Buy Republic Airways to Profit from its Farewell to Frontier Airlines
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The third time should prove to be a charm for Republic Airways Holdings (NASDAQ: RJET) in its quest to move Frontier Airlines out from its corporate structure and off its financial statements.
In 2009, Republic Airways topped Southwest Airlines (NYSE: LUV) in the bidding war for Frontier Airlines, purchasing it for about $1.1 billion in considerations. Southwest Airlines was the ultimate winner, by far, as the acquisition has proven to be an unmitigated disaster for Republic Airways.
Last November, Republic Airways announced that it was going to sell Frontier Airlines. As a result, the share price of Republic Airways soared. This is not surprising as the market has been less than welcoming. American Airlines tried to sell American Eagle, but there were no takers. Delta Airlines (NYSE: DAL) just announced that it was grounding Comair. Needless to say, Southwest Airlines certainly did not step forward to reclaim the previously desired Frontier Airlines when a "for sale" sign was taped to its nose almost a year ago.
As no buyers could be found, early in 2012, Republic Airways announced that it would consider spinning off Frontier Airlines. Again, the stock soared. Republic Airways went from trading around $3.50 a share in early January to over $6.
As this has not yet transpired, the share price for Republic Airways has again slumped. Republic Airways needs desperately to rid itself of Frontier Airlines. Management obviously realizes that: so do any potential buyers, which is probably why none have made a bid that has been made public.
At present, the market capitalization for Republic Airways is $223 million, less than one-quarter the purchase price for Frontier Airlines about three years ago. The acquisition cost of Frontier Airlines is about the size of the market capitalization for discount airline rivals of Republic Airways such as JetBlue Airways (NASDAQ: JBLU) and Spirit Airlines. Before its recent run-up in anticipation of a bid for American Airlines, that was about the size of the market capitalization for US Airways (NYSE: LCC), too.
Frontier Airlines also lards up the balance sheet of Republic Airways with higher costs and debt. The debt-to-equity ratio for Republic Airways is 4.75. That means it required $4.75 in borrowing to create every dollar of shareholder equity for Republic Airways. Much of that came from the costs of buying Frontier Airlines. The chart below reveals how the debt-to-equity ratio for Republic Airways soared after the acquisition of Frontier Airlines in late 2009.
By contrast, the debt-to-equity ratio for Southwest Airlines is 0.48. JetBlue has a debt-to-equity ratio of 1.48. Delta Airlines has been on a major campaign to lower its debt burden, too. As Republic Airways has a negative profit margin of 3.51%, it can ill afford this expense. That obviously explains the efforts to rid itself of Frontier Airlines.
In early August, Republic Airways stated that it would spin off Frontier Airlines in the first half of 2013. That is a de facto admission that no one wants to buy Frontier Airlines. But the stock still popped from around $4.50 a share to about $5.50 in a short time period. That premium is gone, however, as the share price of Republic Airways is back down to around $4.60.
Until Republic Airways moves Frontier Airlines, it is crippled, trying to compete with one wing tied behind its back. It must now sit on the sidelines as rivals such as US Airways, JetBlue and Delta Airlines are reported to be considering bidding for American Airlines, now that it is in bankruptcy. It is very difficult for Republic Airways to improve its business operations without shedding Frontier Airlines first.
For investors, there is another jump coming in the share price of Republic Airways: when it finally announces the spin-off of Frontier Airlines and the exact details. Frontier Airlines is obviously still for sale, but that is not going to happen. A spin-off is the only alternative. In 2007, Republic Airways was trading for around $24 a share. Moving forward without Frontier Airlines will be a major step towards ascending back to a stock price at those lofty levels.
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