Tuesday, February 28, 2006

Simmons Air Saga

After much turmoil and confusion, Simmons Air aparently has more hurdles to leap before finally taking off from Ocean City. The good news is that the piggy-back relationship with Cape Air for its certification & operational expertise is done. It appears to be a wet lease/cost-plus arrangement with Simmons taking on the risk that the passengers for Ocean City-BWI are ready to fork over cash for the service. We’re not aviation lawyers, but we don’t think there is much to do on the regulatory side for Simmons at this point if they use the Cape Air name thus avoiding the approvals surrounding a d/b/a arrangement. In the article, it is claimed that Simmons is suggesting that there is. If someone knows for sure please let us know. There certianly is a chance that Simmons and/or his supposed 650 investors are getting nervous about re-starting service that apparently had little market support when it was originally launched.

Monday, February 27, 2006

Allegiant Rising Fast

As noted in this article referenced by a pro-Worcester Airport blog, Allegiant has no plans to stop growing. We have been hearing that they have been starting to make the rounds of banks in hopes of putting together an IPO for sometime this year. We'd expect Raymond James to be in the mix as they acted as an agent in the private placement of equity for Allegiant in the spring of 2005. Although it took a while to put together, Raymond James came through by attracting reputable investors such as Declan Ryan. Ryan is best known for his stake in Ryanair and Tiger Airways. We'd expect Morgan Stanley to be a part of it as well. Why? Name one airline IPO they haven’t been a part of in the past 5 years.

Besides making Maury Gallagher an even more wealthy man than he already is (we assume he cashed out of a bit of his Valujet equity before the stock’s descent), an IPO would also provide even more capital for this already cash rich company to grow. The company said they were sitting on $60mm in cash late last year. That plus the IPO funds would go a far way for a company whose cost of growth is low. MD80 prices have risen to just a few million above part-out levels to $5mm-$9mm (meaning they're still dirt cheap). Since they serve empty airports, they often get nice incentive packages as well. The MD80s might burn a little more than other types, but at that price it’s well worth it.

So they have the airline humming side-by-side with the travel company business and lots of cash to grow, plus there are plenty of sure-fire profitable markets to grow into….or is there? Yes there are, but that brings up one area of concern about Allegiant. They have a spotty market planning record. You might say that they should have a spotty record given that they enter tertiary markets, and we would agree. But, as of summer 2005, they had pulled out of 25% of their markets over only a 5 year period. The Baton Rouge debacle is legendary. This is a cause for concern as it drives doubt about their claims of the mass of growth opportunity remaining and how much time & resources they will waste as they move lower and lower down their list of airports to grow into.

Start-ups: Upcoming Short Series

We’ll be putting together a short series on just a couple of the start-ups in the market for capital. This post is a brief primer on the start-up environment in early 2006.

It is apparent to just about everyone by now that starting new airlines is a favorite pastime of the wealthy, the not-so-wealthy, and everyone in between. There is a tried and true collection of jokes about start-ups. You know…they usually start with something like, “Do you know how to get a million dollars quickly?” …We’ll spare you from reading the punch-line.

Well, the start-up business plans keep coming. What is interesting is that some of these start-ups are capturing the attention of the most reputable segments of the industry. Why? For starters Virgin America captured the attention of Airbus, Boeing, GECAS and others very early on in their financing process because the team had the Virgin name on the cover page of its pitch book and because they had a rich billionaire behind them. Some of the other start-ups out there have done it the hard way. Yes, solid business plans have been built up slowly over many years, data has driven strategic planning (not the distant location of a relative of the CEO), and solid management teams have been recruited. Important is the fact that the giants of the industry such as the major lessors and banks recognize that there is a big opportunity right now for new entrants in the US. What opportunity? Doesn’t the market have too much capacity, not too little?

Let’s just skim the surface here instead of giving the long answer:
Ryanair cost per passenger: $46
easyJet cost per passenger: $76
Southwest cost per passenger: $94

So do Ryanair and easyJet have incredibly low costs or does Southwest have high costs?

Short answer: Southwest has high costs.

Slightly longer answer: Ryanair, easyJet, Gol, and Air Asia all learned from Southwest and each other and have perfected the point to point low cost model. Put simply, the highlights of the successful point to point model include flying lower stage lengths (maximizing departures per day per aircraft), high seat density, and scaleable networks that drive productivity. Wage rates are important too, but their importance tends to be greatly overstated by American legacy carrier CEOs who have no choice but to go after the low hanging fruit that pay rates are.

Luckily for Southwest, just about every other carrier in the US has higher costs than it does, thus its strong market position. Incredible as it may seem, the true low cost model described above is not practiced by any other US airline…beside Southwest. Unfortunately for Southwest, its desire to grow roughly 10% per year has driven the carrier further and further away from the network structure that drove its low costs over the past few decades. It is true; after all, that Southwest’s cost advantage today has as much to do with fuel hedging as any other factor. It’s equally true, however, to say that the only way its balance sheet was strong enough to hedge when they did and to the level they did was because of the adherence to the pure point to point low cost model that it practiced through the 90’s (this subject is worthy of a separate post …it’s amazing how many slides of other airline’s that I had to sit through at the JP Morgan conference last week whining about Southwest and its hedges).

Although Southwest’s employees are still very productive, they are becoming less so because the pursuit of the growth opportunities that the airline needs to impact its earnings do not fit the point to point low cost model that got it where it is today. And, after 30 years, a legacy structure will develop along with higher wage rates. That will catch up with just about any carrier of that age. Southwest is no exception. It has the highest wage rates in the industry in many of its labor groups.

So there is no reason why much lower costs than Southwest (let alone the majors) can’t be achieved in the US market by a new entrant. That is why there is an interest in start-ups. The American airline’s cost structures are unnaturally high and that presents opportunity in the largest air service market in the world. The story on the cost side is set.

Now the problems begin. Where do you find the revenue? And, if you find it, do the opportunities properly fit the point to point low cost model described above? Just about every revenue opportunity in the States is being hoarded by the existing carriers, and those carriers won’t give up most of their sources of revenue without a fight. In these cases of aggressive revenue protection, the low cost provider is usually not the survivor. Why? Could those economics books we all took in the first year of undergrad actually be wrong? Well, this isn’t a game of economics. It’s a game of politics. United lost untold millions by competing head to head with Independence at Dulles…during their bankruptcy. Even in bankruptcy, the existing carriers have enough power with frightened creditors and politicians to afford to try to kill new entrants that attempt to poach long-held revenue streams. These new entrants need to spend more time in refining their revenue strategy than in any other area. If the revenue strategy is developed properly through credible political partnerships, competitive diversification and/or insulation, then the next crop of start-ups just might have a chance to thrive. We’ll get into the individual revenue strategies of the start-ups we profile as this series unfolds.

Sunday, February 26, 2006

Skybus Ready to Roll?

We've heard that Skybus has its funding in place. Columbus' Mayor's speech last week certainly lent some credibility to that.

We'll get more into Skybus, their business plan, their financing story and why startups are getting attention from credible pockets in the industry in the near future.

US Department of Labor Begins Investigation of Aloha

This does not seem to be much of a concern. If the reports are true, it focuses on events before the bankruptcy. We’ll provide updates if the situation develops in such a way that may affect Aloha’s current strategic positioning.

Saturday, February 25, 2006

Trouble Brewing at Sun Country?

A partnership holding a minority equity interest in Sun Country has filed a suit in a Minnesota court against the airline and other investors/management. One of the partners is a local entertainment attorney and the other is a real estate developer also located in the MSP area. The article suggests that the partnership feels that they deserved or were promised a bigger piece of the now expanding equity pie immediately following Sun Country’s emergence from bankruptcy. If that is the case, it seems a bit suspicious that it would be brought up by the partnership now…when the increased investment’s value would likely increase in an arbitrage-like fashion if the equity infusion takes place. Petters would not want to walk into the Sun Country equity purchase with a lawsuit hanging over it. That will give the partnership group some leverage with the company. We’ll keep an eye on this.

A bigger concern in our minds is the hint that Sun Country would focus the use of the new equity at MSP. Just because Northwest is weak, does not make them vulnerable. If anything, it makes them a more irrational competitor than ever.


Welcome to the Emerging Airline Monitor.

Here you will find frequent news and comments about smaller US-based air transport companies. We will focus on the business and strategy of these carriers as opposed to the operational aspects.