines," and "Theodore Air," a stab at United's recently announced low-fare subsidiary. "People would just shorten that to 'Ted,' and that's no name for an airline," DeLisi said to whoops and hollers.

He continued with the list: "Free Bird" (the most requested rock and roll song in history), "Free Air" (rejected because everything would be free), "No B.S. Airlines" (rejected for its political incorrectness), and "Dairy Air," (rejected for the same reason).

And the number one rejected name for ACA's new low-fare airline?


What the Analysts Are Saying

Blaylock & Partners, a Wall Street investment firm, said ACA management visited its office Nov. 13 to offer the company's plan for its future low-cost carrier. ACA focused on the merits of flying as an independent carrier out of Dulles rather than dwelling on the impending takeover offer from Mesa.

ACA management told Blaylock analysts that the idea of starting a low-cost carrier has been in place for several years now, since before the United bankruptcy filing in December 2002.

ACA said that the Dulles market is more than sufficient to support another independent carrier. ACA also told Blaylock that the carrier does not like the future economics of the revenue-guarantee code-sharing contracts with United, and foresees worsening economics with regard to these agreements.

"Even though there may be some merit to ACAI's argument, we still have doubts as to its viability, but, more importantly, we do not believe that the market will give the company the time it needs to make the necessary changes," Ray Neidl, an analyst with Blaylock, wrote in a report on the meeting. "Unless there is political involvement, we believe that some sort of deal will be worked out [between ACA and United on a new code-share agreement] in early 2004."

Mesa stands to benefit from its attempted takeover of ACA either way.

"If [Mesa] acquires ACAI at the current offering price or slightly above, it will obtain an existing partnership with a large fleet of financed RJs. If it is unable to make the acquisition, the company still has an aggressive growth strategy for its core airline, with the main risk being obtaining financing for an aggressive expansion," Neidl wrote.

"If ACAI is able to continue to pursue its plan to become an independent airline, we expect the stock price to fall back into single digits due to the uncertainty of the transformation and its timeliness," Neidl said.

Meantime, Mesa Air Group, the parent of Mesa Airlines, posted a profit during the latest quarter, despite troubles in financing new airplanes and obtaining used aircraft.

The Phoenix-based airline earned $10.7 million, or 27 cents a share, for the fourth quarter ended Sept. 30, compared with a loss of $20.8 million, or 64 cents, in the same quarter a year ago.

Revenue for the latest period jumped to $175.5 million from $132.2 million.

During the fourth quarter, Mesa continued its RJ expansion by adding three CRJ-200 aircraft, four CRJ-700s and two CRJ-900s to its fleet.

Mesa's bid to acquire ACA may have suffered a setback when ACA placed its order for the 25 Airbus planes. Analysts said it may be hard for Mesa to break that deal, should Mesa gain control of ACA.

In a Nov. 13 letter to ACA's board of directors, Ornstein cautioned against placing the Airbus order, because they are "inappropriate aircraft" for a regional carrier.

"We believe that entering into an aircraft purchase commitment or taking other action that would preclude your stockholders from fairly considering the exchange offer/merger proposal we have previously communicated to you would constitute an impermissible "shark repellant" and would be inconsistent with your fiduciary duties under Delaware law [which has jurisdiction in such mergers]," Ornstein wrote. "We believe that by entering into any binding aircraft purchase agreement with penalty clauses or non-refundable deposits the ACA board would be wasting valuable corporate assets and would be acting contrary to the best interests of its stockholders solely for the purpose of entrenching yourselves and management. I am sure you have heard and will continue to hear from your shareholders on this issue."

Skeen wrote back that ACA's board is fully aware of it fiduciary responsibilities to its shareholders and reiterated that ACA wants out of its code-share agreement with United because it would create:

  • greater risk over the life of the contract, particularly with respect to costs that would be required to be borne by ACA but that would be solely within United's control;
  • margins based on operating performance standards that could be reset by United at its discretion; and
  • no assurance that the terms of the non-binding agreement would not be renegotiated by United when and if it finalizes its reorganization plan and emerges from bankruptcy.

Mesa said it still plans to move ahead with its offer and will try to replace ACA's board with a new one that would approve of the takeover.

Mesa wants to continue to operate ACA as a regional carrier under a code-share with United. ACA currently operates as United Express and Delta Connection.

>>Contact: Rick DeLisi, ACA, 703-650-6550; Jonathan Ornstein or Peter Murnane, Mesa, 602-685-4000; Steve Lipin or Tim Payne, the Brunswick Group, 212-333-3810; Ray Neidl, Blaylock & Partners, 212-715-6627.<<


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