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Hawaiian Holdings

(HA) - Get Free Report

unit Hawaiian Airlines and privately held Aloha Airlines have competed for five decades, so it can hardly be said that they're strangers to the concept.

But there is clearly a new intensity to the battle for supremacy in the skies over Hawaii. Air travel to the island chain reached an all-time high last year, and it shows no signs of slowing.

A new entrant, scrappy

Mesa Air Group

(MESA) - Get Free Report

, says it will start offering inter-island service this spring, prompting a lawsuit by Hawaiian. Another new competitor,

US Airways Group


unit US Airways, just added two daily round-trip flights between the mainland and Hawaii, and it plans 21 more weekly round-trip flights in March.

Routes to Hawaii are already crowded, with nearly 20 daily flights from Los Angeles alone. Nevertheless, US Airways says its new Hawaii flights exceeded revenue forecasts in their first two months. Meanwhile, investors including Carl Icahn are surveying the landscape.

The short explanation for the increased focus on Hawaiian air service is that the same two events that reshaped mainland aviation also heavily affected the 50th state. The Sept. 11, 2001, terrorist attacks bolstered Hawaii's image as a vacation destination that's safe yet exotic -- "Peoria with palm trees," as airline consultant Mike Boyd put it. Plus, the widespread use of bankruptcy court to restructure airline costs extended to Hawaii.

Old, Yet New

In the past nine months, both Hawaiian and Aloha have emerged from bankruptcy with better cost structures.

"There's been a resurgence of travel to Hawaii because people view it as a safe holiday, and Aloha and Hawaiian have restructured," said Mesa CEO Jon Ornstein in an interview. "Both are well-known brands, among the oldest airlines operating. But they have different strengths. Hawaiian came through bankruptcy with a stronger balance sheet, while Aloha has a more competitive cost structure."

Aloha, which will celebrate its 60th anniversary in July, emerged from Chapter 11 earlier this month. It spent 17 months in court cutting costs, primarily labor costs, by $75 million, and jettisoning about $250 million in debt.

"This is a 60-year-old start-up," CEO David Banmiller said in an interview. "Like a fine wine, we have all the benefits of 60 years of maturing, and like a start-up, we have a low cost structure."

Aloha also has the benefit of Banmiller's 38 years of airline experience. As the

Minneapolis Star-Tribune

once put it, "his resume reads like a departure board at O'Hare," and it includes stints at TWA, AirCal, American Airlines and Sun Country. Aloha is the third airline he has led through bankruptcy.

"After a while you get to know exactly what you need to do," Banmiller said. "We did draconian heavy lifting to dramatically reduce costs, and now we are pretty well poised to be able to withstand anything that might interfere with our ability to compete."

Aloha, with about 3,400 employees, a fleet of 21 jets and a specialty in niche markets such as Sacramento, San Diego, Orange County and Oakland, earned $17 million on revenue of $450 million last year.

The company's investors are led by California billionaire Ron Burke's Yucaipa Cos. Banmiller said there are no plans to go public. He also revealed that Icahn expressed interest in Aloha through an intermediary in several phone calls during the late stages of the bankruptcy.

However, the Yucaipa deal was already far along. Banmiller was acquainted with Icahn, who sought to buy the second Pan Am and later was involved in American's 2001 takeover of TWA, which Icahn once owned.


(AMR) - Get Free Report

is the parent of American.

"Carl's no dummy," Banmiller said. "If you take an industry that's been in the tank but that isn't going away, and you find in that industry a good company that has lowered costs through bankruptcy, then it's a valuable entity going forward."

Hawaiian, which emerged from two years of bankruptcy protection in June, also has its fans.

"They've got one of the strongest balance sheets in the industry," said Jay Burnham, manager of hedge fund Armory Advisors, a $100 million fund that invests in distressed debt and holds about a million shares of Hawaiian. Burnham describes himself as "strictly a balance sheet guy" who focuses on income statements.

"We think their earnings power was about a dollar a share before they announced their expansion," he said. "It should be about $1.50 now." The airline said Feb. 14 that it will acquire four Boeing 767-300s from

Delta Air Lines

( DALRQ) to expand its service.

Founded in 1929, Hawaiian has a fleet of 25 jets, 135 daily departures and more than 3,300 employees. After emerging from bankruptcy protection during the quarter ended June 30, it reported earnings of $7.8 million on revenue of $224 million in the quarter ended Sept. 30, and net income of $1.4 million on revenue of $69 million.

What Ornstein Plans

"They were profitable in the last two quarters, and I assume they will break even or be slightly profitable" in the fourth quarter, said Burnham. A spokesman said CEO Mark Dunkerley wasn't available for an interview.

Nick Capuano, director of equity research at Imperial Capital, a Beverly Hills, Calif., brokerage and boutique investment bank, called Hawaiian "a well-positioned niche airline with a new fleet." He has a price target on the stock of $8.50, and his firm has received compensation from Hawaiian for investment banking services.

Capuano said that the cost of the four 767s was a relatively low $32 million, and that even with added costs estimated at $34 million to upgrade the planes for trans-Pacific operations, the purchase is still is a bargain. He said he anticipates that the planes will be used to bolster flight frequencies in markets such as San Diego and San Jose.

Furthermore, the new planes will mean that trans-Pacific routes will account for about 80% of Hawaiian's business, up from 70%, he said. That will help shield it from Mesa's entry into the inter-island market.

Mesa's plan has clearly attracted Hawaiian's attention. Ornstein says Mesa will begin service this spring with 50-seat CRJ200s, serving routes that Hawaiian also flies. Posted fares are all under $100 for a round trip, or about half of Hawaiian's fares. Hawaiian's lawsuit alleges that Ornstein reviewed confidential documents during the bankruptcy and is using the information to help him compete.

Ornstein said the suit is simply an effort to stymie competition. He said he has been looking at the inter-island business since 1992, and that fares in the market are at a relatively high level. "Obviously, that attracts competition," he said. "That's the way our system works."

With $300 million on its balance sheet, Mesa will be in Hawaii for the long term, Ornstein said. "We will put the existing marketplace into a huge state of flux because of the additional capacity and our ability to remain in the market."

Capuano notes that despite the high interest in Hawaii, the inter-island market is actually shrinking, because the proliferation of mainline flights means more nonstop service to various islands.

Burnham speculated that Hawaiian will win the lawsuit because "any first-year lawyer knows that you can't go into a war room and then start a similar business a year later after you sign the required nondisclosures and noncompetes."

Aloha and Hawaiian are in good shape after their reorganizations, Boyd said, with both benefiting because "they stay out of each other's way." Still, neither should ignore the potential impact of Mesa.

"Everyone is scratching their heads about the Mesa thing, but most of us learned long ago, never underestimate Jon Ornstein," he said. "He could be setting up the most successful 50-seat operation in the history of the world, or he could be getting ready to acquire someone. Whatever he may do is probably something that the rest of us could never dream of."