As a bankrupt carrier, Mesaba Aviation gains greater flexibility in negotiating its future relationship with its bankrupt code-share partner, Northwest Airlines [NAWQ].

Mesaba, the primary unit of MAIR Holdings [MAIR], filed for Chapter 11 bankruptcy protection on Oct. 13 as its claims against Northwest continue to mount. Northwest now owes Mesaba more than $30 million, primarily for services provided before Northwest's Sept. 13 bankruptcy filing. MAIR itself did not file for bankruptcy.

After it restructures its operations in bankruptcy, Mesaba would provide Northwest "and any other carriers" a more cost-competitive service, Mesaba president John Spanjers said. In a press conference after the filing, Spanjers said that the service agreement Mesaba struck with Northwest in early September gives it "a little bit more flexibility" to fly for others.

With both Mesaba and Northwest now in bankruptcy, either company can "affirm, reject or renegotiate" their service agreements, said Mesaba spokeswoman Elizabeth Costello. In bankruptcy proceedings, the bankrupt company usually has the upper hand in negotiating with its creditors or service providers in a take-it-or-leave-it approach. The two firms are now on equal footing before the courts.

Neither side has taken any steps to affirm the service agreement that was signed one week prior to Northwest's filing.

Northwest and Mesaba may be legal equals, but Northwest still holds the upper hand - it continues to control all the planes that both Mesaba and Pinnacle Airlines [PNCL] fly.

Faced with the potential of losing 55 percent of its fleet, Mesaba had to act quickly because "it is almost impossible" to adjust its operations and business plan without bankruptcy court protections, Spanjers said. The carrier was in danger of running out of cash by year's end.

Spanjers outlined two initial waves of layoffs affecting 220 workers, and promised to seek salary reductions for all employees and concessions from suppliers.

"Our focus in bankruptcy is to right-size the airline with whatever they [Northwest] will do with the fleet. At the end of the day, Northwest will make fleet decisions. We must quickly respond to re-size our operations.

"Our goal is to readjust our cost structure to match the fleet size and fix the overhead. We want to emerge with a cost structure that is very competitive for Northwest as they emerge from their bankruptcy."

As the first nine Avro RJ85s are removed from the fleet effective Oct. 31, Spanjers said 70 employees, including pilots, mechanics and flight attendants, will be laid off. By Jan. 4, when 10 Saabs are parked, another 150 will be laid off.

In addition to the nine Avros and 10 Saabs, Northwest will not be providing 13 Bombardier [BBD] CRJ 200s that were to be delivered in the coming months. Since last April, Mesaba has spent $7 million to get its pilots and mechanics trained on the 50-seat RJs and its facilities equipped to handle the plane. Northwest had promised at least 15 CRJs to the Mesaba operation. Only two have been delivered and they are to go into service next month.

Mesaba will find out in mid-December if it will lose the right to fly the remaining 26 Avros in its fleet. Northwest has told its bankruptcy court that it will return the Avros to the leaseholders unless a lower rental rate can be obtained.

Spanjers said if the entire Avro fleet is lost, there will be additional layoffs.

While Spanjers said the carrier would seek salary reductions, it does not have a target in terms of net savings or a fixed percentage cut, Costello told Regional Aviation News.

On Oct. 4, Mesaba asked the Mesaba unit of the Air Line Pilots Association (ALPA) to begin talks to seek a voluntary wage reduction, said Tom Wychor, chairman of the Mesaba unit. The union, following ALPA guidelines, was in the process of requesting financial documents when the carrier filed for Chapter 11.

"Clearly this is a revenue problem, not a cost problem," Wychor said. He noted that the pilots are paid rates in the middle of their peers.

The CRJ captain's rate that was created in the January 2004 contract would pay a first-year captain $55 per hour - the same rate as Pinnacle's. In 2004, labor attorneys Ford and Harrison calculated that average first-year CRJ captains earn $53.41 an hour.

As one cost-saving move, Mesaba on Oct. 12 began closing its Cincinnati base station, which handles the overnight maintenance of the Avro fleet. The carrier plans to restructure a number of its supply chain contracts to eliminate costs as the Avros leave its fleet, Spanjers told the court.

Unlike other recent airline bankruptcies, only Mesaba - the carrier - is seeking court protections and not the parent holding company, MAIR. The Mesaba filing does not impact Big Sky Airlines, MAIR's other carrier. MAIR was not included because the problem was at the operational level and could be fixed at that level, said Jon Austin, MAIR's spokesman.

As it files for bankruptcy, Mesaba lists $108.5 million in assets and $87 million in debts. Its largest creditor is Allied Signal Engines, which is owed $3.6 million.

In a filing with the U.S. Securities and Exchange Commission, MAIR said it would commit $35 million to Mesaba in debtor-in-possession financing. It would make $15 million available now and the remaining $20 million would be available "increments" provided Mesaba meets "certain additional conditions," including presenting a five-year business plan by Jan. 31. In addition, the two companies are now represented by two different law firms in the court proceedings.

By not including MAIR in the proceedings, the holding company has been able to protect its stock value and its shareholders. Northwest is the largest single shareholder of MAIR stock with 9.8 million shares, or 39.6 percent of the common shares. Carl Pohlad, 89, the board chairman and a director since 1995, owns 9.9 percent. He also is the owner of the Minnesota Twins. No other individual owns a large stake in the company. CEO Paul Foley owns 1.8 percent of the stock.

Raymond James analyst James Parker upgraded his rating of MAIR stock from "underperform" to "market perform." At midday on Oct. 14, MAIR's stock price was up 15.6 percent to $5.39.

"Mesaba should be able to cut costs in bankruptcy to a level more consistent with its reduced revenue stream," Parker said.

In a worst-case scenario, Mesaba would end up flying only the 49 Saabs, which could produce profits of 42 cents per share on revenue of $220 million next year. Parker said the best-case scenario would have Mesaba continuing to operate the 26 Avros and possibly 70-seat RJs for Northwest or another carrier, which could add 23 cents per share for an annual profit of 65 cents per share.

>>Contacts: Elizabeth Costello, Mesaba, (651) 367-5264; Tom Wychor, ALPA, (952) 573-3157; Jon Austin, MAIR, (651) 367-5231; James Parker, Raymond James, (404) 442- 5860.<<