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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
