What’s Atlantic Coast’s True Motivation?

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What’s Atlantic Coast’s True Motivation?


Prepared by Chip Munn, June 30, 2003

Atlantic Coast Airlines (ACA) decision to break ties with United Airlines (UA) to start its own low-fare carrier is an interesting development and regardless of how the dispute ends, one likely loser is UA.

AC said it expects to begin an independent operation and cancel up to 34 orders for 50-seat regional jets in favor of 15 to 25 larger aircraft from Boeing or Airbus, which will further increase the unit costs for an already high-cost regional jet (RJ) operator. The Company has selected Skyworks Capital to assist it in the acquisition of larger aircraft that would allow service on longer routes. In addition, the company has hired GKV Communications, an independent Baltimore-based agency, to create its first advertising and branding campaign.

The ACA plan has been met by significant skepticism among investors with the stock sliding to a 3-1/2-month low of $6.78 on Tuesday with industry observers questioning the move partly because the airline will lose 85 percent of its revenue if the UA agreement is rejected.

J.P. Morgan analyst Jamie Baker Baker questioned the plan to launch a low-fare carrier using 50-seat RJ’s. We are highly skeptical of Atlantic Coast''s plan to transition to discount-carrier status, Baker said in a research note.

Jim Higgins, Credit Suisse First Boston analyst said, No one who owns this stock bought it for the uncertainty they now face. An ACA that is largely detached from the only direct source of demand for its product (UA) looks to us to be a competitive sitting duck for a genuine low-cost carrier already operating larger jets -- JetBlue and AirTran come to mind.

ACA has about $189 million in cash and cash equivalents and only $53 million in total debt at the end of the first quarter, therefore, the airline will have a relatively strong balance sheet entering its independent operation. But it is far from certain how the airline will succeed when during its first day of independent operation it will see an 85 percent drop in revenue obtained from its UA relationship.

In addition, AC, not UA, hold the Dulles gate lease agreements for all of the flights it operates as UA Express. That means UA would need to scramble to arrange for new gates and for a new carrier(s) to provide UA Express service at the same level – which will be difficult.

Thus, if the move is so risky than why would ACA attempt to end its relationship with UA and what are the risks for UA? Moreover, why could ACA chief executive officer Kerry Skeen be forcing UA chief executive officer Glenn Tilton’s hand?

Before ACA can proceed with its plan to become an independent airline, UA must decide to either honor the current marketing agreement or reject the agreement in its entity, before the carrier can exit Chapter 11. If UA decides to keep its current ACA contract in place than the bankrupt airline would be required to pay above market RJ feed rates, which could make the Dulles hub unprofitable during the current industry restructuring.

If UA decides to reject its ACA lease and replace the RJ operator, then UA must find a replacement airline to operate 158 Dulles departures to 40 cities in the Northeast, Midwest, and Southeast, currently flown under the United Express banner by ACA. This would be no easy task because Tilton would have to find an airline willing to put the infrastructure in place at most of the 40 airports and to operate at the Dulles hub, similar in scope to ACA’s current operation.

Analyst Michael Linenberg at Merrill Lynch said, We think the possible disruption to UA and resulting adverse economics would effectively negate the financial justification for a hub at Dulles; not what UA needs right now given its financial condition.

Therefore, the move will make it harder for UA to successfully emerge from bankruptcy, continue to operate its Dulles hub, and find a suitable partner. UA would need to find new space at Dulles and find a carrier who could set up a regional network with spoke city operations. Thus, could UA be forced to throw in the towel at Dulles?

UA management appears to be once again caught in another quagmire because the airline appears unprepared to react to the ACA announcement. In a press release UA said it was surprised by ACA’s decision and the company left open the possibility of a code share deal, which from this observer’s perch could be Skeen’s real motivation, but UA could dearly pay for a future relationship.

Why? I believe Washington-based consultant Morton Beyer said it best. They (ACA) don’t have reservations, sales, marketing, or ticket-counter facilities at airports. The biggest problem is no regional carrier has been able to go it alone. I think it’s an unmitigated disaster, Beyer said.

Regardless, how UA proceeds further clouds the company’s future, the Dulles hub is now at risk, and the ACA news will have an effect on UA’s potential Plan of Reorganization. Either way, UA will be a loser to ACA’s bold move, which will make it more difficult for the Chicago-based airline to successfully emerge from its formal restructuring.

Separately, US Airways (US) could be hurt by ACA''s plans to cease operating as a UA partner and convert to a low-fare carrier.

The move would put pressure on US’ fares at Washington National Airport and could create some traffic diversion. Josh Marks, associate director of the aviation institute at George Washington University said, If ACA pulls this off, they will hose US’ high-end revenue base at National. However, during its analyst’s conference call on Monday US chief executive officer Dave Siegel said, I''m confident that ACA will turn itself into a low-fare airline, but there''s never been anything low-cost about them. I’m more than a little skeptical they can be a low-cost airline.

Best regards,

Chip
 
True Motivation? Same as with any business....MAKE MONEY! They did not like what they could get from United and decided on another path.

Only airlines making a go of it these days doing it are LCCs. Consumers and the investment community believe it too.

BTW, they plan to buy Boeing or Airbus - I don't think the expansion is primarily based on flying 50 seaters.

Hurt United and USAir? Absolutely. LCCs are here to stay. Southwest and JetBlue are not the end of it.
 
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On 7/30/2003 11:59:52 AM ual06 wrote:

Why is this on two boards ?

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Just in case you didn't get to the other board. Thanks Chip, very informative! Looks like we're in for some more cuts.
 
N230UA:

I saw all of the articles you referenced, however, could these be additional orders? If not than UA could have a huge problem on its hands at IAD and its ability to emerge, unless it eliminates the hub, which the creditor's committee previously requested.

Best regards,

Chip
 
Earlier today I thought ACA chief executive officer Kerry Skeen was trying to force UA chief executive officer Glenn Tilton's hands to obtain a better deal, but tonight's news...makes me think UA is scrambling to find a replacement operator, thus UA must believe ACA is moving forward to fly as an independent airline.

Specifically, Reuters reported two U.S. regional airlines on Wednesday said they were in talks with Bombardier Inc. on firm orders for 55 regional jets that would be worth up to $1.5 billion at list prices. Mesa Air Group Inc. and SkyWest Inc. need the regional jets to provide new or expanded feeder service for long-term agreements with bankrupt United Airlines.

Complete Story: [url="http://www.reuters.com/newsArticle.jhtml?type=topNews&storyID=3190926"]http://www.reuters.com/newsArticle.jhtml?t...storyID=3190926[/URL]

Best regards,

Chip
 
Chip, you're late to the game.

These orders by Mesa and SkyWest were announced well in advance to yesterday's Reuters article.

The article is simply stating Mesa and SkyWest will be officially completing the transaction for a/c with bombardier.

Look before you post.

Feb. 27, 2003: "United Airlines, Mesa Air Group Reach Agreement; Mesa to Become 4th United Express Carrier In July"

June 10, 2003: "United Reaches Agreement with SkyWest Airlines on New Rates and Fleet Growth"

July 1, 2003: "Mesa Air Group Announces MOU With United Airlines for Up to an Additional 60 Regional Jets"

Finally, United had a contingency plan for ACA defecting:

July 2, 2003: "United Reaches Agreement with Air Wisconsin on Amended United Express Contract... an additional 20 regional jets in the United Express program in Washington, Chicago and Denver."

July 10, 2003: "United Reaches Agreement with Trans States Airlines... 25 50-seat regional jets. These aircraft will be in service within months."
 
United today, in response to speculation that it may close its hub at
Washington Dulles, said the airport will remain an important part of the
company's unsurpassed global route network.

"We are committed to keeping Washington Dulles as one of our hub
airports and to providing all of our customers and constituents in the
Washington, D.C., area with the highest levels of service on a flight
schedule that fits their needs," says Doug Hacker, United's executive vice
president-Strategy. "No matter who we choose to operate as a United
Express partner at Dulles, we will continue to offer our customers non-stop
service to all destinations that are currently serviced by Atlantic
Coast Airlines under the United Express brand."

United has been the largest carrier at Washington Dulles since it named
the airport as a hub in 1985 and will continue to be the No. 1 airline
in Washington. The company's ability to connect traffic to Europe,
Latin America, Asia and the West Coast, as well as provide service to key
East Coast destinations, makes Dulles a strong part of United's
hub-and-spoke network.

Key Facts About United's Service in Washington:

* United is the only carrier serving Europe, Latin America and the
U.S. West Coast non-stop from Dulles;

* United is the only carrier that offers service from Washington to
all three New York airports;
United and United Express will continue to offer more than 240 daily
flights to 69 non-stop destinations from Dulles;

* From all three Washington-area airports, United and United Express
will continue to offer our customers 270 daily flights, including
non-stop service to the U.S. West Coast from both Dulles and Baltimore;

As United stated earlier this week, customers are not affected by ACA's
recent announcement and can continue to book confidently with United
and United Express for any of their travel needs. The current contract
with ACA to provide United Express service remains in full force and
effect. While the company believes that it is still possible a deal can
be reached, United has an alternative plan that will provide continuity
of United Express service to our customers should a deal not be
negotiable.
 
Relax everyone. I think Chip, (as usual) is blowing this way out of proportion. UA is not giving up Dulles, and will continue to serve all routes currently served, whether it is through ACA or an alternative.


Everybody grab a cold one and chill!
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Out of curiosity, does anyone know when and how ACA gained control of the Dulles gates and facilities? I would imagine that UA controlled them from even prior to the 1985 hub-founding until recently. Why were they transfered? How much did UA get for them?
 
UA's public announcement is likely designed to provide confidence to the traveling public and employees that the hub will continue operation. One of the major airline bankruptcy concerns is passenger defection. Unlike another commodity business, when a customer buys a ticket they spend their money, but may not receive the benefit of this expense until months later.

Obviously, if passengers begin booking away from UA how will this effect the airline and in particular the stringent DIP financing requirements that tighten every month.

It was important for UA to issue this information, but nobody truly knows ACA's intention. Furthermore, if UA was "surprised" by ACA's announcement to part company with the major airline, I believe it's unrealistic to believe two days later UA has "alternatives" in place for 40 markets.

Yes, there should be employee concern because this issue clearly clouds UA's future even more.

Best regards,

Chip
 
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On 8/1/2003 4:55:04 PM Chip Munn wrote:

Yes, there should be employee concern because this issue clearly clouds UA's future even more.

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Thanks for pointing out how we ought to be feeling about this. We wouldn't want any UA employees feeling good about anything now, would we...

New slogan: Chip's not happy, until UA employees aren't happy!
 
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On 8/1/2003 4:55:04 PM Chip Munn wrote:


I believe it's unrealistic to believe two days later UA has alternatives in place for 40 markets.----------------​

Can you say UA* codeshare flights? Are there any UA/ACA markets that arent accessable by a UA* flight operated by USAirways?
 
Perhaps the real question should be "What's UAL's True Motivation"? There is an old saying "Beware Lezarus ye Stompus". Could it be that UAL is encouraging ACA to stomp on the family jewels and thereafter possibly gain control of those express gates at IAD?
 
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On 8/1/2003 4:55:04 PM Chip Munn wrote:


UA's public announcement is likely designed to provide confidence to the traveling public and employees that the hub will continue operation. One of the major airline bankruptcy concerns is passenger defection. Unlike another commodity business, when a customer buys a ticket they spend their money, but may not receive the benefit of this expense until months later.
 
Obviously, if passengers begin booking away from UA how will this effect the airline and in particular the stringent DIP financing requirements that tighten every month.
 
It was important for UA to issue this information, but nobody truly knows ACA's intention. Furthermore, if UA was "surprised" by ACA's announcement to part company with the major airline, I believe it's unrealistic to believe two days later UA has "alternatives" in place for 40 markets.
 
Yes, there should be employee concern because this issue clearly clouds UA's future even more.  
 
Best regards,
 
Chip  

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The alternative is named US Airways, or should I say Mid Atlantic?

US Airways, the United Connection!
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