ExpressJet to Fly Routes Less Traveled

The ghost of FlyI haunts ExpressJet(XJT:NYSE).

The Houston-based regional carrier said last week that it will launch a branded service with 50-seat regional jets. The move results from a surplus of airplanes in its fleet, partially due to a disagreement with its principal customer, Continental(CAL:NYSE).

Sound familiar?

In June 2004, regional carrier Atlantic Coast Airlines launched FlyI, a branded service with 50-seat regional jets, after a disagreement with its principal customer.

Atlantic Coast's business plan consisted of an improbable scheme to change its name and charge low fares while operating high-cost regional jets from a Dulles hub. The move placed the carrier in direct competition with United(UAUA:NYSE), a customer until United sought to cut the cost of its regional contracts in bankruptcy court. FlyI ceased flying in January 2006.

On a Jan. 24 conference call, as ExpressJet CEO Jim Ream unveiled his diversification plan, three analysts prefaced questions with references to FlyI. Each time, Ream distanced himself from the failed predecessor.

While FlyI set up a Dulles hub in direct competition with United, ExpressJet will operate only point-to-point service on routes with no competition. With 224 daily flights to 24 cities, no single city will have a significant share. "When you have 44 aircraft working and 59 different city pairs, it will have a real pre-deregulation look to it," Ream said.

While FlyI put all of its planes into the independent operation, ExpressJet will dedicate less than 20% of its fleet, and will keep flying most of the rest for Continental. And while FlyI sought to compete on price, ExpressJet will not. Unlike "what Independence Air was trying to do, we'll charge fare levels that are consistent with the marketplace," Ream noted.

While the first routes will not be announced Thursday, newspapers in Spokane, Wash., and Fresno and Sacramento, Calif., already are anticipating service. Fresno could gain flights to three other California cities -- Ontario, San Diego and Sacramento, The Fresno Bee speculated.

Many in the airline industry are pessimistic about the experiment's future.Mesa Air(MESA:NYSE) is unlikely to follow ExpressJet into setting up a large independent operation, CEO Jonathan Ornstein said on a conference call last week. Given lower costs throughout the airline industry, Ornstein said that the opportunity "has come and gone in terms of start-ups for independent carriers" and that he prefers to have a partner's financial backing.

In a recent report, Merrill Lynch analyst Mike Linenberg maintained a sell rating on ExpressJet shares and reduced his 2007 earnings forecast to 30 cents a share from $1.10. Merrill Lynch has a business relationship with ExpressJet that includes acting as a market-maker and providing other services.

Linenberg said the company is seeking uses for 69 jets. "As XJT works to transition the 69 jets to new platforms, we expect execution risk to be high," he said. "On the cost side, we are expecting substantial expenses related to the transitions."

On the call, Ream indicated that his interest is to design an airline around an aircraft. Clearly, 50-seaters are best suited for routes that lack nonstop competition, because they are neither the most economical airplanes nor the most comfortable -- although passengers will be offered XM satellite radio and complimentary meals on longer flights.

"It used to be there was a tremendous advantage to the smaller aircraft," Ream said. "That advantage has shrunk, [but] we still think the 50-seat airplane generates a lot of strategic flexibility. If you can find the right city pairs where this aircraft is the right size, there's a little more benefit there then people are giving [it] credit for."

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