How did Mesa slip into bankruptcy?

 Many missteps led to Mesa’s bankruptcy, will the airline learn from its mistakes?

On Jan 5th, Mesa Air Group Inc. filed for Chapter 11 bankruptcy protection in New York, citing an untenable financial situation.

The Phoenix-based regional airline is asking a federal bankruptcy court to allow it to continue flying and operating during its reorganization.

Although many analysts have seen this coming for a long time, the news still caused quite a stir among airline industry professionals, people are wondering: what happened to Mesa? Granted the airline industry in general is going through a rough patch among the current economic crisis,  but why is Mesa faltering while other regional carriers are doing relatively well?

Here are some factors I feel may have contributed to Mesa’s downfall:

1. The operating environment for 50-seat regional jets has changed.

Between 1993 and 2001, the 50 seat regional jet enjoyed tremendous growth. Although many people were doubtful about those small jets in the beginning, once Cincinnati-based Comair, a launch customer for the 50-seat Canadair Regional Jet, showed real success filling in gaps that Delta mainline planes couldn’t do profitably, or doing some hub bypass flying, the race was on to get as many RJs as you could get, at one point, airlines need to wait for 2 years for deliveries.

That was then, the operating environment for small regional jets changed dramatically over the past few years.

On one hand, the fuel price doubled or tripled to over 5 usd/gallon in late 2008 before settling down in 2009 when the recession hits, but is still much higher than the 1990 price, that greatly increased regional aircraft operating costs. On the other hand, with the fast growth of the low cost/low fare airlines such as Southwest Airlines and Ryan Air, the average airline ticket price has demonstrated a downward trend for the past ten years, basically airlines are paying more money to operate aircraft but getting less revenue on each flight. While this trend negatively impact mainline operations, the small regional jet operation is hit extremely hard. Due to its small capacity, the operating cost per seat of the 50-seat regional jet is almost twice as much as that of larger aircraft such as a A320. Combined with a low fare, some 50-seat flight can’t make money even if the aircraft is full.

As a result, the industry is increasingly shifting to 70-0seat or 90-seat regional jets for their added customer comfort and improved economics.

2. The regional airline business model is changing, and Mesa is not adapting very well.

In the years following 9/11, while almost all the mainline carriers in the US were in the red and needed government bailout money to survive, the regional airlines were doing surprisingly well- they were all profitable and making money. but how?

Turns out all the regional airlines have a “Guaranteed revenue per departure” agreement with their mainline partners, under this agreement, the regional airlines are guaranteed a fixed payment from their mainline partners regardless of how many passengers they actually feed into the system, and the major airlines are responsible for pricing, route planning and marketing efforts.

In Mesa’s case, about 96 percent of its consolidated passenger revenue came from code-share “revenue guarantee” agreements with US Airways, United Air Lines and Delta.

Under current harsh operating environment, it is only natural that mainline carriers such as Delta, United are looking to their regional to shoulder some of that risk.

In May 2008, Skywest, another US based regional airline, entered into a “at-risk” agreement with United airline to fly seven 50-seat Bombardier CRJ200 for the mainline carrier. Under this agreement, Skywest will absorb all the operating costs of the regional aircraft and pro-rate any profits with United, it is not doubt a welcoming development for United Airlines.

In Nov 2009, United terminated an agreement for Mesa to operate 26 CRJ200 on its behalf, with the aircraft to be phased out by April 30, 2010. Prior to that, Mesa also lost a contract to operate 10 Dash8 for United.

3. Missed opportunities and poor relationship management with mainline partners.

In an interview with Flight Global reporter Mary Kirby, Mesa CEO Jonathan Ornstein admitted that he has made a mistake and missed a opportunity to secure more business for his regional airline.

That opportunity was seized by Republic Airways, another regional airline group, who in September 2005  purchased 113 slots at Ronald Reagan Washington National Airport, 24 at LaGuardia Airport, and 10 Embraer 170 aircraft from US Airways with an agreement to lease those assets back to US Airways. The deal was necessary for US Airways to emerge from bankruptcy protection. In return, Republic got a new contract and made a handsome return on its investment.

"Clearly the company would be in far different shape if we had in fact invested in US Airways," says Ornstein.

He adds: "I would say probably the single biggest mistake in my career was not making that investment…"

You can read Kirby’s story here: http://www.flightglobal.com/blogs/runway-girl/2008/02/mesa-ceo-jonathan-ornstein-adm.html

It is well known that Mesa is locked in an legal fight with Delta , after Delta canceled its agreement with a Mesa unit in 2008 saying it had poor completion rates.

Mesa also got into fight with United over some quite straightforward language in a contract to replace 10 CRJ200 with CRJ700. According to aviation blogger Brett Snyder:

If you’re interested in the anatomy of a dysfunctional relationship, let me introduce you to United (UAUA) and its regional partner Mesa Air Group (MESA). A relatively straightforward part of the contract in which Mesa flies some aircraft under the United Express brand is now the center of attention. A combination of what appears to be ego and lack of interest has now exploded to land these two in court, fighting it out.

… …

Mesa, on the other hand, really screwed this one up. If they were willing to deliver the airplanes by April 30, why go through all these shenanigans? Who cares if the first notice was valid? They kept pushing the issue and now, it wouldn’t surprise me to see them out of luck.

 You can read the whole story here: http://industry.bnet.com/travel/10004273/united-airlines-fights-mesa-air-group-over-airplanes-part-i/

4. Unscrupulous business practices – The Hawaiian debacle

While Hawaiian Airlines and Aloha Airlines went through bankruptcy in 2004, Mesa met with them and reviewed operational records and forecasts, but ultimately decided not to acquire or invest in either airlines. Two years later, after Mesa announced plans to launch a subsidiary airline called “Go!” in Hawaii, Hawaiian Airlines sued to block the launch, claiming that Mesa had violated a confidentiality agreement. Aloha Airlines filed a similar suit against Mesa later in 2006.

In September 2007, the CFO of Mesa Air Group was fired after being found deleting files from his work computer, even though the company argued that he was deleting porn from the computer, the judge overseeing the Go! case ruled that Mesa destroyed evidence and ordered Mesa to pay an $80 million settlement with interest, along with legal fees, to Hawaiian Airlines.

No doubt that settlement is a huge blow to Mesa’s cash flow and contributed to its eventual bankruptcy filing.

5. Bad fleet planning

Mesa has a total of 177 aircraft in its fleet, but 52 of them are parked. Most of these out of service aircraft are 50 seat RJs and even smaller turboprops such as Beechcraft 1900 and Bombardier Dash8.

In addition, 25 more aircraft will be out of service after their contract with United ends in the near future.

Clearly the company didn’t plan for market volatility and failed to respond to the shifting market trends in a swift and decisive way.

In Dec 2006, Mesa entered into a joint venture agreement with China’s Shenzhen Airlines to form a regional subsidiary called Kunpeng Arilines. Mesa was hoping to offload their idle CRJ200s  to Kunpeng,  that plan was quickly proven to be just wishful thinking, Kunpeng now fly 5 Embraer E190 with 100 ARJ21 on order.

In Aug 2008, Mesa indicated that it intends to sell all of its shares in Kunpeng to Shenzhen Airlines.

6. A bad reputation, and a tarnished brand

After the news of Mesa’s bankruptcy application broke, there are a lot of discussion on the internet and some common themes about Mesa emerged:

• Bad customer services
• Low reliability
• Low pay for pilots and staff
• Won’t be missed
• Other airlines will easily pick up their routes and services

With these kind of brand image, it is not surprising that both Delta and United wanted to end their code-share agreement with Mesa. If Mesa survive it is current crisis, it will have to work hard to address these issues.

What lies ahead?

As painful as Chapter 11 is, it is probably the medicine that Mesa desperately need.

"After careful consideration, the company determined that a Chapter 11 filing provides the most effective and efficient means to restructure with minimal impact on the business and our customers," Chairman and CEO Jonathan Ornstein said. "This process will allow us to eliminate excess aircraft to better match our needs and give us the flexibility to align our business to the changing regional airline marketplace."

He added that despite efforts over the last two years to trim costs and debt, MAG is

"nonetheless faced with an untenable financial situation resulting primarily from our continued lease obligations on aircraft excess to our current requirements. . .Our company has ample liquidity to support itself during this process and we are confident we will emerge from Chapter 11 an even stronger operation."

Breaking free from leases or purchasing obligations through Chapter 11 will no doubt offload some unwanted smaller aircraft and financial burden from Mesa’s shoulder, but to return to profitability and to drive future growth, Mesa need to do some soul searching and address some of the issues listed above.