7. Fortune magazine reported that SkyWest, an independent regional airline, negotiated a financial arrangement with Delta and United to provide regional jet service for the two major airlines. For its part of the deal, SkyWest agreed to paint its jets the colors of Delta Connection and United Express and to fly routes specified by the two airlines. In return, Delta and United agreed to pay SkyWest a predetermined profit margin and to cover most of the regional airline's costs. Fortune explained that while the deal limited volatility in earnings since Delta and United covered SkyWest's fuel costs, increased its load factor (the percentage of seats occupied), and managed its ticket prices.
Fortune suggested that Wall Street liked the deal because SkyWest's market valuation instead from $143 million to $1.1 billion after it began its service with the two major airlines. Explain carefully how this arrangement with Delta and United could have caused the value of SkyWest to increase dramatically even though it limited the amount of profit SkyWest could earn.
The arrangement between SkyWest and Delta, and United could have caused the value of SkyWest to increase dramatically even though it limited the amount of profit SkyWest could earn due to several factors:
1. Increased Load Factor: The agreement required SkyWest to fly routes specified by Delta and United, which likely included popular and high-demand routes. This would have led to increased passenger traffic and a higher load factor (the percentage of seats occupied). A higher load factor indicates better utilization of the airline's capacity and can result in increased revenue and profitability.
2. Reduced Volatility in Earnings: One of the major advantages of this agreement for SkyWest was that Delta and United agreed to cover most of the regional airline's costs, including fuel costs. This reduced the volatility in earnings for SkyWest as it no longer had to bear the fuel price fluctuations, which can significantly impact an airline's profitability. Consequently, investors would view SkyWest as having more stable and predictable earnings, increasing its attractiveness and thus its market valuation.
3. Brand Association: By painting its jets in the colors of Delta Connection and United Express, SkyWest gained brand association with two major airlines. This association boosted SkyWest's reputation, credibility, and market visibility. As a result, passengers could perceive SkyWest as a trusted regional airline, leading to increased bookings and potential expansion of its customer base. The positive market sentiment associated with such brand partnerships can positively impact the company's market valuation.
4. Long-term Partnership: The strategic alliance with Delta and United signaled a long-term partnership, implying stability and future growth prospects for SkyWest. This improved its outlook and investor confidence, both of which are crucial factors in determining a company's market valuation.
Overall, this arrangement with Delta and United provided SkyWest with stable revenue streams, reduced volatile costs, increased market visibility, and presented growth opportunities. These factors combined to create a positive perception and investor interest, driving up the company's market valuation from $143 million to $1.1 billion, as reported by Fortune magazine.