Republic reaches outward for growth opportunities

 - July 27, 2009, 10:57 AM

Republic Airways stands to become the 11th largest airline in the U.S. if its plans to acquire Milwaukee-based Midwest Airlines and sponsor Frontier Airlines’ emergence from Chapter 11 bankruptcy meet with regulators’ approval. Republic, which now consists of Republic Airlines, Chautauqua Airlines and Shuttle America, already ranks as one of the regional airline industry’s largest groups, flying 212 regional jets for six mainline partners.

A seventh partner, Hawaii’s Mokulele Airlines, as of May 1 fell under the control of Republic when the Indianapolis-based airline raised its equity position in the operation to 50 percent, took over three of the five board seats and set in place plans to send a fourth Embraer E170 to the islands by the end of the summer. But, as has become painfully apparent in an industry tied so inextricably to the major airline business, growth opportunities with existing mainline partners have virtually evaporated, leaving anyone with the expansion ambitions of Republic CEO Bryan Bedford with little choice but to go in search of acquisition targets.

As has proved the case with most of the industry, Republic during the first half of this year saw little, if any, capacity growth as cuts at its mainline code-share partners resulted in less need for connecting service. This past May, for example, the company generated 851 million revenue passenger miles (RPMs)–a 5.2-percent decrease from the same month last year–while available seat miles (ASMs) dropped 4 percent, to 1.12 billion. Block hours fell to 58,467–a 10.3-percent decline from May 2008–and the airline registered a load factor of 75.8 percent, compared with 76.8 percent a year earlier.

However, the airline seemed to turn a corner in June, when it registered a 4.5-percent increase in RPMs, to 907.4 million, compared with the same month last year, to go along with a 3.5-percent increase in capacity, to 1.14 billion ASMs. While block hours fell 6.8 percent, to 58,757, the group’s load factor rose from 78.5 percent to 79.3 percent. It carried 1.8 million passengers during the month, enough to register a 3.2-percent jump from the same period last year.

Thankfully, for Republic, most of the capacity cuts it instituted up until June came in the part of its business that generates the lowest margins. In fact, from the second quarter of last year the size of its operational Embraer E-Jet fleet rose from 101 airplanes to 131. During the same period the number of 37- to 50-seat regional jets fell from 114 to 77.

Even though fuel prices have dropped considerably over the past year, some regional airlines have turned mandates for capacity cuts into opportunities to return their highest-cost small jets to their lessors, and hold onto equipment they lease on shorter, less expensive terms. As the cost of ownership of small RJs plummets in the secondary market, the ability to move in and out of leases on those airplanes proves invaluable. In fact, the first of a dozen ERJ 135s and ERJ 145s Republic committed to the Midwest Connect network began service just last month, as Republic began taking control of routes flown by SkyWest Airlines with CRJ200s.

Bedford’s choice of takeover targets shouldn’t come as a complete surprise given the ties his company has maintained with Frontier and Midwest in recent years. In the case of Frontier, now operating under Chapter 11 bankruptcy protection, Republic agreed to refinance a $40 million debtor in possession loan to the Denver-based low-fare carrier on March 5. Under the condition of the loan, Frontier agreed to pay $150 million in damages for its early termination of a code-share deal the two companies maintained until June 23 of last year, when Republic removed the last of 12 E170s it had flown out of Denver for Frontier.

Assuming the plan passes muster with financial regulators and another airline doesn’t outbid Republic for Frontier, the Indianapolis regional will assume 100 percent of the equity in the bankrupt carrier for $108.75 million this fall. With the buyout, Republic would for the first time operate so-called “mainline” jets– namely, 38 Airbus A319s, 10 A318s and three A320s. It would also re-enter the turboprop business as it takes control of the 10 Bombardier Q400s now flown by Frontier subsidiary Lynx Aviation out of Denver.

Although a U.S. bankruptcy court last month approved Republic’s proposal to invest in Frontier, the investment agreement provides for an auction period during which Frontier may seek competing bids.

If Frontier identifies a more favorable bid, it can end the Republic agreement. Under the auction procedures, any interested bidders need to submit an initial proposal by August 3 and a final proposal by August 10.

Meanwhile, Republic faces fewer barriers in its plan to take full control of Milwaukee-based Midwest Airlines by early this month. The agreement to acquire Midwest from Fort Worth, Texas-based private equity firm TPG Capital involves a fairly straightforward $6 million cash payment and a $25 million, five-year note convertible to RJET stock at $10 a share. TPG would also gain the right to nominate a member to Republic’s board.

In retrospect, Republic might have signaled its interest in Midwest in May, when it agreed to add a pair of 100-seat Embraer E190ARs to its existing code-share deal starting this month. By June Republic had agreed to lend Midwest another $6 million on top of the $25 million it injected last September, and introduce the aforementioned 12 Embraer ERJ 135s and ERJ 145s into the Midwest Connect fleet through next January.

Now flying twelve 76-seat E170s for the Milwaukee-based airline, Republic began flying the Embraer E-Jets under the Midwest Connect brand last October. Plans called for the pair of E190s to begin replacing Midwest’s nine Boeing 717s, which, in turn, appear headed to Mexican low-fare operator MexicanaClick. That airline has already begun to replace 25 Fokker 100s with three of the 16 Boeing 717s Midwest returned to the manufacturer last September.

The expulsion of the 717s would spell the end of Midwest Airlines’ ability to offer the extra-wide seats– placed in a two-by-two configuration in a cabin designed for a six-abreast layout–that it used to help distinguish its service from the competition.
However, with the smaller and more fuel-efficient E190s, Republic plans to restore much of the service Midwest cut last year. Routes on which the 717s could no longer serve profitably could return to the Midwest network, which lost 40 percent of its destinations since last September.

Meanwhile, Frontier and Midwest plan to begin code sharing late this summer, perhaps easing Republic’s consolidation of ticketing functions if it gains regulatory approval to take control of both carriers. Frontier said it would release more details of the program at a later date.