When Transport Minister Marc Garneau announced plans in early November to change ownership rules governing Canadian airlines, it was a major victory for travelling Canadians and the handful of young carriers looking to provide them better value than is currently available from the only medium-haul games in town, domestic majors Air Canada (TSX:AC) and WestJet Airlines (TSX:WJA).
Two up-and-coming airlines in particular – Canada Jetlines and Enerjet – received immediate exemptions allowing them to include foreign shareholders up to the 49% level, or nearly double the current limit of 25%.
That exemption makes all the difference in the world according to Mark Morabito, President and CEO of Jet Metal (CVE:JET), the public company planning to merge with Canada Jetlines and spearhead the effort to raise the capital needed to get planes into the air by the end of 2017. It looks like a good marriage as well: a highly experienced group of airline executives in the Canada Jetlines organization uniting with a team on Morabito’s side that over the years has raised more than US$ 800 million dollars for companies in a variety of business sectors.
Surprisingly perhaps, Canada is the only G7 nation without what the industry refers to as a ULCC, or Ultra Low-Cost Carrier. These no-frills airlines enjoy a high success rate in other countries, flying to secondary airports and taking other measures to keep costs down, while stimulating new demand by creating a class of fare that attracts customers who otherwise might not fly.
Those assessing the potential of this model in Canada might start by noting the hordes of B.C. travelers shunning Vancouver for flights out of Bellingham, and Ontario flyers crossing the border to use airports in Buffalo. The Conference Board of Canada estimated in 2012 that some 5 million Canadians cross the border each year to access better airfare values at nearby US airports. Given that the country’s population then was around 35 million people, 5 million crossing the border just to fly is a lot.
Morabito says it is a simple (though not necessarily easy) matter to duplicate the value proposition on the Canadian side of the border. “We are not inventing anything new,” Morabito explains. “We are just importing the business model into the country that Ryanair (LON:RYA), EasyJet (LON:EZJ) and many others have done very well with – quick turnarounds, no frills, Point A to Point B, a lot of use of secondary airports.
“In Canada, there is an entire network of underutilized, secondary airports. People have demonstrated their willingness to drive to get lower airfares in US border cities. Kitchener, London, Quebec City, even places like Ottawa and Regina are underutilized. It creates an opportunity.”
Surely, one would think, Air Canada and WestJet could throw some of their financial heft at the smaller airports for a while to suppress the new kids on the block. Morabito recommends thinking again. “The two majors utilize a hub and spoke model, and once you adopt that approach you have to feed your hub. Pearson is a hub for WestJet and Air Canada. They are not going to fly to Kitchener or Hamilton with any frequency because they need to get their passengers into their hub so they can get them onto other planes – that’s the whole point of that model.”
A few minutes with Air Canada’s online booking engine substantiates Morabito’s claim. Try to book an Air Canada flight from Vancouver to Kitchener a month out and you’ll find it can’t be done because Kitchener does not even show up as an option. You can get to Hamilton, but it will cost you about the same as a flight to Tokyo, and it can take twice the time because of the need for two long stops.
“The catchment for Kitchener-Waterloo is over 1 million people, and on top of that the city is an important technology hub,” says Morabito. “There is the University of Waterloo, COM DEV International, D2L Corporation, and a host of others – it is a major center for technology innovation and that is one of the reasons that the governments of Ontario and Canada have been making investments there.
“For an area to grow, however, you need to have air access, and travelers in Kitchener-Waterloo right now are forced to make a long drive to Toronto. The area is economically held back by a lack of air service. If the Kitchener-Waterloo catchment was located in the US, there would be flights in and out all day long, and they would increase as the economic activity increased. If you want the area to be a strong, vibrant, innovative center for technology and other economic development, which clearly the governments do, you have to have regular air service.”
So, what steps remain before the company can begin providing flights at fares 30-40% less than the majors charge for a similar leg?
“We have a number of broker-dealers vying to lead our next round of financing, which is for a minimum of $6 million,” says Morabito. “Once the financing completes we meet the final condition for the amalgamation, so the two companies will merge and proceed to execute the business plan.
“Beyond that we are looking at raising another $35 million to $50 million but a lot of it will be debt. Then the biggest hurdle is obtaining your Air Operator Certificate, for which the government requires you to set aside about $27 million during the first 12 months of operation.”
Morabito says there should be plenty of foreign capital available given the gap in Canada’s airline landscape and the numerous success stories to point to in the US, UK and other regions. “Once you have a lead order from a group or groups that have made money in this space and know what they are doing, it is easier to attract the rest of the money in Canada because it is considered considerably de-risked at that point.”
Potential investors will be pleased to learn that if fun in the sun is more your cup of tea, Canada Jetlines also plans to service California and other US destinations, plus vacation hotspots such as Mexico and the Caribbean. Indeed, they sound much like the product offerings Canadians pop across the border for on such a regular basis.
“Gaining the support of the secondary airports and surrounding communities plus convincing the various levels of government that our idea was sound was very time consuming,” says Morabito. “But it was definitely worth it. I think Minister Garneau’s announcement opens the door not only to a great business opportunity, but to making a difference in the lives of potentially millions of people.”
Story by ProactiveInvestors