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The old rumor mill got another one right. AMR Corporation (AMR), American Airline’s (‘AA’) parent company, recently announced its intention to move ahead with a spinoff of American Eagle, its short-haul regional carrier. Eagle, the US’s third largest regional airline (at least based on aircraft operated – it’s fourth in fare-paying passengers), generates revenues from operating flights and from ground handling services.
The move isn’t unexpected considering it has been under ‘consideration’ for close to five years now and American is one of the last airlines still retaining its in-house regional business. Theoretically, at least according to the recently filed Form 10, a split will benefit both companies as AA will be able to diversify its regional carrier usage (Eagle operates 93% of its regional flights) to cheaper options and Eagle will be able to pursue business from other airlines.
Immediately following the spin, American will likely still be Eagle’s only customer though and the two companies have hammered out a nine-year agreement dictating their relationship. The deal allows for some contracts to expire (via aircraft retirement or rebidding) after set dates and the sections detailing the agreements are must reads within the Form 10.
The companies have agreed to a capacity purchase agreement (‘CPA’), which in other words means that Eagle generates a fixed fee for operating routes on behalf of American, who determines the flights’ pricing, seating and other related items. Most of the expenses are passed through to American aside from things like labor and airplane maintenance. A CPA is designed to protect the regional airline from some of the wild fluctuations which affect the industry such as oil prices and ticket prices.
Controlling those costs, especially labor, will be crucial going forward. Eagle believes its “labor costs are higher than those of most other regional airlines” due to an experienced, but pricey unionized labor force. Not a good trait for a company operating in an industry with razor thin operating margins.
Eagle’s current fleet might also pose a problem, as 72% of its jets have 50 or fewer seats. These have recently been money losers and most regional carriers are switching to larger, 70 seat jets in order to combat higher fuel prices. Eagle hasn’t been able to adjust its fleet due to limits set in its contact with American’s pilot union.
One positive for the company is that American has agreed to take ownership of all Eagle aircraft and its associated debt. This move will leave Eagle with a relatively clean balance sheet and some needed flexibility with its capital structure. Eagle will lease the aircraft from American for a nominal fee. The move should aid Eagle in its pursuit of new business especially where it might need to purchase new aircraft.
Some competitors to examine for comparable analysis include: Pinnacle Airlines (PNCL), Skywest (SKYW), Republic Airways (RJET).
Airlines are a tough businesses and I think Warren Buffett has some choice words about the pains of investing in the industry. The spin could be completed as soon as the end of this year and we will keep you updated as more information is released.
Disclosure: Author holds no position in any stock mentioned.
