Regional Feed To Be Expanded If AirTran/Midwest Merge

AirTran (AAI) said it would not only retain Midwest Airlines' (MEH)

regional feeder service provided by wholly owned subsidiary Skyways, it would

expand the Midwest Connect operation, jettisoning plans for 50 seaters in favor

of larger regional jets. The statement was made by AirTran Airways Chair and CEO

Joe Leonard, whose plans to take over Midwest Airlines prompted one analyst to

say that he made it "fun to be an airline analyst again." AirTran said the

transaction could be completed by the end of the first quarter 2007 and would

create an airlines with $3.5 billion in revenues.

Midwest has a request for proposal out to select regional carriers to

provide regional jet service with 50-seat regional jets. It plans to start the

new service in 2007 to right size markets and as a vehicle for route and

frequency expansion. (RAN, November 6, p.6) However, Leonard told investors that

50 seaters were increasingly unprofitable with mainline route structures and

would definitely not work with a low-cost operator. The exact details of any

changes are pending permission by the Midwest Airlines board that AirTran can

begin the due diligence process. However, Midwest Airlines rebuffed the $290

million takeover bid for the third time, saying it would not be in the best

interest of its stakeholders to pursue a merger with AirTran, something AirTran

has been working on for over a year but announced last week. The decision to

announce its offer was likely a bid to go directly to stakeholder's. Indeed,

Leonard said, despite the rebuff, the company thought both Midwest and AirTran

stakeholders needed to know about the offer which, he said, would provide a 30

percent price premium on Midwest's 30-day stock price average and an 89 percent

premium on its average closing price during the last six months. "To an outside

observer, this is a natural," he said. The bid is for $11.25 per share in cash

and stock and, in discussions with investors, Leonard said that if, during due

diligence, further value was found, AirTran would be willing to pay for it.

Financing is already in place.

Midwest Air Group Chair and CEO Timothy Hoeksema said that the board

spent considerable time evaluating the offer, engaging investment banking firms

and an outside consulting firm in the effort.

"During their comprehensive review, those advisors considered the offer

in light of Midwest's business and strategic plans," he said. "Under that plan,

we are projecting annual capacity growth of more than 10 percent over the next

three years, including a 50-seat regional jet program, along with significantly

greater growth in profitability. Additionally, we view AirTran's offer at only

about $5 per share, because it includes approximately $6 per share in cash that

already belongs to our shareholders. While it is the fiduciary obligation of the

board to review credible offers, the board unanimously concluded that Midwest's

business plan as a stand-alone company would support a considerably better

return to our shareholders than the AirTran offer...Our product and service are

unique and are not readily compatible with a merger with another carrier."

Hoeksma added that Midwest employees have been overwhelmed by public

support of the board's decision, especially given the airline's place as the

hometown Milwaukee airline.

For now, AirTran says the deal would provide $60 million in incremental

synergies which does not include the value of their presence in their respective

hub markets at Atlanta, Milwaukee and Kansas City. The combined carrier would

have a nationwide reach and expands AirTran's largely north-south sweep to

include the east-west Midwest Airlines network and its long-sought presence in

the Great Lakes region. The company has been eyeing the Midwest market for some

time having tried to acquire 14 gates at Midway two years ago, before being

outbid by Southwest Airlines. AirTran has only four gates at the airport.

Leonard also told investors that the company was "laser focused" on the

Midwest bid and was not thinking about any further acquisitions at this time.

However, he pointed out in response to an observation that the combined carriers

still lacked a strong West Coast presence, AirTran had forged a deal with

Frontier for consumers to book each other's flights and earn frequent flier

miles as well. (RAN, November 20, p.1)

While Leonard touted the synergies of their similar fleets and cultures,

there is little overlap between the two networks and is limited to four

overlapping nonstops between Milwaukee and Atlanta, Orlando, Tampa and Fort

Myers, Fla. The combined carriers would grow AirTran into the nation's 10th

largest carrier in terms of enplanements. With $1.45 billion in revenues last

year, it is currently the eleventh largest based on revenues. It employs 8,000

and is continually expanding its employment roster and network. Midwest is now

the 15th largest carrier with revenues of $700 million and 3,300 employees. The

combination would result in an carrier with $3.5 billion in revenues

Calyon Analyst Ray Niedl said the merger makes sense given the route

networks are complementary and their strong fleet commonality as well as

continued pressure for industry consolidation. AirTran would also jettison the

more costly MD-80s in Midwest's fleet in favor of Boeing 737s which will save 30

percent in operating costs alone. He also indicated these facts make the

regulatory gauntlet more likely to approve the deal and added that the emergence

of a new national low-cost carrier might force JetBlue (JBLU) into a merger in

order to create the critical mass to compete. Even so, Midwest has protected

itself from hostile takeovers having put in place a poison pill.

AirTran, which said it is looking for a friendly takeover, expects

network synergies of $40 million per year driven by improved fleet and capacity

utilization as well as increased aircraft utilization. AirTran stated that cost

synergies of $20 million annually will be obtained through replacement of MD-80s

with cost-efficient 737 aircraft and by gaining efficiencies on maintenance and

facilities. AirTran believes there would be $35-$40 million of transaction costs

for reconfiguration of aircraft and rationalizing facilities, according to


Combining Two Strong Airlines

: Primary Hub AirTran Airways : Atlanta Hartsfield-Jackson International Airport Midwest Air Group : Milwaukee General Mitchell International Airport : Smaller Hubs /Focus Cities AirTran Airways : Baltimore-Washington, Boston, Orlando, Chicago-Midway Midwest Air Group : Kansas City : Fleet at Year End AirTran Airways : 87 Boeing 717-200s 40 Boeing 737-700s 60 Boeing 737 deliveries Midwest Air Group : 25 Boeing 717-200s 11 MD-80s Regional Jets 2 MD-80 deliveries : 2006E Revenue AirTran Airways : $1.9 B Midwest Air Group : $0.7 B : Current Mkt. Capitalization AirTran Airways : $1.2 B Midwest Air Group : $0.2 B