SkyWest Catches Delta in a Tough Spot; Snaps Up ASA in Shrewd Move

Three years ago, Delta Air Lines approached SkyWest with a question: Would the Utah-based holding company be interested in buying Delta's Atlantic Southeast Airlines subsidiary?

SkyWest chief executive Jerry Atkin was intrigued, and a conversation began. In early 2005, the talk turned serious, and in August the two companies announced a deal.

Suddenly, SkyWest, founded in 1972 as a puddle jumper to fly business travelers between St. George and Salt Lake City, had morphed into the largest and among the most profitable independent regional carriers in the United States.

To put the deal in perspective, SkyWest was buying an airline not much smaller than itself. Atlanta-based ASA's revenues were close to $1 billion last year. It employs about 5,700 people and last year it carried 12 million passengers.

The deal was hard to refuse. For $425 million, SkyWest was getting an airline that bankrupt Delta had bought in 1999 for $700 million. Since then, ASA had more than doubled in size, adding more than 100 regional jets and nearly 3,000 employees.

"It was a business opportunity, which we look for on a regular basis, that happened to be in the wrapping of an acquisition, rather than SkyWest waking up and saying, 'Oh, we're on an acquisition binge and [ASA] is the first one,' " said 57-year-old Atkin, who has run the company for 31 years from its desert redoubt in St. George.

Translation: ASA was the biggest move in SkyWest history, but it didn't fit the pattern of growth developed during the three decades Atkin has guided the airline.

A different approach: Although SkyWest had bought an airline in the past - it acquired Sun Aire in 1984 - and Atkin has thought of starting a low-cost airline in the mold of a Southwest or a JetBlue, SkyWest is known as a contract carrier. Instead of flying under its own brand name, SkyWest operates as Delta Connection and United Express, supplying airplanes and crews for Delta and United Airlines.

That strategy isn't about to change. SkyWest recently submitted bids for two more carrier contracts, which boils down to growth without the headaches inherent in an acquisition.

Atkin refuses to identify the companies. But he says they are among the top five or six major airlines, and they are not Delta or United. They would be "significant business," involving "an appreciable number of airplanes."

"Whether it would be buying a company, or whether it would be adding 60 to 70 airplanes, the effort and money and stuff that goes into it is not different, and it's a lot cleaner to do without an acquisition," he said.

Observers say Northwest Airlines and Continental Airlines are the most likely companies. "I would bet, dollars down, that Northwest is one of them. Continental is the other," said Ray Neidl, an airline analyst for Calyon Securities in New York.

Starting March 31, Northwest passengers flying from Asia into Los Angeles and San Francisco will no longer be provided connections to Las Vegas and Phoenix by America West. Last year, Northwest ordered regional carrier Pinnacle Airlines to ground jets it leases from Northwest. And Northwest told another regional carrier, Mesaba, that it will take back 35 of its jets and return them to leasing companies.

In December, Continental told ExpressJet it was pulling back 69 regional jets after failing to win a cheaper contract from the carrier. Continental also said the airline would seek bids from other regional carriers to operate the aircraft at a lower cost. It already has a relationship with SkyWest, which flies a few routes for the Houston-based carrier.

"SkyWest is a leasing company, and there are too many of those leasing companies out there. There will be a shakeout, and SkyWest is in the pole position to survive," said Michael Boyd, president of the Boyd Group, an Evergreen, Colo.-based consulting company that tracks the airline industry.

Striking a balance: Boyd said SkyWest is "one of the best-managed companies in America, not just airline companies. It's inarguable. Look at the quality of work that they do. Their airplanes are squeaky clean."

Boyd isn't the only SkyWest fan. In January, Forbes magazine called SkyWest one of the best managed companies in the United States, pointing out that its sales have grown at an annual clip of 20 percent over the past five years. Calyon's Neidl says SkyWest is "one of my top three [airline stock] picks. It's a high-growth carrier, well run, profitable. I just think they are in a powerful position to make money and grow."

The ASA acquisition points up the negotiating skills that SkyWest executives can marshal. When Delta approached Atkin, it had more in mind than raising some much-needed cash to pay down debt and fight off a looming Chapter 11 bankruptcy. The airline had come to believe that an independent company could run ASA more effectively. The Atlanta-based carrier had one of the poorest on-time and lost-baggage records in the industry. And, although ASA was profitable and Delta was not, its cost structure was too high.

"So, besides the obvious cash, there was a strategic part of it. They believed that the operation could be run better and more cost-efficiently [if it were] owned by an independent carrier who, frankly, could be fired. Whereas, when you own it, you sort of are married together and you have to put up with whatever you end up with together," Atkin said.

For its part, SkyWest was loaded with cash it had built up for a suitable business opportunity and the chance to do more flying for Delta made sense. Although SkyWest was a regional carrier for Delta, more of its revenue came from United, which was in bankruptcy. Even so, SkyWest's United business was increasing faster than its Delta business. Buying ASA would strike a better balance, Atkin said.

A gamble pays off: But would a better balance be a safer balance? After three years, United was getting close to emerging from the protection of a bankruptcy court. Delta, on the other hand, was spiraling toward insolvency. Atkin said he calculated the risk of buying ASA, but plowed ahead anyway. A certified public accountant who sits on the board of Zions Bancorp, he crafted a deal that, five months later, makes him smile with pleasure.

"We were able to take what we felt was a pretty reasonably calculated, protected risk, if there's such a thing, which was pretty unique in how it was done. I'm not sure anybody else would have dared buy a company from a company, whose revenue came from that company, who they knew there was a high chance of them going into bankruptcy shortly thereafter. We figured out a way to do that."

The basic outlines of the ASA deal were announced one week before Delta filed for bankruptcy. SkyWest injected Delta with $330 million at the closing. But it held back the remainder of the purchase price until a bankruptcy judge affirmed SkyWest's 15-year contract to carry Delta's connecting passengers.

The holdback was a powerful incentive for Delta to honor its commitments to SkyWest. A contract affirmed in bankruptcy court is virtually ironclad. SkyWest had feared Delta would use bankruptcy to renegotiate or throw out the contract. Now, blessed by the court, the pact was binding.

"Although there's not zero risk, when a contract is confirmed in bankruptcy, it certainly makes it about as valid a contract as you can get, short of Delta just plain not getting out of bankruptcy. And so that was a very important thing," Atkin said.

The second part of the deal involved the purchase price. In better times, when the industry was healthier, the purchase price of an airline typically exceeded the value of its assets. Not so this time. The price SkyWest paid was roughly equal to ASA's asset value.

"So if things blew up, we at least had assets [that were worth] about what we paid for. There's certainly a risk in that, but there's a lot less risk than if you paid twice as much as there were assets for and it went bad," Atkin said.

"There's probably not a nice way to say this. We bought ASA for a little less than it would have been bought for three years ago and with Delta in great shape," he said.

Atkin said the gamble is paying off. Early last month, the company reported financial results for the first full quarter since the acquisition. Earnings surged 83 percent in the fourth quarter on revenue that jumped 127 percent.

"There's work to do, but it has so far," Atkin said. "There's been no surprises."

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