Republic growth strategy fraught with risk

By purchasing two struggling airlines for which it flies, Republic Airways Holdings is taking aboard substantial risks that threaten its profitable niche, analysts say.

Frontier Airlines and Midwest Airlines are not only leaking money, but fly at an altitude where major carriers routinely dogfight in a fare war Republic hasn’t had to fight as a contract carrier.

The two contracts account for a mere 3 percent of Republic’s $1.5 billion in regional airline revenue.

In flying contract routes for clients such as Frontier and Midwest, Indianapolis-based Republic has been able to pass on to the mainline carriers the soaring price of jet fuel. As the owner of two of those carriers, it couldn’t do that.

"By pursuing such a risky strategy, Republic risks surrendering a competitive niche it has worked so hard to build. The industry is littered with casualties of carriers that tried to grow too fast," said Joseph Schwieterman, a professor of transportation studies at DePaul University, in Chicago.

Airlines are devalued at the moment, he said, and, "Republic is seizing the initiative, despite the risks."

Yet the two airlines Republic wants to buy are "very troubled assets," says Jay Sorensen, a former Midwest Airlines executive, now president of Shorewood, Wis.-based airline consultancy IdeaWorks.

Frontier is already in Chapter 11. Midwest, which lost $447 million last year, would be in bankruptcy if not for Republic’s pumping in millions of dollars previously to prop it up.

Analysts are also concerned because Republic, as a contract carrier, lacks experience directly marketing or selling tickets to passengers. Nor, said Sorensen, does Republic have turnaround experience in this arena, "and that is what these two assets require."

"I look at this deal and I shake my head. I don’t understand what they’re doing," Sorensen added.

Defensive move?

For his part, Republic CEO Bryan Bedford isn’t saying much. He couldn’t be reached for comment. But when announcing the Frontier and Midwest deals in the span of two days, he emphasized the need to maintain revenue diversity. He noted the merger of Republic’s largest customer, Delta Air Lines, with Northwest Airlines last year, and the likelihood of additional carrier combinations ahead.

In agreeing to buy Midwest, for $31 million, and Frontier, for $108.8 million, Republic also gets carriers with brand recognition. Frontier’s hub is Denver International, while Midwest operates principally at General Mitchell International, in Milwaukee. Republic becomes a two-hub company—therefore potentially one with enough critical mass to wield a punch.

Bedford told Midwest employees he planned to grow the carrier, which has been rapidly shrinking amid its financial troubles, to levels of nearly a year ago.

At the same time, Republic said it would bring cost savings to Midwest, such as shunting some of its back-office functions to Republic. The biggest potential savings would be in replacing Midwest’s line of MD-80s and Boeing 717s with more fuel-efficient 70- and 94-seat Embraer jets.

"They control the manner in which the aircraft are operated and enhance the revenue stream," said Robert Mann, CEO of airline consultancy R.W. Mann & Co. in Port Washington, N.Y.

But there could be unintended political consequences for Republic’s core regional business.

Frontier happens to be United Airlines’ arch rival in Denver. At the same time, United is Republic’s third-largest customer, generating 21 percent of Republic’s 2008 revenue.

"I can’t imagine United is very thrilled at this moment" with Republic, Mann said. He wonders whether that could hurt Republic when its United contract is up.

Moreover, Republic’s ownership of carriers with larger planes, such as Frontier’s Airbus A320s, could incite labor unions representing pilots for the major airlines for which Republic flies its regional jets. Mann points to the so-called scope clause that prohibits regional carriers from operating aircraft above a certain size.

"The interesting thing will be to see if some pilot group comes out of the woodwork to exert their scope clause limitations," he said.

Major meddling

There may be some other surprises to emerge as well.

The same day Bedford was in Milwaukee to announce the Midwest deal, Southwest Airlines announced it was expanding into that city.

And Southwest is becoming formidable in Denver—Frontier’s home—as well.

If the competition from Southwest isn’t enough of a problem for Republic, then closing the deal on Frontier might be another. Other carriers can still make a bid for Frontier in bankruptcy court, Sorensen noted, wondering if Southwest may step in.

It wouldn’t be the first time.

During the first bankruptcy of now-defunct ATA Airlines in 2004, Southwest swooped in at the last minute and topped an offer AirTran Airways made to acquire ATA gates at Chicago Midway Airport. Midway was ATA’s hub and ATA was Southwest’s biggest competitor in Chicago.

At least ATA was a veteran of the ruthless price wars among major carriers. Republic, for all its success in the regional airline industry, is not. Republic’s foray into owning major carriers reminds Sorensen of the unsuccessful attempt by regional carrier Atlantic Coast Airlines to enter the mainline business.

The Virginia-based regional entered the cutthroat sector after losing a contract to fly regional jets for United. In 2003, ACA was remade into Independence Air, operating as a low-cost scheduled carrier at Washington Dulles. It went from 50-seat regional jets to much larger Airbus A319s.

But it didn’t last long—Independence filed for Chapter 11 a couple of years later and ceased operations in 2006. Some blamed lack of operating experience in mainline service and wounds from established carriers that slashed fares in Independence Air’s key markets to drive it out.