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:: November 2005 Letter ::

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Dear Fellow Airplane Mourners,

Check out the chalk outlines on the tarmac. Two dead airplanes: Bombardierís CRJ-200 and Embraerís ERJ 135/145. Didnít see that coming. Airplane deaths are always tragic; forensic pathology is the worst part of the aviation market analystís job. But any good autopsy tells a neat story.

Okay, they arenít really dead. Both manufacturers implied that airliner production could one day be resumed. Both also said the airframes will live on in corporate and/or military configuration, although the Armyís Aerial Common Sensor fiasco probably rules out a major ERJ 145 triumph. But as of November both manufacturers plan to suspend 50-seat airliner production next year.

The decisions capped an amazing run. The first CRJ was delivered in 1992, the first ERJ in 1996. Over 2,000 have been built. And the peak years were quite recent: annual production in 2000-2003 exceeded 250 planes. Watch that last stepóitís one hell of a drop.

The story of these two jets tells the tale of US legacy airlines over the last decade. Delta, American, Continental, Northwest, USAirways, United, and others were the big customers, as they desperately tried to reform themselves. You canít shrink route networksóextensive hub-and-spoke networks were the essence of big, lumbering legacy carriers. But you could shrink the planes, keep critical mass intact, and raid each otherís route networks. These guys were hemorrhaging cash, and 30/50-seat RJs were there to help.

At first it worked, particularly for Delta and later for American and Continental. But as everyone climbed on the bandwagon, the excess capacity made a bad situation worse. The four majors in bankruptcy now have the legal right to get out of any lease/purchase obligations, and if they donít return planes theyíll at least negotiate lease rates downward. This Christmas it might just be snowing unwanted RJs. Even though only 43 CRJs/ERJs are parked right now the threat of RJs cascading out of legacy airline service is a great reason to suspend production.

But the big over the waterfall moment of the CRJ-200ís life was the Independence Air debacle. Independence was the name/proclamation chosen by Atlantic Coast (ACA) after deciding to not share Unitedís pain. Independence, or FLYI as its impossibly clueless shareholders knew it, was presented as a way of preserving ACAís unnaturally high margins even as United sank deeper into red ink. Rather than just a typical fee-for-service role pumping passengers into Unitedís route network, FLYI elected to fly its own routes for the low-cost travel crowd.

This was one of the all time greatest let's drink the Kool-Aid events in aviation history. FLYIís dream of reinvention as a discount carrier might have been possible if the entire 80-something CRJ fleet was swapped out for A319s overnight. But with a fleet of 50-seat RJs with very high seat mile costs (worsened by high oil prices), the battle was lost before it started. And of course United used other feeders to stay in the markets it lost after ACAís defection, greatly exacerbating overcapacity.

Technically FLYI is still alive, in much the same way that my dream of owning Tuscany is still alive. But itís a reasonable bet that its 60+ CRJs will be lining up at soup kitchens this winter.

FLYI also proved that 50-seat RJ economics only worked in the hothouse confines of a legacy carrier system. For the legacy majors, costs didnít matter. Critical mass, route networks, market share, and business volume mattered. Trivial issues like costs and profits were for upstarts like Southwest or JetBlue. The majors' critical mass-based approach isnít impossible. But when you have six guys with the same philosophy overcapacity rules out profits.

To sum up, these high cost RJs helped high cost carriers survive. Then they helped a high cost LCC wannabe dump cheap capacity on the market, distorting it and penalizing healthy competitors. Thatís all very funny. Some of the time, a new plane can make a difference. But very often, it shouldnít.

All this humor might be lost on a FLYI shareholder (see http://finance.yahoo.com/q?s=FLYI&d=t for something that no shareholder ever really likes seeing). Then again, FLYIís very creation removed all doubt that thereís too much dumb money chasing too few good ideas in this industry. Perhaps the stock ticker should have been CFIT; the FLYI business plan had more in common with Controlled Flight Into Terrain than a real business plan. Where can I find credulous investors like these? Iíve got beachfront property in Puerto Discreto that needs developing.

As CRJ-200/ERJ 145 production winds down Embraer and Bombardier both have successful families of larger jets (ERJ 170/190 and CRJ-700/900) which will help make up the lost revenue. Embraer has its cleverly conceived (but abysmally monikered) Phenom business jet series. Bombardier has its futile and embarrassing CSeries and a profitable but curiously neglected business jet unit.

Despite the successful larger RJs, regional aircraft are a deflating market. Therefore, this will remain a duopoly. Remember the sheer horror of Alliance Aircraft? And let us never again speak of Fairchild Dornier. AvCraft, the legacy FD, has just been ordered dissolved by bankruptcy court. The rather handsome FD 728JET prototype is now an equipment organ donor. Letting a business go bankrupt in job-starved Germany without state aid or intervention is an almost unimaginable feat. If you canít make it there, you canít make it anywhere. Any RRJ or ARJ-21 true believers still around?

And in retrospect, I never saw the brief and terrifying reign of the 50-seat RJ coming. I never saw it going. The future just kind of happened. Thereís something postmodern about that.

This month weíve updated the Regional overview, along with the 787, King Air, Citation, TBM 700, Lynx, NH 90, Jaguar, and KT/A/T-50 reports. Enjoy the holidays.

Yours, Watching The Detectives,

Richard Aboulafia

 

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