January 24, 2005 - 2:12am EST by
2005 2006
Price: 1.75 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 79 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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How about a turn-around play in a sector famous for value destruction, ego maniacial managers, and union gridlock? If that doesn't make you choke on your in-flight pretzels, then read on.

As a former high-flyer, and wall street darling, Atlantic Coast Airlines had it made. Under a fee-per-departure income schedule, the company could operate flights which were profitable even when load factors were low due to a contractual agreement with United Airlines under which it (ACA) received several revenue streams with minimal risk. Added to this desirable structure was a location bonus. During the 90's Atlantic Coast built a premier presence at Washington-Dulles airport. For a variety of reasons, including governmental growth, technology industry growth in Northern Virgina, and congestion at Washington-National airport, air-traffic to the area exploded. Atlantic Coast Airlines, the predecessor to Independence Air was the dominant carrier at Dulles, with more departures per day than every other carrier combined in 2000.

Although the fee-per-departure, or block-hour, revenue stream is superior in many ways to a typical ticket sale based revenue model, it is vulnerable to the parent or "code-share" company. Although Atlantic Coast built a relationship with Delta Airlines, it was highly dependent on United Airlines with 85% of revenue originating there. While in bankruptcy United attempted to renegotiate the terms of its payment schedule with ACA Holdings, the parent of Atlantic Coast Airlines. ACA said no.

Apparently ACA believed it had the cash, about 350 million, and the management expertise, Ed Acker a former Pan American CEO, to join the big leagues and form its own low cost carrier ala Jet Blue. It should have known better, it promptly crashed and burned. Although well funded, the company experienced a multitude of start-up costs, including AOG or Aircraft on Ground times during the transition to Indepence Air, its new flag. The only thing worse than having to pay for expensive aircraft is to pay for them to stay parked on the pavement, and in Q4'04 only 1/3 of the company's aircraft were in service for the full quarter as painting and modifications were completed for the launch of the new airline. The stock, which traded at $30/share in 2001, dropped to as low as $1 when last quarter earnings were released, as bankruptcy seemed imminent.

The company experienced a near perfect storm of problems in conjunction with the launch of the new carrier. A brutal fare war got underway as the legacy carriers fight to stave off their own BK's in the face of competition from USAir and United. Fuel prices spiked to multi-year highs. Increased security and regulation added to the cost of business at just the wrong time, and throughout the industry overall passenger miles never fully recovered from September 11th. Without backing out one-time charges, operating expenses as a % of revenues more than doubled Q4'04, the first really independent quarter, relative to q4'03. Load factors plummeted from a typical 70% to less than 50%, while marketing and sales expenses rose 160%.

If the picture is so bleak then why am I boring you with this? Because despite the value destruction, this is still a value stock. Management realizes this and is moving quickly to try and mitigate liquidity issues before things get too bad, and others are on board with this. As of last quarter end there was still 200 MM of working capital available. A recent convertible raised 125 MM at 6% and conversion at around $13/share. Concessions have been made by GE Aircraft Capital on 20 aircraft leases whereby these small jets can be returned early and without penalty thanks to a strong market in Europe to which they can be remarketed. Additionally
Airbus is allowing soft financing concessions to delay delivery of scheduled large aircraft. Renegotiations such as these have prompted S&P to downgrade the company which has no doubt exacerbated several other problems despite these being intrinsically positive moves.

Of course vendor financing is always easy, but there are some additional encouraging moves afoot. United Airlines has extended an offer to take the company back as a code-share partner. I assume the fee schedule would be different, but this would represent the kind of move which could breath new life into this type of situation. There is also the possibility that if this were to occur, then Indepence Air would continue to operate the larger
Airbus aircraft under its own livery. Not only could it receive guaranteed
revenue under the fee-per-departure model, but it would benefit from fitting certain routes with the inherently cheaper cost structure of operating large aircraft where appropriate. This has been hindered in the past and would actually benefit United, but was shot down prior due to the UAL pilot union. Unlike then, the unions are not now in a position to do much bargaining and will likely take what they can get.

An additional sweetner is the possiblity of a buyout. Mesa Air Group, which is another code share carrier, obviously felt its operations would dovetail nicely with Independence Air and proposed a tender offer when the group was still Atlantic Coast. The move was opposed at the time, but I feel management might feel differently about a parachute under today's circumstances.

There are significant risks to this situation, and I've tried to be fairly blunt on some of it. I realize that my metrics are barely considered, but the situation simply begs the question of whether this albatross can be reincarnated into the angel it once was before it hits the ground. There's a fair chance it can.


-Reversion to fee-per-departure model.
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