Major Airlines Are Launching A Regional Jet Battle

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The competition between the major airlines in the United States is well known and various tactics employed by each have been a contributing factor in more than a fair share of airline bankruptcies. But with the consolidation in the airline industry that has occurred over the past few years, there are fewer, but stronger, competitors in the major airline space. Now with regional flights being a critical part of feeder networks, major carriers Delta Air Lines (NYSE: DAL) and American Airlines (NASDAQOTH: AAMRQ.PK) are turning attention to managing their regional operations.

A story of bankruptcy

Delta is beginning to work to better align the interests of Endeavor Air, formally Pinnacle Airlines, with those of its own network. After Delta shuttered its regional carrier Comair, it seemed that the Atlanta-based airline had left the regional flying business for good. That changed when Delta acquired bankrupt Pinnacle Airlines, a regional carrier that tried to expand too much but still had ties to Delta for regional flying.

Like most airline bankruptcies, part of the restructuring involved slashing employee pay. In this case, those cuts were necessary for Delta to see Pinnacle as economically advantageous. By the end, Pinnacle would change its name to Endeavor Air and sign an exclusive contract with Delta in a move that once again returns the aviation giant to the regional airline business.

Another story of bankruptcy

While Pinnacle’s bankruptcy flew under the radar for much of the media, the bankruptcy of American Airlines grabbed plenty of attention. As the last legacy carrier to declare bankruptcy, American finally decided it was time to restructure despite not being in too bad of financial shape to begin with. Sure, the airline had a money losing pattern over the past nine quarters but it did not have immediate debt obligations due and it still had a significant amount of cash left over to make payments. Nonetheless, American Airlines and its regional partner American Eagle both sought bankruptcy protection in late 2011.

One of the things that made the American Airlines bankruptcy so interesting is that the airline was able to continue with one of the largest aircraft orders in history. As part of a fleet renewal program, American realized it needed to modernize its fleet to effectively compete with other major carriers. The whole time American Airlines was in bankruptcy it attracted the interest of US Airways (NYSE: LCC) which was rather upfront about seeking a merger. After on and off negotiations, the final agreement was that the newly merged airline would be called American and would be 28 percent owned by US Airways shareholders and 72 percent owned by stakeholders of AMR Corp, the parent company of American Airlines and American Eagle.

Changing the regional carrier

The new American has already got major cost savings obtained through its reorganization but it is seeking additional concessions at American Eagle. Tulsa World reports that union chairman Tony Gutierrez considers Delta’s competitive advantage in regional flying to be “massive”. This is clearly a plus for Delta since the airline will pay less in costs for regional flying going forward. With regional flying being such an important part of bringing passengers into the main airline network, the cuts extracted from employees at Pinnacle will give Delta a major cost advantage over competitors.

Of course AMR Corp wants American Eagle to be more competitive with Endeavor Air in the future and any savings obtained would benefit shareholders of the new American which would be made up of US Airways shareholders, AMR creditors, and current AMR shareholders.

How to play the cost savings

Current shareholders of AMR are actually expected to receive a small part of the new airline. However this amount is only 3.5 percent plus what is determined through the equity plan in the reorganization. As a result, AAMRQ shares are like options on US Airways shares good until the merger closes. For investors looking at a more long term horizon, US Airways shares are the closest one can get to buying shares of the new American Airlines since the merger will be a takeover of AMR through an all share merger.

With this in mind, investors looking for the long term cost benefits from any additional concessions from American Eagle employees may be interested in shares of US Airways. Since the merger is expected to close in the third quarter, US Airways shareholders could begin to recognize these cost savings in the near future.

The deal with Endeavor Air employees has already been struck and Delta can now begin the process of best aligning Endeavor with its own mainline operations. Not only is Delta trying to get cost saving from employees but the airline is also eliminating 50 seat aircraft in favor of more economical 70 plus seat aircraft. With this multi-part strategy Delta is hoping to boost profits by saving on both the labor and fuel sides.

Regional rivalry

Airlines often outsource regional flying but in the case of American Eagle and Endeavor Air, the parent company owns the regional carrier. This has presented a situation where the parent airline tries to get additional concessions to become more cost competitive with other regional carriers. While the employees probably don’t like it, these cost savings are how airlines can increase their bottom lines and build value for shareholders. The next few months may give a hint as to how successful AMR is in getting concessions from American Eagle workers. And in that time, we may also get a better picture of the new American Airlines.

Alexander MacLennan owns shares of Air Canada and Delta Air Lines. He also owns the following options: long $22 Jan 2015 Delta calls, long $25 Jan 2015 Delta calls, long $30 Jan 2015 Delta calls, long $17 Jan 2015 US Airways calls. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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