Continental to spin off wholly owned subsidiary

 - May 21, 2008, 8:50 AM

In a move widely expected to portend an industry trend in years to come, Continental Airlines last month confirmed its intention to sell 20 percent of its now wholly owned Continental Express subsidiary on September 1, laying the foundation for an eventual full spin-off of the Houston-based regional airline. The decision became official when Continental Airlines’ wholly owned subsidiary, ExpressJet Holdings, filed a registration statement with the Securities and Exchange Commission for an initial public offering of its class-A common stock. ExpressJet owns ExpressJet Airlines, the regional airline that operates as Continental Express.

Soon after the six-month anniversary of the planned offering, subject to a favorable ruling from the Internal Revenue Service, Continental Airlines intends to spin off to its stockholders the remaining shares of ExpressJet. In connection with the planned offering and spin-off, Continental Airlines plans to retire $150 million of its outstanding debt and has suspended its previously announced stock repurchase program until a later date.

As expected, the news drew sharp reaction from the Air Line Pilots Association, which soon learned that the spin-off would result in a termination of the flow-through provision in Continental Express’ pilot contract. The provision, negotiated while the Independent Association of Continental Pilots (IACP) represented both Continental and ConEx pilots before they joined ALPA on June 1, gives Continental Express pilots preferential hiring consideration at the major airline.

“We listened intently to management’s plans and now have a better understanding of the blueprint for what they wish to build for the future of our airline,” said Capt. Pat Burke, chairman of the ALPA unit at Continental and Continental Express. “We, too, have a blueprint for our future as career pilots for this airline that we have drafted and will be pursuing in October, when both pilot groups initiate talks for new collective-bargaining agreements. Just as the company must pursue its vision and its goals, so will we to ensure that our pilots’ career expectations are realized.”

Meanwhile, Continental Express MEC interim executive administrator Capt. Josh Rubin echoed the concerns of ConEx pilots who believe the divestiture will hurt their chances of earning promotions to the mainline. “From the myriad smaller carriers, many pilots decided to come to work for Continental Express because of the opportunity of a flow-through to the mainline,” said Rubin. “These pilots built Continental Express into the success it is today, while keeping an eye on the prize of becoming a mainline Continental pilot with higher wages, enhanced benefits and a better quality of life. It would be grossly unfair to change the rules of the game midstream.”

Of course, the potential for lowering costs by freeing ConEx from the inherent administrative burdens of the larger company prompted Continental’s decision to divest in the first place. Although the ability to better control the actions and policies of their regional affiliates have led airlines such as Delta toward full buyouts, the stock values of independently owned regionals continue to outperform those of wholly owned subsidiaries by a wide margin, leading major airlines such as Continental to reconsider their strategy.

United Airlines, for one, has avoided ownership of its regional partners, primarily because it places more emphasis on the cost benefits independent ownership brings. On the other hand, Delta’s full ownership of Cincinnati-based Comair likely contributed to an aggravation it would have preferred to avoid. Eyeing the deep pockets Delta Air Lines brought to the negotiating table, ALPA sought to raise the salary scale of Comair’s pilots to that of Delta’s, leading to a three-month walkout that cost the parent company some $200 million in revenue and nearly spelled the end of the Cincinnati-based regional.

As contract negotiations for Continental Express approach this fall, Continental will have already taken the first step toward ridding itself of similar concerns. If all goes as planned, Continental Express will become fully independent by March 1 next year.