Once-mighty Mesa Air Group must shrink substantially to survive
by Dawn Gilbertson - July. 07, 2010 12:00 AM
The Arizona Republic
On a blue canvas behind the reception desk at Mesa Air Group's headquarters, a US Airways Express regional jet towers over photos of the smaller planes the commuter carrier flies for other airlines.
The artwork is a few years old but serves as a fitting symbol of the dominant role US Airways is playing behind the scenes as once-mighty Mesa tries to restructure its shrinking business and emerge from Bankruptcy Court protection.
At stake are Mesa's 3,200 jobs, a corporate headquarters and a long-term relationship with deep roots in Arizona.
Mesa, based in Phoenix, doesn't fly planes under its own banner. It has contracts with major airlines to operate commuter flights out of their hubs. In Phoenix and Charlotte, N.C., it's US Airways Express; Chicago, United Express; and New York, the Delta Connection.
All but its US Airways business has been declining dramatically, precipitating Mesa's bankruptcy filing in January.
Tempe-based US Airways, whose partnership with Mesa dates back more than 20 years and has seen both sides in distress, holds considerable sway in the 6-month-old Chapter 11 case because it is Mesa's largest remaining client and has just two years left on its contract.
That has Mesa working hard to negotiate with US Airways and its aircraft lessors to extend the agreement beyond 2012 so the regional airline emerges from Chapter 11 without the threat of renewed financial troubles less than two years down the road. Some industry watchers say Mesa can't survive bankruptcy without an extension on the US Airways contract.
Mesa and its creditors committee say that's not the case, given its cash on hand and remaining years on the contract. Other options for the company include seeking an investor or a buyer.
The matter is expected to be decided this summer against a dismal backdrop for the regional airline business.
Industry doldrums
Mesa filed for Chapter 11 in January because it has too many airplanes for the current market, too many of the wrong types of planes and entered into a series of less-than-successful ventures.
Regional airlines such as Mesa are dependent almost solely on their major airline partners, and they have been shrinking dramatically over the past two years as the industry struggled through an oil crisis and unprecedented recession.
Fares on commuter routes have also fallen due to increased competition in secondary cities from Southwest and others.
It all adds up to reduced demand for the smaller jets that were the darling of the industry fewer than 10 years ago. Nearly half of Mesa's planes are 50-seaters.
"This is an airplane that is really limited in its revenue potential and is an airplane that at $50 oil is kind of right on the edge," said Bill Swelbar, a consultant who is now a researcher at the Massachusetts Institute of Technology's International Center for Air Transportation. "The economics have just kind of turned upside down."
Oil ran up to nearly $150 a barrel two years ago and is now over $70 a barrel.
Mesa has the additional challenge of a history of operating woes, a fact the company blames on the congested airports it serves, including New York and Chicago, for Delta and United. Delta fired Mesa from two contracts because it said it had too many flight cancellations and delays in certain markets. Mesa notes that its performance in Phoenix, in contrast, is strong.
When major airlines cut back Mesa's flying or a contract ends, the airline is left with a bad equation: planes with long-term leases and no incoming revenue. It's akin to someone with a pool of rental houses having tenants move out en masse yet still having to pay the mortgages.
The lease payments were crushing Mesa. Mesa tried to find new homes for the 50-seat planes major airline partners were returning, but the efforts fell far short of expectations.
A touted joint venture in China never got beyond five planes and ultimately failed. The airline moved a handful of planes to Hawaii to start its own interisland service, Go!, but that service has not expanded as planned due to fierce competition and other factors.
Mesa tried to negotiate lower aircraft-lease rates for its planes outside of bankruptcy, among other efforts, but was not successful.
The upshot: a slew of planes with nothing to do. Mesa entered bankruptcy with 178 planes in its fleet, 52 of them out of service and another 25 headed that way. That's 43 percent of its fleet.
United is down to 20 Mesa planes in service, fewer than one-third the number in service a year ago. Delta is returning 22 planes in August on top of more than a dozen earlier.
Mesa has 53 planes in service at US Airways. Without US Airways' considerable business, the company that once counted $1.3 billion in annual revenue has little left.
A quiet case
The first six months of Mesa's case have been pretty sedate, at least publicly.
No major objections have been lodged to key issues on record, no high-profile moves have been launched to replace management and no protests have arisen over Mesa's spending. Capt. Angelo Matziaris, chairman of the airline's pilots union, which is a member of the creditors committee, said "everything is going as advertised."
The only items on the docket that might count as "controversial" also haven't caused a stir: an anonymous letter to the judge criticizing chairman and chief executive Jonathan Ornstein's management of Mesa and a filing that discloses Mesa's financial adviser, Imperial Capital, hired Ornstein's daughter to be a summer intern in human resources.
"This is the quietest bankruptcy in the history of the airline industry," Swelbar said.
One possible reason, he suggested: Mesa wouldn't necessarily be missed in a business that all expect to continue to shrink given the poor economics and major airline mergers.
"It's a less relevant story today than it would have been eight to 10 years ago," Swelbar said. "It's really a non-event."
Ornstein said the relative calm stems from the fact that the parties in the case are aligned to keep Mesa in business. The planes it plans to keep are larger regional jets with as many as 86 seats.
"These are people we've known for a long time," he said. "Everyone's working cooperatively. If we weren't, we'd be hearing it from the creditors."
He calls Mesa's case a "technical bankruptcy" because it filed simply to reject aircraft leases as bankruptcy laws allow. It plans to shrink from 178 planes to fewer than 80 to match its fleet with the current demand for regional flying. The employee base will shrink to about 2,500 and it will move across the street from its current headquarters to save money on its rent.
Mesa did not seek emergency financing when entering Chapter 11. It has not sought financing since then. Ornstein said there is no need because Mesa is generating cash from its operations.
The company has generated $52 million in cash from its operations since it filed, according to its monthly financial reports. It ended May with $60 million in cash, double the amount it had when it filed, though that figure is boosted by not paying the leases on the planes it's returning.
Mesa has a cumulative net loss of $3.6 million on revenue of $337 million between January and May. It posted a $6.3 million profit on an operating basis.
"That changes the dynamics (of a case) when you are operating with your own cash as opposed to a lender's money," said Lorenzo Marinuzzi, a partner with Morrison and Foerster, which represents Mesa's unsecured creditors committee. Members include regional jet manufacturers Bombardier and Embraer and the Air Line Pilots Association, which represents Mesa's pilots.
Things are often more acrimonious when there is a bank or other outside lender keeping tabs on its money, he said.
Marinuzzi said there have been no surprises in the case but calls it a difficult one.
"This is a challenging case in a industry that is almost always challenging to begin with," he said. "There's just not a demand for this kind of flying at the rates currently being paid."
A US Airways deal?
Major airlines such as US Airways want to pay regional airlines less to operate the commuter flights, if they do at all, because the economics have changed so much in the past few years.
They have the upper hand and know it, with some commanding cash up front from regional airlines to secure a long-term contract. ExpressJet recently gave United Airlines stock benefits worth an estimated $11.2 million as part of a new contract that replaced Mesa's business. Industry officials call it "pay to play."
That portends a hard sell by US Airways as Mesa seeks to extend the contract, its preferred route out of Chapter 11.
The two have been partners since US Airways was America West. Mesa invested in the airline when it came out of Chapter 11 in 1994 and considered making a large investment when America West bought the old US Airways out of bankruptcy in 2005. Mesa also had a long relationship with the old US Airways before its merger with America West and made financial sacrifices during that airline's 2004 bankruptcy.
"USAir has been our friend, and we've been partners with them for a long time and helped them," Ornstein said. "But don't think for a second that they're not trying to figure out every ounce of leverage they have to use against us."
US Airways executives declined to comment on negotiations. But President Scott Kirby said in the airline's employee newsletter in May that the airline either needs to replace the planes at Mesa with another carrier when the contract is up or extend the deal "for a long period of time." He expected the matter to be resolved this summer.
Kirby has told the airline's pilots that US Airways wants to get rid of the eight 50-seat jets used by Mesa and strike a better deal on the roughly three dozen 86-seat jets Mesa flies for it.
Wall Street analysts are already penciling lower Mesa costs in their financial outlooks for US Airways given Mesa's weak bargaining position.
One analyst said in a report this month that he assumes Mesa needs to extend its contract with US Airways to exit Chapter 11. He even mentioned Mesa's liquidation as a risk for US Airways because it would disrupt their commuter operations.
To cut costs like US Airways wants in exchange for a long-term contract, Mesa has a lot of work to do. It will have to convince smarting lessors to reduce its lease payments, make financial sacrifices of its own and possibly turn to labor groups for concessions.
"If we get a deal done with US Airways, it is not unlikely that the creditors who are going to be kicking in the bulk of the money are going to ask, 'What will everyone contribute, including management, including employees,'" he said.
Mesa has new pilot union leadership, and Ornstein concedes they were not warm to the idea of concessions when the topic was briefly discussed. The pilots, who have seen their ranks shrink by 400 to 1,000, with more furloughs on the way, said lease costs, not labor, are Mesa's primary problem. Ornstein said for now they have been left out of the equation.
"We're not going to sit here and fight everybody over it," Ornstein said. "This is going to be a cooperative effort or it's not going to get done."
Marinuzzi said if the talks aren't progressing, a decision has to be made whether to move on so Mesa doesn't linger in bankruptcy.
"The question is, at what point does it no longer make sense to try to negotiate for long-term extensions?" he said.
Other options
Ornstein bristles at the suggestion that Mesa won't survive without a new deal with US Airways.
He said Mesa can emerge from bankruptcy this fall by simply assuming the US Airways contract as it is. The guaranteed revenue for the next two years and the company's growing cash balance would buy it time to renegotiate the US Airways deal or figure out other options for the 86-seat planes, which he said are still in demand.
Marinuzzi doesn't disagree.
Ornstein said Mesa does not need cash to emerge from Chapter 11, but bringing in an investor is not out of the question. The creditors committee has approached potential parties but declines to discuss specifics or the level of interest.
An outside investment would bolster its finances and might give it more bargaining room in its talks with US Airways, whether now or as the contract expires.
A purchase of Mesa by a competitor or other buyer is not out of the question but is a long shot given industry struggles, observers said. There also would be labor hurdles to overcome, and any deal would have to be approved by its major airline partners.
US Airways might even be interested at the right price. It already owns two commuter airlines, PSA and Piedmont, which operate out of its East Coast hubs, and could add Mesa to the mix.
Thus, most of the alternatives lead back to US Airways.
"I think there would be more (outside) interest in a Mesa that has a long-term agreement with US Airways," Marinuzzi said.
Mesa hopes to file a plan of reorganization by the early September deadline set by the court. It has already received one extension. Multiple extensions are not uncommon in large cases.
Swelbar sees a rocky road.
"It's just a simple truth that there are structural issues taking place inside the regional sector that are going to make filing a plan of reorganization difficult," he said.
Read more: http://www.azcentral.com/arizonarepublic/business/articles/2010/06/27/20100627biz-mesa-air-group-bankruptcy0627.html#ixzz0t9T1xxdP
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