Spin-off Would Be First Airline IPO This Year; Stock Sale to Raise $330M

Memphis-based Pinnacle Airlines, a subsidiary of Northwest Airlines [Nasdaq: NWAC] and the nation's 13^th largest regional carrier, is seeking to spin off from Northwest. Pinnacle, once a wholly owned subsidiary of Northwest, today is majority owned by three Northwest employee pension plans, and the fiduciary overseeing those pensions plans is pushing for the initial public offering (IPO), according to Pinnacle's filing with the U.S. Securities and Exchange Commission (SEC)

Pinnacle intends to sell all 19.4 million shares of its common stock in the IPO, for $15 to $17 per share, which is expected to raise up to $330 million. A sale date has not been set, but one Wall Street analyst said to expect it to happen sooner rather than later. Another source with knowledge of the carrier's plans told CRAN that the IPO could take place as early as this week.

Pinnacle's IPO would be the first airline IPO this year. The Northwest Airlines Pension Plan for Pilot Employees, the Northwest Airlines Pension Plan for Contract Employees and the Northwest Airlines Pension Plan for Salaried Employees, which are offering the shares, hold 89 percent of Pinnacle's stock, while Northwest owns just 11 percent.

Northwest had owned 100 percent of Pinnacle until a federal regulator approved Northwest's use of Pinnacle stock to help it cover a $1 billion shortfall in its employee pension plans (CRAN, Sept. 8). The action allowed Northwest to contribute up to 100 percent of Pinnacle's stock in lieu of cash to Northwest's three pension plans.

Last January, Northwest contributed 2.8 million shares, or 12.9 percent, of Pinnacle's common stock to the Northwest pension plans to satisfy $43.8 million in pension obligations due at that time. Then in September, Northwest contributed an additional 16.6 million shares, or 75.7 percent, of Pinnacle's common stock to the Northwest pension plans to satisfy $309 million in new pension obligations.

"It may be a function as much of difficult economic times, as a need for cash, etc., which produces [the need for] spinning off," George Hamlin, director of Merge Global, an aviation consulting firm, told CRAN. "It's also possible that this could turn into an accordion: that there was a need for money, you do an IPO, and [Pinnacle] becomes independent. It could come back into the fold at some point in the future."

Northwest attempted to offer an IPO for Pinnacle in early 2002, but pulled the plug before it took place, according to a Wall Street analyst, who asked not to be identified. By law, analysts cannot comment on IPOs until 25 days after the public sale.

One of the key pieces of information in Pinnacle's SEC filing is its proposal to reduce its target profit margin to 10 percent from 14 percent, the margin the company stated in 2002.

"You might ask yourself, 'Why was it 14 percent before?' " the analyst asked. When Northwest first attempted the Pinnacle IPO in 2002, it was one of three carriers that filed similar prospectuses at about the same time. The others were for the public sale of ExpressJet [NYSE: XJT] and Republic Airlines. Only the ExpressJet deal was completed because the equity markets eventually fell apart, the analyst said.

"Pinnacle is rather small relative to ExpressJet, and Northwest wanted to get as much money out of the deal as possible," the analyst told CRAN. "Well, if it's small, how do you get as much money out of the deal as possible? What you do is you make it a highly profitable company. Typically, people will value a company in terms of its price- earnings multiple. If you want a high price, then what you need to do is generate the big 'E' -- earnings.

"How do you generate big earnings? You slap a very profitable contract on the thing. Because if you're Northwest, and Pinnacle is your 100 percent-owned subsidiary, which it was back then, you can boost the earnings by slapping on a very generous contract. If it's [your] wholly owned subsidiary, you can put up any contract you want. What [Northwest] did was they attempted to make it highly profitable last year so they could sell it for a lot of money. In the meantime, [United Airlines (OTC: UALAQ)] has gone bankrupt, people understand that these contracts are not as generous as they used to be, and so they [Northwest] wouldn't get credit for having this big, porky offering margin in there anymore. So they're changing it again, to 10 percent."

Under SEC rules, Pinnacle and Northwest cannot comment on the IPO for 21 days after it is launched.

Northwest did say that Pinnacle's IPO would not affect the relationship between the two airlines and would not affect Northwest's overall business plan. While Pinnacle may soon gain its independence, it is under contract to serve as Northwest's regional partner though Dec. 31, 2017.

"We, Northwest, do not anticipate any change in our relationship with Pinnacle for the foreseeable future," Bill Mellon, spokesman for Northwest, told CRAN.

Northwest leases jets to Pinnacle and covers many of the carrier's expenses. It also controls Pinnacle's scheduling, pricing, reservations and ticketing, and is entitled to all passenger and cargo revenues associated with its aircraft.

Pinnacle provides scheduled passenger service on an all-regional-jet fleet of 71 Bombardier [Toronto: BBDb] Canadair Regional Jets (CRJs), with roughly 450 daily departures to 76 cities in 29 states and two Canadian provinces.

Northwest earlier this year agreed to increase Pinnacle's fleet by 58 CRJs to 129 total by Dec. 31, 2005, and those plans are still in place.

"We've made that commitment, to 129, which is all of our firm orders for the CRJ," Mellon said. "We've allocated that to Pinnacle so that's still right on track and isn't impacted by the Pinnacle IPO."

Northwest also has acquired options on an additional 175 CRJs, but Mellon said Northwest would not comment on whether those options would be exercised or who would receive those planes.

As a result of Pinnacle's anticipated increase in fleet size and changes in its route structure, Pinnacle forecasts that its passenger capacity, or available seat miles (ASMs), will grow at a compounded annual rate of about 24 percent from 2003 through 2006. In the nine months ended Sept. 30, Pinnacle increased its ASMs by more than 53 percent over the same period last year. Pinnacle also hopes to grow through Northwest exercising its option on the 175 additional CRJs.

"We believe that our strong operational performance and cost-efficiency position us well to compete for the additional 175 CRJ aircraft that Northwest has on option order and that Northwest has not yet committed to any regional airline," Pinnacle said in its SEC filing. "As another element of our growth strategy, we intend to seek opportunities to provide regional airline service to other major carriers."

Pinnacle's IPO filing does not preclude the carrier from obtaining more aircraft from another major carrier, or exploring new code-share agreements, although there are a few restrictions.

"As part of its ongoing review of its operations, Northwest Airlines Corp. has determined that this offering would enable both Northwest and Pinnacle Airlines Corp. to focus on their core competencies as a major airline and a regional airline, respectively," Pinnacle said in its SEC filing. "Northwest will concentrate on marketing and scheduling to maximize system revenue, and on the operation of its own mainline fleet. Pinnacle will focus on the efficient operation of regional jets and the growth of its fleet, both for Northwest and, potentially, for other major airlines."

It is imperative for the IPO to happen soon, to render the holdings of Northwest's pension plans liquid and to give Northwest Airlines an infusion of cash, the Wall Street analyst said. "It's a private investment, not a liquid investment, so the pension fund has no ability to easily go out and resell the stock. They have to go through this IPO process."

According to Pinnacle's Nov. 7 SEC filing, Pinnacle will not receive any of the proceeds from the sale of the shares in the IPO. The Northwest pension plans and Northwest Airlines will receive all net proceeds from the sale of their shares.

The IPO provides for a "put option," which grants Northwest's pension plans an option to require Northwest to purchase, at any time, all or any of the shares of Pinnacle's common stock held by the pension plans.

"The incentive for both parties is to get this thing public quickly because then it makes it a liquid investment for the pension fund, and in fact, this IPO contemplates selling all of the pension funds' stock," the analyst told CRAN. "Secondly, because it was a private investment and it was therefore illiquid -- not easily saleable -- Northwest gave the pension funds a 'put' option."

"The agreement between Northwest and the Northwest pension plans relative to Northwest contributions of Pinnacle stock says that the pension plans have the right to give it back to Northwest in exchange for cash, which means that Northwest is not off the hook until this thing is IPO'd," the analyst said. "Both Northwest and its pension fund plan have an incentive to get this puppy out there as quickly as possible."

Pinnacle, one of the fastest growing regional airlines in the nation, flies as a Northwest Airlink carrier serving Northwest's hubs in Minneapolis and Detroit and Memphis. Northwest acquired Pinnacle Airlines, formerly Express Airlines I, on April 1, 1997, for roughly $33 million.

>>Contact: Bill Mellon, Northwest, 612-726-2331; George Hamlin, Merge Global, 703-526-6694.<<

Details of the Proposed Pinnacle Airlines Initial Public Offering

Common stock offered by the Northwest Airlines Pension Plans

19,400,000 shares

Common stock to be outstanding before and after this offering

21,892,060 shares

Common stock to be owned by the Northwest Airlines Pension Plans and Northwest after this offering

Upon completion of the offering, the Northwest Airlines Pension Plans will not own any shares of Pinnacle's common stock. If the over-allotment option granted to the underwriters is not exercised, Northwest will own 11.4 percent of Pinnacle's common stock after the offering. Northwest will not own any shares of Pinnacle's common stock if the over-allotment option is exercised in full.¹

Use of proceeds

Pinnacle will not receive any of the proceeds from the sale of the shares in this offering. The Northwest Airlines pension plans and Northwest will receive all net proceeds from the sale of their shares in this offering.

Dividend policy

Pinnacle does not anticipate paying any dividends on its common stock in the foreseeable future.

Proposed Nasdaq symbol

"PNCL"

¹The number of outstanding shares of Pinnacle's common stock does not include 858,200 shares of common stock issuable upon exercise of options that will be outstanding under Pinnacle's 2003 Stock Incentive Plan upon completion of the offering. Pinnacle's analysis of the offering assumes no exercise by the underwriters of the over- allotment option to purchase up to 2,492,060 additional shares of common stock from Northwest.

Source: Pinnacle Airlines filing with the SEC, Nov. 7, 2003