Embraer, Bombardier Stop RJ Deliveries

US Airways [UAIRQ] is bankrupt again, but it is still flying - for now.

With the court's blessing, US Airways will continue to pay its five regional code-share partners - Mesa Air Group [MESA], Republic Airways [RJET], Trans States, Colgan Air and Shuttle America - to maintain the current network. However, the carrier will not be receiving any more of the 108 new regional jets it has ordered.

The carrier needs to put forth a "credible" recovery plan soon or it may slip into liquidation. If US Airways is forced to file Chapter 7, then all bets are off as to the fate of the carrier, its code-share partners and its planes. It has less than 120 days to chart the new course.

CEO Bruce Lakefield promised the court after the Sept. 12 filing that he plans to return the carrier to solvency.

Embraer [ERJ] and Bombardier [BBD] top the list of US Airways' creditors. The carrier owes $8.7 billion total, according to its Chapter 11 filing. Both regional jet manufactures and General Electric Capital Aviation Services (GECAS) - the primary financier of the new jets - are having "serious discussions" concerning the fate of the future RJ deliveries. US Airways' wholly owned regionals - MidAtlantic Airways and PSA - have been receiving the new planes.

Embraer, owed $1.4 billion, is the largest creditor. It has delivered 22 of the 85 Embraer 170s that US Airways ordered in 2003 - as it was exiting its first bankruptcy. At the time, the order was valued at $2.1 billion and the carrier was the North American launch customer of the new Brazilian RJ.

US Airways owes Bombardier $947.9 million for future aircraft commitments. The Canadian firm has supplied 40 of the 85 RJs it ordered in 2003. Bombardier had two CRJ 200s and 43 CRJ 700s remaining to deliver. Twelve planes were to be delivered before Jan. 31, 2005.

Instead, GECAS will take 16 planes - eight from this year's production order and eight from next year's - and it will market them to other carriers. Bombardier will attempt to find new customers for the remaining four planes to be built this year, said John Paul Macdonald, a company spokesman.

Bombardier provided US Airways with interim financing for 14 of the planes it delivered this year. The carrier has been making payments directly to Bombardier for these planes.

In addition to the money it owes to the airframe builders, US Airways owes GECAS$335 million either for jet engines commitments or for payments on RJs it is leasing from GECAS.

While some analysts have speculated that the bankruptcy filing could result in additional business for some of the regional partners, Mesa CEO Jonathan Ornstein told CRAN, "I imagine we will be doing about the same amount of flying. If they can get it fixed, we would be delighted to expand our operations with them. I think we will have to wait and see what happens."

As part of the Chapter 11 restructuring, Raymond James analyst James Parker suggested that GECAS might decide to place a portion of the new Bombardier jets with Mesa and the new Embraer jets with Republic. The two code-share partners would then fly the planes as part of the US Airways Express network. Outside of MidAtlantic, Republic is the only other North American operator of the new Embraer 72-seat jet. Mesa and Republic have greater credit stability, making them the preferred candidates to hold the planes rather than the twice-bankrupt US Airways.

A successful transformation under Chapter 11 would increase the carrier's regional flying, said airline consultant Robert Mann. "I think this will accelerate the conversion of more US Airways narrow-body routes to the regionals. Any time they can replace a domestic narrow-body mainline jet with a small jet flown by a regional partner, they are reducing the costs of maintaining that spoke on the network."

However, the regional partners may need to do a hard assessment before agreeing to assume the responsibility of operating new aircraft for US Airways Express. "If they judge that US Airways will be in business for the long term, they will run, not walk to do a deal. However, if there is a question that the assets may not be flying long for US Airways, they would walk, not run - but they would still go and talk."

Should US Airways be forced to liquidate, Parker said GECAS might still want to transfer the planes to Mesa and Republic to be used in new code-share relationships.

Liquidation would be disruptive, Ornstein said, "It would be my preference that they not liquidate. Could there be an opportunity in liquidation? Sure. The risk that is attendant with the opportunity is such that I would vastly prefer that they not liquidate. Our strategy would be to sign with a new partner or get out of the aircraft. We have already begun to talk to our lessors about what if the worst off occurs. We will try to sublease them. If we can find a home for 30 of the 59 planes, then it is a manageable problem."

However, Parker raises the possibility that both Mesa and Republic may only find new code-share partners on the basis of revenue-sharing deals. Revenue sharing in the future may be considerably less profitable than in the past because of high fuel prices and low air fares, he said.

A carrier operating in Chapter 11 has 120 days to either terminate an aircraft lease or reach new terms. Faced with this deadline, Mann said US Airways has less than four months to craft a new business plan. "They can't plan on any more than 120 days. It is a very fast track to get everything done," he said.

Mann noted that it would be a mistake to follow the same, slow, methodical course that United Airlines [UALAQ] is using to restructure itself while operating in Chapter 11. United will mark its second anniversary in bankruptcy in December.

Unlike two years ago when the carrier had the upper hand because of a soft market for used aircraft, Mann said, the "markets have clearly firmed up. There are places in the world today that lessors can get attractive rates compared to what US Airways may be willing to pay."

Mann held out the possibility that GECAS could pull its regional jets from the carrier if it felt it could get better lease rates elsewhere.

In a filing with the court, US Airways has said it will return 23 planes: one Boeing [BA] 737, 12 Dornier 328s and 10 Dash 8s.

"If US Airways is able to reduce its costs and improve operating results, it may still face a challenge in attracting financing to exit from Chapter 11, as the federal loan guarantee program it used before is no longer available and it seems unlikely that its largest shareholder will invest more equity," said Philip Baggaley, an analyst with Standard & Poor's in lowering its rating to "D."

The company's largest shareholder, the Alabamastate retirement systems, may lose most of the $240 million it invested to recapitialize the company in 2003.

US Airways has $750 million in cash on hand. Last week, citing its bankruptcy filing, it refused to make a $110 million pension fund payment. The U.S. Air Transportation Stabilization Board (ATSB) last week agreed to allow the carrier to tap into its cash to pay its bills. The carrier's cash is part of the collateral the ATSB holds as a guarantee of its $700 million loan. When the carrier renegotiated terms of the loan last March it reduced the $900 million loan with a $250 million payment, but it was also required to maintain a $700 million cash balance (CRAN, March 22).

Because of its limited cash balance and few assets not already pledged as collateral, US Airways has not been able to secure debtor-in-possession financing, which is a normal practice for a business trying to reorganize while in bankruptcy.

The key to any restructuring of US Airways is to get its labor costs in line with the low-fare carriers. US Airways "with the same labor costs per block hour as JetBlue [JBLU] would be one of the most profitable in the world," Ornstein said. "It is just that simple. Everybody is complicating things by talking about route network problems, the acquisitions, and too many fleet types. Forget all of that. Their labor costs are twice as high as their competitors' on a block-hour basis. The unions have to come to grips with that. The company has to come to grips with that."

The carrier had been seeking $800 million in annual labor cost savings from all its employees. However, only the pilots had been willing to negotiate a new wage scale while the other unions refused to talk to the company. A proposed pilot package was never submitted the rank-and-file for a vote.

"The question is if they can act decisively, then I think they can make it," Ornstein said. "They cannot act fearful as is the standard corporate reaction."

Mann noted that the unions were reluctant to grant the company a third round of wage concessions because the "company was unable to employ that flexibility [obtained in the earlier concessions] to come close to the low-cost carriers on productivity.

"I think it was the lack of credibility that resulted in them not getting a consensual reduction this time around. They're thinking that there was a risk that the next round of cuts will go down the rat hole just like the last two.

"If this company really does have a credible plan - and can really implement it - then this round of cuts will be the ones that fund the restructuring." Mann said, and then added, "Hope springs eternal that they might just get it right this time."

>>Contacts: Philip Baggaley, S&P, (212) 438-7683; John Paul Macdonald, Bombardier, (514) 855-7972; Jonathan Ornstein, Mesa, (602) 685-4001; James Parker, Raymond James, (404) 442-5860; and Robert Mann, (516) 944-0900.<<