For US regional carriers, scale has been the key to survival in the past year, as three major independent powerhouses have emerged to capture the bulk of business from their network partners - but how the country's regional industry will change over the next five to 10 years is open to question.
In late 2010, SkyWest and Pinnacle positioned themselves to become partners to the largest US carriers, as SkyWest purchased ExpressJet and Pinnacle bought Delta's wholly owned subsidiary Mesaba. Delta also sold another regional subsidiary, Compass Airlines, to privately held Trans States Holdings.
US regional consolidation has mirrored the spate of mergers among US network carriers. For both sectors, this decade's era of consolidation was kick-started in 2005, with the well-documented America West-US Airways merger and SkyWest's acquisition of Delta subsidiary Atlantic Southeast Airlines.
Pinnacle chief financial officer Peter Hunt has reminded financial analysts that in 2005 there were seven large independent regional carriers: now, he says, there are two - Pinnacle and SkyWest. He eliminates large regional operator Republic Airways after its 2009 purchase of Denver-based low-cost carrier Frontier Airlines. Earlier this year Mesa Air Group emerged from Chapter 11 protection with a much smaller fleet, comprising 76 aircraft.
After acquiring ExpressJet, SkyWest now accounts for 81% of United-Continental's total regional jet fleet of 552 aircraft. Pinnacle's regional jet fleet for Delta comprises around 43% of the network carrier's total Connection-brand aircraft fleet, which totalled 546 at 30 September 2010. United and Continental closed the financial transaction covering their merger in October 2010.
But for SkyWest, and to a lesser degree Pinnacle, the acquisitions leave them with a significant degree of ever-undesirable 50-seat jets. All the 200 or so ExpressJet aircraft joining SkyWest's Atlantic Southeast Airlines subsidiary are 50-seat jets. Pinnacle's acquisition of Mesaba enlarges its 76-seat Bombardier CRJ900 fleet by 41 aircraft to 57, but the combined airlines still operate 145 44- to 50-seat CRJs.
In parallel to discussions about the ExpressJet acquisition, SkyWest has in its negotiations with Continental on the ExpressJet capacity purchase agreement positioned itself to take advantage of lease expirations beginning in 2013.
Previously, SkyWest has also been quick to highlight that Continental is the owner or primary lessor of the ExpressJet aircraft, leaving little direct risk for the shells to SkyWest.
United and Continental pilots will need to thrash out scope clause issues
In the agreement solidified between SkyWest and Continental for the operation of the ExpressJet aircraft, Continental does have some rights to pull down the fleet. However, SkyWest's chief financial officer Brad Rich has stressed that his company has certain replacement rights, within its Continental agreement, to maintain a certain percentage of flying - and also the ability to add 15 growth aircraft over the contract's 10-year duration. There is also the possibility to move to a larger fleet type pending changes to Continental's scope clause limiting regional aircraft to 50 seats.
Scope clauses are more lenient at United, and United and Continental pilots will need to thrash out that difficult issue as they work to conclude a joint collective bargaining agreement with United-Continental management.
Pinnacle finds itself in a somewhat similar position with its 50-seat jets. The carrier subleases its 50-seat aircraft from Delta, and chief operating officer Douglas Shockey believes this gives the company a favourable position to potentially replace those aircraft with 76-seat jets.
Both SkyWest and Pinnacle stress the importance of scale, as uncertainty is likely to cloak the US regional industry over the next few years. SkyWest chairman Jerry Atkin says that while consolidation among legacy carriers is driven by impetus to grow yields and revenue, in the regional sector it is driven by improving efficiencies - specifically, for his company, through combining ExpressJet and Atlantic Southeast. "We still have a way to go but we are seeing some of those improvements we were looking for," says Atkin.
Pinnacle's Shockey says that consolidation leads to costs being lowered and greater efficiencies achieved for pass-through to network partners. It is "undoubtedly true" that rate pressure exists as capacity purchase agreements between regionals and their major partners begin to expire during the next few years. "Years ago, we made money even if the majors didn't. I don't think they [majors] like that idea any more," he says.
Consolidation helps regional airlines attain the necessary efficiency to offer improved rates in capacity purchase contracts with their legacy partners, in Shockey's view.
Scale also offers carriers such as SkyWest and Pinnacle the nimbleness not afforded by those with smaller fleets. More frequently, legacy airlines are asking regionals to move aircraft around at short notice, and a larger fleet allows those regional feeders to satisfy these requests.
The Bombardier Q400 turboprops operated by Pinnacle's Colgan Airways subsidiary were largely concentrated at Continental's Newark hub when they entered service in 2008. Now Shockey says the 29 Q400s operated by Colgan are fairly spread out across the United-Continental's hubs at Newark, Houston and Washington Dulles, with a few operating from Cleveland and Chicago. "For us that's good," he says. "It helps us show the virtues of the aircraft [Q400] and how well they work in the system."
SkyWest's Atkin recognises similar trends, saying "it's not a big deal" for a carrier with a 200-plus aircraft fleet to move five of them to satisfy a major partner's scheduling needs, but for an operator with a 50-aircraft fleet, it is drastically different. SkyWest has a 710-strong regional jet fleet, compared with the 548 Boeing narrowbodies operated by the USA's leading domestic carrier Southwest Airlines.
But the scale being achieved by SkyWest and Pinnacle in the regional sector is not being driven by projections of massive growth opportunities with US legacies over the next decade. Massachusetts Institute of Technology airline analyst William Swelbar predicts that opportunities for US regional carriers will compress going forward, explaining that it is a matter of "unwinding the crazy growth that went on a few years ago".
Atkin agrees that growth for regionals "will be nothing like the last 10 years", and SkyWest is striving to be better than carriers that will either "fall out" or be unable to compete.
Carriers with unforecastable futures in the US regional sector include American Eagle, which parent AMR seeks to divest; Comair, Delta's only remaining wholly owned subsidiary; and Mesa, which suffered a significant reduction in revenue when its contract with major partner US Airways was restructured.
Swelbar of MIT sees a tough case to stir private equity interest or a shareholder spin-off for American Eagle, but another regional carrier could negotiate paying a certain price for a guaranteed stream of revenue.
Ironically, the two major companies driving consolidation in the sector both say they would prefer organic growth versus more acquisitions.
"Given a choice, our preference is to grow naturally," says Shockey. "But if an acquisition arose that would be a nice fit, we wouldn't be opposed to that."
Internal growth is still the preference for SkyWest - but Atkin also remarks that his company "looks at everything that's happening" in the US aviation sector.
Read our take last year on the US regional sector on flightglobal.com/regionals10