United partners brace for coming storm

 - January 9, 2008, 4:14 AM

Last month’s rush to speculation over the effects of United Airlines’ decision to file for Chapter 11 bankruptcy protection had just spread to include conjecture about its regional affiliates when Atlantic Coast Airlines released an illuminating statement on the status of its code-share relationship with the world’s second-largest carrier. One of many creditors of the Elk Grove, Ill.-based airline, ACA confirmed that United owes it $10 million for services performed before the December 9 bankruptcy filing. ACA also acknowledged its exposure to a “number of risks” stemming from the bankruptcy, including the potential for United to reject the terms of its code-share contract and the possibility that lenders could cut off the flow of financing for airplanes.

In fact, United reportedly hopes to draw as much as $80 million in annual contract concessions from its three United Express affiliates, including Air Wisconsin and SkyWest. To help its cause, it has entertained competing bids from two other regional airlines. One of those understood to have shown interest–former United Express partner Mesa Air Group–reestablished a presence in Denver early last year to serve a new code-share partnership with Frontier Airlines. However, the Phoenix-based regional has begun to curtail its relationship with Frontier as a lingering environment of razor-thin yields results in “less than satisfactory” returns for Mesa. The pro-rate contract allows either party to adjust frequencies and/or exit markets altogether, leaving Mesa the option of redeploying its Denver-based CRJs with other partners.

Meanwhile, uncertainty spawned by United’s dire financial condition has apparently left executives from at least two of the three United Express carriers at a loss for words. In fairness, even they would seem hard pressed to predict an outcome before United presents its restructuring plan to the courts. Besides, as United postures to renegotiate service fees, no one seems particularly anxious to broadcast to the world their deteriorating position.

To its credit, St. George, Utah-based SkyWest Airlines issued a comparatively forthright appraisal of the hardships certain to accompany United’s attempts to restructure its contracts. According to SkyWest, its margins will undoubtedly suffer as United tries cutting enough costs to emerge from bankruptcy within 18 months. That process began in earnest on Friday, December 13, when bankruptcy trustee Ira Bodenstein met with more than 60 United creditors in Chicago to form a committee tasked with “counseling” the airline on various financial and strategic matters. Although Atlantic Coast and SkyWest appear on the list of creditors, their comparatively minor debt exposure precluded either from winning seats on the committee.

Flying CRJs and Jetstream 41s as United Express from Dulles International and Chicago O’Hare Airports, Atlantic Coast estimates its net exposure to United’s bankruptcy at roughly $6 million. Although United owed Atlantic Coast $10 million for services performed before the December 9 filing, ACA can offset $4 million of that debt by withholding certain services still owed to United. The major airline won approval from the U.S. Bankruptcy Court to honor its pre-petition obligations to its Express carriers, but whether or not United would do so remained uncertain at press time. ACA said it would assess whether or not to take a reserve against the amounts owed to it “following the receipt of additional information from United.”

United also owes roughly $13.5 million to St. George, Utah-based SkyWest, its primary United Express partner on the West Coast. SkyWest estimated that it could offset that amount by some $4.1 million in services, resulting in a net exposure of $9.4 million.

Capital in Question
Perhaps more important than the short-term losses the United Express carriers might incur remains the potential for even further skittishness on the part of capital providers. To put to rest concerns over its immediate ability to finance new deliveries, ACA announced it took delivery and closed the financing on a 50-seat CRJ for its United Express business on December 10. It also said it secured financing commitments for another CRJ last month, three more this month and another two next month. Although those agreements took place before the bankruptcy filing, ACA said the financing parties “informally indicated that they would be prepared to go forward subject to their continuing assessment of the United situation.”

An ACA spokesman said the company would not comment on the status of deliveries beyond February, nor would it comment on the details of negotiations for service-fee concessions. To date Atlantic Coast has taken 72 of 121 CRJs slated to fly within its United system by the second quarter of next year. Also flying thirty 328JETs from Cincinnati, New York La Guardia and Boston for Delta, ACA draws 84 percent of its annual revenue from its United Express business.

One trend that appears to point in ACA’s favor, however, involves its increasing presence at Chicago O’Hare, from where 64 percent of the Sterling, Va.-based regional’s ASMs now emanate. Calling O’Hare United’s “crown jewel,” CEO Glenn Tilton pledged continued emphasis on the airline’s largest hub, where the construction of a new runway, the relocation of three existing runways and an extension of two others stand at the center of a $6.6 billion modernization plan. Conversely, United’s less prominent stake in Dulles may open new opportunities for mainline jet replacement with ACA regional jets, as well as room for other airlines looking for East Coast expansion.

Air Wisconsin, of course, maintains an acute interest in any of United’s plans for both Chicago and Denver, where the Appleton, Wis.-based airline dominates United Express activity with its fleet of 31 Bombardier CRJs, 18 BAE 146s and 10 Dornier 328 turboprops. The least diversified of the three United Express carriers in terms of partnerships with major airlines, however, Air Wisconsin depended on United for virtually all its code-share revenue until it signed a deal with AirTran in October that sent a handful of CRJs to Atlanta.

A privately held company, Air Wisconsin at press time hadn’t commented on the bankruptcy’s potential to disrupt its revenue stream or its ability to finance the 25 CRJs scheduled to enter its United Express system this year. A representative from Air Wisconsin’s public-relations firm said only that the airline expected no immediate changes to its flight schedule.

Meanwhile, the airline perhaps best positioned to weather a decline in its United Express business showed the most concern for the potential implications to its balance sheets. SkyWest, whose United contract accounts for just 35 percent of its ASMs, nevertheless admitted that its exposure to rate reductions from both its United and Delta Connection contracts would demand “aggressive” cost-cutting efforts aimed primarily at its employee groups. Although SkyWest said it believed that 28 of the 36 new CRJs scheduled for delivery next year would enter service primarily in Denver for United, the Chicago-based airline’s plans to revive its Shuttle by United division could conceivably threaten further flying opportunities for SkyWest on the West Coast.

“United’s filing illustrates the tremendous challenges our industry faces,” said SkyWest president and CEO Jerry Atkin. “Our major airline partners, and the airline industry in general, are dealing with lower revenues from fewer passengers traveling, and those who are traveling are paying lower ticket prices.” SkyWest cautioned investors that its financial performance could suffer.

“We are targeting cost-reduction alternatives with the help of our employees and intend to pass a substantial amount of the savings to our major partners in rate reductions for 2003 and beyond,” said SkyWest executive v-p and CFO Brad Rich. “Although not all aspects of our rate agreements with Delta and United have been finalized, and may not be finalized for some time, it is likely that our margins will be lower and less predictable going forward.”

Of course, the entire regional industry hopes the trend toward the transfer of mainline routes to affiliates continues, allowing airlines such as SkyWest, Air Wisconsin and Atlantic Coast to compensate for lower yields with more volume. In United’s case, much depends on its ability to relax scope-clause provisions even while it extracts more pay concessions from its pilots. “Both Delta and United have stated the importance of [introducing] more smaller aircraft into their larger networks,” said Rich. “If delivered, [the CRJs scheduled for introduction this year] will increase our available seat miles by approximately 40 percent.”