AirTran (AAI) said it would not only retain Midwest Airlines' (MEH) regional feeder service provided by wholly owned subsidiary Skyways, it would expand the Midwest Connect operation, jettisoning plans for 50 seaters in favor of larger regional jets. The statement was made by AirTran Airways Chair and CEO Joe Leonard, whose plans to take over Midwest Airlines prompted one analyst to say that he made it "fun to be an airline analyst again." AirTran said the transaction could be completed by the end of the first quarter 2007 and would create an airlines with $3.5 billion in revenues.

Midwest has a request for proposal out to select regional carriers to provide regional jet service with 50-seat regional jets. It plans to start the new service in 2007 to right size markets and as a vehicle for route and frequency expansion. (RAN, November 6, p.6) However, Leonard told investors that 50 seaters were increasingly unprofitable with mainline route structures and would definitely not work with a low-cost operator. The exact details of any changes are pending permission by the Midwest Airlines board that AirTran can begin the due diligence process. However, Midwest Airlines rebuffed the $290 million takeover bid for the third time, saying it would not be in the best interest of its stakeholders to pursue a merger with AirTran, something AirTran has been working on for over a year but announced last week. The decision to announce its offer was likely a bid to go directly to stakeholder's. Indeed, Leonard said, despite the rebuff, the company thought both Midwest and AirTran stakeholders needed to know about the offer which, he said, would provide a 30 percent price premium on Midwest's 30-day stock price average and an 89 percent premium on its average closing price during the last six months. "To an outside observer, this is a natural," he said. The bid is for $11.25 per share in cash and stock and, in discussions with investors, Leonard said that if, during due diligence, further value was found, AirTran would be willing to pay for it. Financing is already in place.

Midwest Air Group Chair and CEO Timothy Hoeksema said that the board spent considerable time evaluating the offer, engaging investment banking firms and an outside consulting firm in the effort.

"During their comprehensive review, those advisors considered the offer in light of Midwest's business and strategic plans," he said. "Under that plan, we are projecting annual capacity growth of more than 10 percent over the next three years, including a 50-seat regional jet program, along with significantly greater growth in profitability. Additionally, we view AirTran's offer at only about $5 per share, because it includes approximately $6 per share in cash that already belongs to our shareholders. While it is the fiduciary obligation of the board to review credible offers, the board unanimously concluded that Midwest's business plan as a stand-alone company would support a considerably better return to our shareholders than the AirTran offer...Our product and service are unique and are not readily compatible with a merger with another carrier."

Hoeksma added that Midwest employees have been overwhelmed by public support of the board's decision, especially given the airline's place as the hometown Milwaukee airline.

For now, AirTran says the deal would provide $60 million in incremental synergies which does not include the value of their presence in their respective hub markets at Atlanta, Milwaukee and Kansas City. The combined carrier would have a nationwide reach and expands AirTran's largely north-south sweep to include the east-west Midwest Airlines network and its long-sought presence in the Great Lakes region. The company has been eyeing the Midwest market for some time having tried to acquire 14 gates at Midway two years ago, before being outbid by Southwest Airlines. AirTran has only four gates at the airport.

Leonard also told investors that the company was "laser focused" on the Midwest bid and was not thinking about any further acquisitions at this time. However, he pointed out in response to an observation that the combined carriers still lacked a strong West Coast presence, AirTran had forged a deal with Frontier for consumers to book each other's flights and earn frequent flier miles as well. (RAN, November 20, p.1)

While Leonard touted the synergies of their similar fleets and cultures, there is little overlap between the two networks and is limited to four overlapping nonstops between Milwaukee and Atlanta, Orlando, Tampa and Fort Myers, Fla. The combined carriers would grow AirTran into the nation's 10th largest carrier in terms of enplanements. With $1.45 billion in revenues last year, it is currently the eleventh largest based on revenues. It employs 8,000 and is continually expanding its employment roster and network. Midwest is now the 15th largest carrier with revenues of $700 million and 3,300 employees. The combination would result in an carrier with $3.5 billion in revenues

Calyon Analyst Ray Niedl said the merger makes sense given the route networks are complementary and their strong fleet commonality as well as continued pressure for industry consolidation. AirTran would also jettison the more costly MD-80s in Midwest's fleet in favor of Boeing 737s which will save 30 percent in operating costs alone. He also indicated these facts make the regulatory gauntlet more likely to approve the deal and added that the emergence of a new national low-cost carrier might force JetBlue (JBLU) into a merger in order to create the critical mass to compete. Even so, Midwest has protected itself from hostile takeovers having put in place a poison pill.

AirTran, which said it is looking for a friendly takeover, expects network synergies of $40 million per year driven by improved fleet and capacity utilization as well as increased aircraft utilization. AirTran stated that cost synergies of $20 million annually will be obtained through replacement of MD-80s with cost-efficient 737 aircraft and by gaining efficiencies on maintenance and facilities. AirTran believes there would be $35-$40 million of transaction costs for reconfiguration of aircraft and rationalizing facilities, according to Niedl.

Source: AirTran Airways