Frontier to Exit Bankruptcy, Become Subsidiary of Republic Airways

Republic Airways announced today that it will purchase 100% of the equity in Frontier Airlines for nearly $109 million, allowing Frontier to exit bankruptcy protection as a wholly-owned subsidiary of Republic. The unexpected move is in part a testament to the attitude of many at Frontier who were far less defeatist than I was about their company. Frontier made many sacrifices and changes, including cutting staff, adding new fees, and trimming flights, but in the end, it appears to have paid off. Or has it?

Frontier is still in a relatively weak competitive position in Denver. Although United has taken serious hits as well, Frontier seems unlikely to grow capacity much at Denver due to the inroads being made by Southwest, Alaska, and other carriers. Of course, the economic downturn and the public's reduction in air travel don't help matters much either if Frontier is looking for traffic growth. Frontier does still have a strong, loyal customer base in the Denver area, and the company's superior product gives it an advantage. But the name of the game is bringing in revenue, and although Lynx seems to be helping, competitive pressures are likely to continue to depress yields at Denver for some time. This is not to say Frontier is down and out. But let's be clear. Even when Frontier was doing well in the earlier part of this decade, well before Southwest entered Denver, the company struggled to find markets outside of Denver to expand to. Various point-to-point routes from Los Angeles were tried, the Memphis focus city was quickly abandoned, routes to Mexico and the Midwest were started and pulled. Unfortunately, Frontier found itself boxed in, and without significant name recognition beyond Denver, the carrier had difficulty making inroads elsewhere. Even if Frontier continues to fly as it does, there will be limited room for mainline expansion outside of Denver. From Denver, however, Frontier could continue to expand its Lynx services to new cities in the West. But there is no reason to think that the presence of Republic will help Frontier further mainline expansion plans.

So what's in this deal for Republic? Why would they want to own a carrier which nearly liquidated and which has few opportunities for growth? The answer is pretty simple. They're desperate. Regional jets are expensive. Very expensive. And with oil prices breaking $70 a barrel recently, combined with failed efforts at raising fares, regional jets are simply not going to be as widely used going forward as they once were. As a result, legacies are working hard to break contracts with vendors of regional lift and squeeze remaining suppliers. The old days, of little risk and steady returns for lift providers, are over. In its stead will be a much more competitive marketplace, with vendors desperately competing for remaining contracts and scrambling not to be left with extra jets.

How are lift providers trying to solve this problem? One way is by starting their own carriers. ExpressJet started its own (now defunct) carrier two years ago, Mesa's Go! continues to provide low-cost air service in Hawaii, and Atlantic Coast Airlines created the spectacular failure that was Independence Air. Why are these companies, which operate high-cost aircraft that don't provide good economics outside of a hub network, starting their own carriers? Not to repeat myself, but they were desperate, and alternative solutions (such as those described below) may not have been readily available.

For carriers that want to avoid the trap of starting their own scheduled service operations, there is another solution to keeping jets under contract. They can put equity in their customers (eg. legacy airlines). Republic has done this with Midwest and US Airways. Air Wisconsin did it with US Airways during that carrier's darkest hour a few years ago. Companies which fail to work with their airline partners to create environments where their lift will be needed will increasingly find themselves in trouble.

But here's the thing: Republic withdrew all its jets from its Frontier contract over a year ago, citing the need to redeploy the jets to other carriers. So why did Republic suddenly decide that they needed Frontier? Because the alternatives—including the real possibility that those jets they pulled won't stay very long in the hands of other carriers—are too disconcerting. Republic already has had experience putting equity in carriers it does business with. This move is simply a logical extension of that. And unlike starting its own branded service, Frontier is a well-known business with an established customer base. Frontier, if it comes back, should have a steady business in Denver, one which will be increasingly dependent on the use of smaller, regional aircraft for its revenues, and one in which Republic can use its aircraft to earn a steady, if modest, revenue stream. Perhaps, if Republic plays its cards correctly, it can spin off Frontier at a later date and recoup its investment.

Although Republic may not have wanted to own Frontier, it's quite possible that in this liquidity environment, very few investors would be willing to invest in a bankrupt airline, and Republic decided to take the chance. We clearly don't have the full picture on how the decisions about this move got made, but I suspect that it's an interesting story. But until that happens, continue to watch the regional lift vendors and what they do to secure positions for their jets. Carriers such as Midwest or even US Airways (once again) could be next in line for equity infusions.