Why is SkyWest Buying ExpressJet?

Last Updated Aug 16, 2010 1:46 PM EDT

SkyWest (SKYW) announced last week that it's buying ExpressJet (XJET) for $133 million and merge the airline into its Atlantic Southeast subsidiary. The consolidation in this industry marches on, but why does SkyWest want to do this? Why would anyone want to buy an airline flying hundreds 50-seat regional jets when there are already too many in the system? If the branded airlines don't want 50 seaters, then why does SkyWest?

ExpressJet, the sole operator of which operates nearly all flights for Continental Express, has been looking for its place in the world for a long time. I've written about it many times before, but after being spun off by Continental years ago, ExpressJet has unsuccessfully tried several models. First there was the branded operation flying point to point on smaller routes. I loved the idea but the 50-seaters being used combined with sky high oil prices led to its demise. The airline also tried to grow a big charter operation, but that has only shrunk.

Its latest play had been to diversify its flying outside of the Continental system. After finally getting a contract with United, Continental had to go and announce a merger, thereby bringing all the ExpressJet flying back into the family. The visionary behind many of these moves, Jim Ream, left for greener pastures at American while ExpressJet continued to lose money. Now, SkyWest is buying it up.

This isn't the first time SkyWest has looked at ExpressJet. Back in 2008, SkyWest made an offer for the airline for $3.50 a share. That didn't go through, and today, SkyWest is paying $6.75 a share. Shareholders of ExpressJet should be very happy to have pulled that in. [Update: There was a reverse stock split late in 2008, so the original offer in 2008 would have brought in about $180 million while this will bring in $133 million. I still say the ExpressJet shareholders should be happy about this considering the continued losses at ExpressJet.]
So why does SkyWest want to do this? We know that SkyWest is actively looking at consolidation in the regional world and purchased Atlantic Southeast a few years ago from Delta. Now, ExpressJet will be merged with Atlantic Southeast, an obvious move since both are heavily unionized while SkyWest itself is not. This should get some costs out of the already costly ExpressJet operation.

By buying ExpressJet, SkyWest gets a brand new contract with Continental, something that will eventually be part of the new United. The contract keeps all 206 of ExpressJet's 50 seat Embraer 145 jets that currently operate for the airline. The last 36 of ExpressJet's airplanes are either under contract with United or flying in the corporate aviation charter business. It's no secret that this industry has far more 50 seat jets than it would like, so why would SkyWest voluntarily pick up more than 200 more of them from ExpressJet, which operates nothing else?

I have to imagine that there's some added security for SkyWest with this new agreement. Nobody wants more 50 seat flying, so maybe by offering a more competitive contract with Continental, it can at least keep more of its fleet flying. And maybe it will put the airline on the fast track for more 70 and 90 seat flying down the road. There had to be some sort of guarantee from Continental that made it worth it to pick up the additional 200 plus airplanes.

More importantly, why would Continental (and eventually United) want this. It's not like there's much of an opportunity to get rid of 50 seaters flown by other operators. Except for around 20 airplanes flown by Trans States, all the 50 seat jet flying for United and Continental is now controlled by SkyWest. And Continental can't reduce the number of planes flown by ExpressJet without consequence. See, Continental actually owns those planes and leases them to ExpressJet. So, if ExpressJet isn't flying them, Continental is on the hook.

So all we can do is speculate about what else is happening behind the scenes. Did SkyWest offer to give better rates on 70 or 90 seat flying in exchange for this longer term contract for 50 seaters? That would give stability to SkyWest and better rates to Continental for larger flying. But that would also get Continental in trouble. Regionals don't have the right to fly any jet larger than 50 seats for Continental, so if a deal was made assuming that the rules would change post-merger, the Continental pilots will be angry.

Does SkyWest have someone who wants to take some of these airplanes off its hands? SkyWest has been trying to get AirTran to grow and it also has an investment in a Brazilian regional carrier. Could those be places to send off more?

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Photo via Brett Snyder
[Updated on 8/14 to reflect that ExpressJet doesn't operate all Continental Express flights, just most of them]