Well, That was Fast...

Just a day after announcing that it planned to buy out Frontier, opening the door for a possible exit from bankruptcy, Republic Airways decided to purchase a second carrier, Midwest, from TPG Group for the princely sum of $31 million. This was down just slightly from the roughly $450 million TPG and its partners (including Northwest) paid for Midwest less than two years ago. And then today, Frontier announced that it will make schedule changes, adding mainline frequencies to several mostly leisure markets, as well as frequencies on Lynx to Salt Lake City, Omaha, and Albuquerque. Service to El Paso and Grand Junction, however, will be discontinued in September. This latter move is welcome, and a possible sign that the market may have bottomed or is coming close to bottoming. For an airline to add new flights during the fall months, let alone in the midst of a recession, is impressive. Obviously, it's anyone's best guess as to whether the new flights will be successful, and the stiff competition they will certainly face from Southwest can't help.

But let's examine the first move more closely. Republic essentially bought what has quickly become an airline in name only. Midwest is rapidly retiring its 717s, and plans to continue to do so even after yesterday's announcement. Instead, Midwest will use E-170s and E-190s operated by a little-known carrier called Republic, an arrangement in place well before yesterday's buyout. So why bother buying Midwest? Aside from being able to exert greater control over their lift, and being able to purchase a well-respected brand for a bargain price, there doesn't seem to be as much point to this move as there did with Frontier. At least Frontier is a well-regarded carrier which has managed to hold its own, if not expand (the announcement above notwithstanding), in the face of Southwest. Although it has adopted a more proactive attitude towards charging for services, Frontier hasn't taken away seat pitch, assigned seating, or onboard television, which are its signature amenities. But Midwest, although it has a well-respected brand, has significantly cut back on its amenities and service as a way to compete, adding more seats to its planes and drastically reducing its onboard food service.

At the end of the day, unfortunately, Midwest simply can't cut it against a strong Delta/Northwest and a nimble carrier with extremely low costs, AirTran. Midwest is bleeding money, unlike Frontier which has reported some small, but significant, profits. Republic's purchasing of Midwest will do little to change the situation at that carrier. Republic has not announced any major operational or strategy changes, and I fear that the end could be near as a result. Service will continue to suffer in the wake of cost cuts, and smaller jets will become uncompetitive in the marketplace since they have higher ASM costs than the larger 717s and 737s which AirTran operates. Many of the routes Midwest services have competing AirTran service, which is cheaper for customers and actually makes money. Midwest should have died long ago, absorbed as part of AirTran. But that opportunity has come and gone, and now it's time to recognize that Midwest, no longer what it once was, will end its days as a small, regional operator before eventually being shut down, with the jets likely going to other airlines Republic contracts with.

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.