Back in 2011, Republic Airways (NASDAQ: RJET ) CEO Bryan Bedford stated that his company was considering a sale of its Frontier Airlines subsidiary. The company had just finished restructuring Frontier, and it had become clear that the decision to buy Frontier out of bankruptcy had been a mistake all along. There were simply few synergies to be had from combining a regional feeder airline and a mainline low-cost carrier.
Nearly two years later, Republic investors are still waiting for a resolution of the Frontier sale "situation". Recently, Republic has been inching toward an agreement with an unnamed buyer -- widely believed to be private-equity firm Indigo Partners. However, Republic has missed multiple self-imposed deadlines to finalize the sale.
Nevertheless, Republic investors should try to bite down on their frustration. No matter what happens with the current sale negotiations, the Republic-Frontier tie-up is destined to be unwound. After that happens, Republic shares are likely to move higher due to the strength of its core regional flying business.
There can be no doubt that Republic's management has lost a lot of credibility over the course of the drawn-out Frontier sale process. In early 2012, Republic stated that it expected to sell or spin off Frontier within six to 12 months. By the time of last year's annual meeting in August, that timeline had slipped to "early 2013".
Unfortunately, while the rumor mill heated up earlier this year, there was no real progress made until the spring. At that point, Republic began negotiations in earnest with prospective buyers, but without reaching a binding offer. On the company's Q2 earnings call in late July, CEO Bedford announced that Republic had reached a term sheet with a prospective buyer, and that Republic was postponing its annual meeting in order to buy more time to complete the negotiations.
Unfortunately, the term sheet has not yet turned into a firm agreement. The annual meeting came and went with no deal in place and, last week, Republic announced that it had extended the prospective buyer's exclusivity period until the end of September.
The major impediment to completing an agreement appears to be an "equity participation plan" for Frontier employees that was implemented as part of the carrier's 2011 restructuring. Frontier's employees are entitled to a significant ownership stake in Frontier as compensation for concessions they made in 2011.
However, the buyer -- presumably Indigo -- is demanding that Frontier employees give up most of this ownership stake. Not surprisingly, labor groups would rather see the deal fall apart than forfeit their ownership claims.
Don't sweat the small stuff
Republic's management apparently remains confident that it can work out an arrangement that satisfies everyone. However, the good thing for shareholders is that it won't be the end of the world if the deal falls through. Republic can fall back to the spin-off plan if the Frontier sale can't be completed. As part of the spin-off, Republic could probably move some of its corporate debt onto Frontier's balance sheet, thereby reducing its interest costs and improving its credit profile.
As I previously argued, assuming a Frontier sale or spinoff, Republic would likely earn $75 million-$80 million after tax in 2014. SkyWest (NASDAQ: SKYW ) , which is a pure-play regional airline (like Republic Airways would be without Frontier), currently trades for more than 10 times expected 2014 earnings. At a similar valuation, Republic would be worth $15-$16 per share, well ahead of Thursday's closing price of $12.74.
In fact, Republic's lower exposure to unpopular small regional jets could potentially justify a higher valuation than SkyWest. This suggests that the main thing holding back Republic Airways stock is investor nervousness about the perpetually delayed Frontier sale. However, with so much potential value waiting to be unlocked, investors are likely to be rewarded well for their patience.
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