When Mesa Air Group [MESA] begins flying in the Hawaiian Islands, it just might shake up the current "cartel" controlled by Hawaiian Airlines, Aloha Airlines and Island Air.

The resulting shake-up could leave Hawaiian and Aloha stripped of their mainland code-share contracts, and Island Air struggling for a new niche, according to Greg Kahlstorf, president of Pacific Wings Airlines.

Mesa late last month announced its intent to start an intra-island carrier with six Bombardier [BBD] CRJ 200s in the first quarter of 2006. While the aircraft would be initially operated under the Mesa Airlines certificate, Mesa CFO Peter Murnane said a new carrier would be formed with separate investors. The yet-to-be named carrier would still be a subsidiary of Mesa Air Group. The operation has been code named Project Hele since the company began studying it in early 2004.

While the service will start with leased CRJ 200s, Murnane said the carrier hopes to "segue" to larger CRJ 700 and CRJ 900 aircraft on the Hawaiian routes. If demand grows for the larger aircraft, he said Mesa would draw upon its current Bombardier order options to obtain them.

Mesa plans to provide high-frequency service - although high frequency was not defined - between Honolulu, Maui, Hilo, Kona and Lihue. "In essence the carrier will operate on a point-to-point basis," Murnane told Regional Aviation News.

The routes that Project Hele would fly are some of the same routes now flown by Hawaiian and Aloha. Both carriers operate mainline aircraft on these routes. Hawaiian flies Boeing [BA] 717s and Aloha flies B737-200s.

"We will be in competition with Aloha and Hawaiian," Murnane said, and not in direct competition with Island Air, a regional carrier operating Dash 8s.

Island Air will be adding two Q400 turboprops to its fleet. The privately held regional carrier filed paperwork in July with the U.S. Department of Transportation (DOT) to be certified to operate the larger turboprops. The first new plane is to be delivered in November and the second will be added in the first quarter next year (RAN, Aug. 8).

Murnane contends that the high cost structures at Hawaiian and Aloha give Mesa an opening for its trademark low-cost operation. He referred to the new carrier as a "low-cost carrier" not a regional or commuter carrier.

Aloha is currently operating in bankruptcy. It filed for Chapter 11 last December. Hawaiian exited Chapter 11 earlier this year after spending nearly two years in bankruptcy court.

"We just think the timing is right," Murnane said. "Now is probably the best opportunity we are going to have. Both Hawaiian and Aloha have cut back on their intra-island flights and they are both high-cost operators."

"If there ever was a time to make the move, it is now," Kahlstorf said. Hawaiian and Aloha "are both tentative at best" in their operations.

"Mesa is a very, very efficient airline and a good carrier," remarked an aviation consultant, who asked not to be named. "I would defer to [Mesa's] judgment. I think they have run the numbers 100 different ways. They would bring some of the amazing competitive lessons to the intra-island service.

"The market has been ripe for a mainline competitor to show up. I was wondering when a low-cost carrier would arrive in Hawaii. Aloha and Hawaiian are not noted for efficient operations. They are older airlines. A good low-cost mainline carrier that arrives out there would give everyone something to worry about."

Mesa is talking to mainline carriers to establish a code-share relationship. "We will certainly start without a code-share," Murnane said, "but it is our intention to have a code-share."

United Airlines [UALAQ] and Delta Air Lines [DALQ], two of Mesa's code-share partners, fly directly to Hawaii. America West [LCC], a long-time Mesa partner, on Dec. 16 will begin service from Phoenix to Honolulu, Kahului, Lihue and Kona. United has a code-share relationship with Aloha and America West has a similar relationship with Hawaiian.

Delta, Murnane noted, does not have a code-share relationship with either mainline island carrier.

Pacific Wings' Kahlstorf suggested that Mesa might be a "proxy" for one or more of its code-share partners.

"For years, the mainland carriers had to rely on Hawaiian or Aloha because they did not have the local infrastructure," he said. "If you are a big legacy carrier on the mainland, what would you prefer to do? Subsidize the operations of a trans-Pacific competitor who is penetrating deeper into your markets, or do business with an established code- share partner that does not represent a threat to your long-haul Pacific routes? Simply install them here has your proxy. That is the basic business premise here as I understand it."

The Hawaiian market "is a high-volume and a low-yield market with very marginal traffic. The larger airlines have always needed tourism to subsidize the local market. The lack of revenue on the intra-island market is what drove Aloha and Hawaiian to the mainland in the first place.

"I think for Aloha and Hawaiian, Mesa will be bad news. For Island Air, it is disastrous news," Kahlstorf said.

At the moment, Island Air carries the Aloha and Hawaiian code on its routes to more remote communities. In addition, it has struck a own code-share pact this year with United and Continental Airlines [CAL].

Stripped of their code-shares, Kahlstorf said, Aloha and Hawaiian would have to function as independents - "something like a Polynesian British Midland" - established brands with some visibility on the West Coast. They would have to learn how to compete with a new model, he said.

If either Aloha or Hawaiian loses their code-shares, then Island Air will probably lose the same code-shares, he said.

As a turboprop operation, Island Air will be at a disadvantage, Kahlstorf said. "We know that given the choice between a jet and a prop, and all things being equal, people will take the jet."

While Murnane said Mesa would be competing with the jets and not Island Air's turboprops, the two carriers will serve three distant island communities - Hilo, Kona, and Lihue. Island Air, a unit of Aloha until March 2004, also flies to Honolulu, Molokai, Lanai, Kapalua, West Maui, and Kahului.

Island Air officials declined to talk about Mesa until the routes have been established.

Impact on Pacific Wings

While Pacific Wings' Kahlstorf is doom and gloom about the impact Mesa will have on the other three carriers, he believes Mesa is an opportunity for his Cessna Caravan carrier.

"We have exclusive service between Kahului and Kamuela. There are not enough people getting off connecting flights to make that a profitable run with a 37-seat or 50-seat plane. If you are talking 18 passengers - for me that is a bonanza. For them, it is a disaster. We focus on the micro markets. [These markets] have enough commercial operations to sustain us, but not enough for a Mesa or Island Air. We have been able to survive without any external traffic. Our focus has been the plumber, cable guy, the student and the person needing dialysis."

Kahlstorf thinks Pacific Wings would be able to compliment Mesa's routes. Mesa will need a carrier to go the small communities with airstrips that can't handle an RJ. "I don't think they [Mesa] will want to use Island Air because of their connections to Aloha and Hawaiian. We already have interline agreements with all the people they do business with.

"I envision a future the small way that Aloha and Hawaiian have Island Air, Mesa will have Pacific Wings."

As Mesa goes about setting up its Hawaiian venture, it will take on outside investors.

While Hawaiian was putting together its bankruptcy exit plan last year, Mesa made a proposal to join in one of four groups that made offers to plow new equity into Hawaiian. In Mesa's case, there were 13 parties competing for a handful of slots on the management team. Mesa was the only airline among a number of venture capital funds. Also making a bid for Hawaiian was Robert Crandall, the former CEO of AMR. Mesa's CFO Murnane declined to say if any of Mesa's earlier Hawaiian contacts were potential partners in Project Hele.

>>Contacts: Peter Murnane, Mesa, (602) 685-4001; Greg Kahlstorf, Pacific Wings, (808) 873-0877.<<