July 15, 2016
Jim Scott STRICTLY PRIVATE AND CONFIDENTIAL Chief Executive Officer Canada Jetlines Ltd. BY REGISTERED MAIL j [email protected] tel: 604-273-5387 The Honourable Marc Garneau Minister of Transport Transport Canada Mark Morabito Chief Executive Officer 330 Sparks Street Jet Metal Corp. Ottawa, ON K1A 0N5 [email protected] tel: 604-681-8030
Dear Minister Garneau:
Re: Request for Issuance of Exemption Order (the “Order”) for Canada Jetlines Ltd. pursuant to subsection 62(1) of the Canada Transportation Act (“CTA”)
1. Introduction Further to the request for an exemption order that was submitted on May 16, 2016 by Canada Jetlines Ltd. (“Jetlines”) and Jet Metal Corp. (“Jet Metal”) (collectively, the “Parties”), the Parties received several questions from Transport Canada staff requesting further clarification regarding certain aspects of the Parties’ request. The Parties have also had the opportunity to carefully review all of the submissions made to Transport Canada by various industry stakeholders in connection with the Parties’ request. This submission provides (i) answers to Transport Canada staff’s questions, and (ii) the Parties’ response to some of the inaccurate statements and claims made in some of the stakeholder submissions. 2. Response to Transport Canada Inquiries Question #1: Would Jetlines accept an amount lower than 49% foreign voting control to be acceptable? RESPONSE: Prior submissions by the Parties have outlined the significant difficulties associated with raising sufficient capital in Canada to launch a new domestic airline. The Parties are confident that they can raise the necessary capital if the foreign ownership limit was increased to 49%. A foreign ownership limit increase from the current 25%, yet lower than the requested 49% will make raising the necessary capital more difficult.
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Question #2: Will the foreign investment be distributed with a single entity or will several parties hold a percentage interest? Would a cap for any one investor be acceptable?
RESPONSE: The Parties anticipate that no single foreign entity will own a 49% voting interest in Jetlines. Rather, it is anticipated that a 49% ownership would be distributed across several foreign entities. That said, the Parties are amenable, should an exemption order be granted, that it be accompanied with the condition that no single foreign investor could own more than a 25% voting interest in Jetlines. Question #3: Is there an Investment Canada Act issue associated with the proposed foreign investment? No. Under the Investment Canada Act, the acquisition of one-third or more but less than a majority of voting shares is presumed to be an acquisition of control unless it can be shown that the acquired shares do not give the investor “control in fact” over the corporation. This presumption is rebuttable upon demonstration that control in fact is not being acquired and that the Canadian business will continue to be operated by Canadians. Assuming that a non-Canadian acquires a 33% voting interest in Jetlines (which is possible but not confirmed or anticipated), it is the Parties’ position that at no time will a non-Canadian be permitted to have control in fact on Jetlines. In fact, non-Canadian investors will be informed, prior to investing in Jetlines, that they will have no ability to influence the day-to-day operations of the ULCC. Accordingly, the Parties do not anticipate their being any concerns under the Investment Canada Act.
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Question #4: What is the Canada Transportation Agency’s view regarding the affect of an exemption on the control in fact analysis? RESPONSE: The Parties provided a copy of its request for an exemption order and related correspondence to the Canada Transportation Agency (“CTA”) on July 5, 2016. The Parties also requested confirmation that, should a non-Canadian own a 49% voting interest in Jetlines, would not be the sole determinative factor considered in a “control in fact” analysis. Put differently, the Parties asked the CTA to confirm that the ownership interest would be but one of a number of factors in determining whether a party is controlled in fact by Canadians. The CTA provided the Parties with a response to their inquiry on July 15, 2016. The CTA interpretation note on Control in Fact provides a non-exhaustive list of sixteen factors would be considered in assessing control in fact. The CTA noted that potential for 49% voting interests held by non-Canadians would relate to two of these factors (risks and benefits and concentration of voting interests). The CTA noted there is an optional process where parties can request that the CTA formally consider the issue and issue an advance ruling.
Although there is as advance ruling process, the CTA has made it clear that "the Agency will only review a proposed transaction when it has advanced to the final stage and draft agreements are in place and awaiting execution.” The Parties will not be in a position to provide definitive documentation from their investor until at least conditional approval on the exemption order has been received. The investor will not engage in negotiations until such time. As a result an advance ruling cannot be obtained at this time. In addition, even though it is already a legal requirement for a Canadian airline, the exemption order could be explicit that it is conditional on the Parties being controlled in fact by Canadians. In any event, the Parties are of the view that given that they have conducted an extensive assessment around the issue of control in fact, that an advance ruling is not required. This is particularly true given that Jetlines is committed to being, at all times, controlled in fact by Canadians. It is implicit in the CTA’s response that the 49% voting interests will be but one of a number of factors considered in the analysis.
The Parties reiterate that while they are seeking foreign investment that may result in up to 49% voting interest being held by non-Canadians, Jetlines will at all times be controlled in fact by Canadians. The Parties will have a variable voting structure, similar to that utilized by WestJet and Air Canada. The Articles of the parties will contain an automatic adjustment mechanism that will weigh down the votes of non-Canadians to ensure that they do not hold voting interests above the required percentage. Further, the Parties have carefully reviewed the CTA interpretation note on Control in Fact and are committed to ensuring that Jetlines is at all times controlled by Canadian.1 For example, among other things, Jetlines will have a Canadian head office, the majority of its directors will be
1 Canada Transportation Agency, Interpretation Note: Control in Fact, available online at
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Canadian, the majority of its officers will be Canadian and shareholder/director meetings will require that a majority of the shareholders/directors present are Canadian, etc. Question #5: If the principal foreign investor will not account for the full 49% of ownership of Jetlines’ voting shares, would the other foreign investors be air carriers or otherwise associated with air carriers? RESPONSE: The Parties anticipate that only the principal foreign investor will be an air carrier. Question #6: Would the investment of your primary foreign investor be in the form of a private placement undertaken after the issuance of an exemption but prior to the listing of Canada Jetlines on the TSX Venture Exchange? If so, what proportion of the shares of CJL would likely be held the primary foreign investor after completion of the private placement? Question #7: In its press release dated 16 June 2016, Jet Metal stated the Transaction is subject to approval of the TSXV. Please clarify whether the TSXV will be required to approve (i) the Transaction, or (ii) the listing application of Canada Jetlines on the TSXV. When would you expect to seek and receive this approval? RESPONSE: A consolidated response to Questions #6 and #7 is being provided since they essentially touch on the same issues. It is important to explain the mechanics of the transaction between Jetlines and Jet Metals to effectively respond to this question. Jetlines and Jet Metal have entered into a business combination agreement that will result in Jet Metal (a publically listed entity) acquiring Jetlines and its business. On closing of the transaction, Jet Metal will be renamed “Canada Jetlines Ltd.” and its sole business focus will be executing the business plan of Jetlines. There are a number of conditions that must be met prior to closing the transaction. The most significant conditions are (i) TSX Venture Exchange (“TSXV”) approval, and (ii) the completion of the financing. On July 14, 2016, the TSXV conditionally approved the transaction. Conditional approval is only required after a significant review and documentation process that ensures the entity will meet all TSXV listing requirements on completion of the transaction. The initial review process is completed by an analyst, who then makes a recommendation to a manager. Once that process is completed, the TSXV executive listings committee meets to review the transaction and determine whether conditional approval should be granted. The Parties have now completed this process, which is the most significant and onerous part of the TSXV approval process. In order to obtain final approval from the TSXV, the Parties must (i) obtain shareholder approval, (ii) pay the listing fees, and (iii) complete the financing. It is a condition of both the business combination agreement and the final approval of the TSXV that the Parties complete the financing. The Parties intend to complete the financing via private placement prior to closing and it is anticipated that the primary foreign investor will participate in this financing. The portion of the shares of the combined entity held by the primary foreign investor is still subject to final terms but is expected to be 25% or less. The Parties have satisfied all of the major conditions, leaving only the financing to complete the transaction. Simply put, without the financing, the transaction will not close.
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Question #8: How would Canada Jetlines ensure that prospective foreign shareholders purchasing shares in either an IPO or on the secondary market are made aware that, upon expiration of the exemption, Canada Jetlines would be required to be in compliance with the Canadian ownership requirements of the Act, and that these requirements could be more restrictive that the terms of the exemption? RESPONSE: As a public company, Jetlines (the renamed entity after the closing of the Transaction) will be required to provide regular continuous disclosure to its shareholders and potential investors that will be available on the SEDAR website at www.sedar.com and the company’s website. The company’s quarterly financial statement filings, and the company’s website, will include a prominent statement and risk factor regarding this issue. Further, any investor purchasing shares directly from the company will have an acknowledgement of this issue in their subscription agreement. Investors and financial advisors who conduct due diligence on the company prior to investing will have this fact easily identifiable to them. All Canadian public companies have a “risk factors” section in their public disclosure and it is known that this disclosure should be referred to prior to making an investment.
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3. Response to Stakeholder Submissions As a general statement, the Parties are extremely pleased to see that a clear majority of the submissions received were supportive of the request for an exemption order. Further, the submissions came from across the country, and from a variety of stakeholders ranging from airport authorities, government officials, and local chambers of commerce. This fact alone clearly demonstrates that there is significant support for the Parties’ desire to launch Canada’s first true ULCC,2 especially since it will benefit local communities across the country. These submissions emphasized, among other things, the following key points:
Airports and communities are un-served or under-served, resulting in reduced economic activity and a lost opportunity for job creation.
The issues associated with lack of direct service as a result of the hub and spoke operations of the two major Canadian legacy airlines.
There is room in the marketplace for a true ULCC with lower fares, with minimal impact to the legacy airlines.
Confirmation of the lack of existing Canadian risk capital. Subsequent to the CTA’s response deadline, the Parties were also provided with a letter from Dr. Gabor Lukacs of Air Passenger Rights. Mr. Lukacs has launched 27 cases with the Canadian Transportation Agency (including a current challenge with respect to NewLeaf), winning 24 of them. Mr. Lukacs has confirmed that he has no intention of challenging the legality of the exemption order sought by the Parties. This is yet another example of how the Parties’ desire to launch Canada’s first true ULCC has been informed by extensive stakeholder engagement and support from all quarters of the air service industry. Submissions received from Air Canada, West Jet, Air Transport Association of Canada, First Air, Northern Air Transport Association, NewLeaf Travel and Helicopter Association of Canada3 are the ones that raised issues regarding the Parties’ request for an exemption order. These issues can be broadly summarized as follows:
The current 25% foreign voting interest limit is working.
A policy review is underway already and no exemptions should be granted during this review period.
2 The Parties submit that contrary to its claim, NewLeaf is not a ULCC but rather, a reseller of seats on Flair Air flights. The ULCC model, as employed internationally, is based on the ULCC operating its own fleet of aircraft, something NewLeaf does not. 3 The Parties submit that the Helicopter Association of Canada’s submission should not be considered given that it is not a relevant stakeholder within the domestic air travel ecosystem.
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An exemption of this magnitude and scope is unprecedented or unfair to other stakeholders.
The Parties characterization of the marketplace is incorrect. Set out below is the Parties’ response to each of these issues. The Parties consider WestJet’s submission as being the most thorough and comprehensive of the submissions received that raised issues regarding the exemption. As a result, the Parties have selected the WestJet submission to specifically respond to certain points raised within the submission. This response can be found in Appendix A to this letter. a. The current regulatory environment has resulted in an uncompetitive duopoly of airlines, high airfares for Canadian consumers, lack of service to secondary markets and leakage of passengers to U.S. border airports
Lack of Airline Start-Up Capital in Canada The primary basis for the Parties exemption order request is the lack of available capital in Canada to fund the start-up of an airline. The current 25% voting interest limit restricts the amount of foreign capital that can be obtained by a domestic air carrier and has resulted in the absence of a ULCC airline in Canada, despite the model’s international success in other G7 countries. However, certain stakeholders stated in their submissions that there is sufficient capital in Canada, but none of them have provided any support for this statement. The Parties on the other hand have provided real examples and independent third party support of the lack of capital. For the Parties earlier submissions on this point, please refer to its June 13, 2016 response to initial questions that were received. Air Canada and WestJet in particular have claimed there is sufficient capital in Canada to fund the start-up of an airline (again without providing any support). Despite these unsupported claims, a review of financings recently conducted by Air Canada and West Jet demonstrates they have relied predominately on foreign capital. Over 90% of the amounts raised in recent financings by Air Canada and WestJet have come from non-Canadian investors. If established airlines such as Air Canada and WestJet can’t access low risk capital in Canada, how is a high-risk start-up airline expected to do so? Please refer to Appendix B to this letter for a summary of these recent financings. Oddly enough, NewLeaf’s submission supports the Parties’ claim about the absence of sufficient risk capital to launch a ULCC. Their submission claimed that NewLeaf, and a potential third ULCC entrant, Enerjet, have experienced the same investment difficulties as the Parties in trying to launch a ULCC. Enerjet is a particularly good example as it is led by the co-founder of WestJet, Tim Morgan. Mr. Morgan was one of WestJet’s leaders from its start-up phase and left the company when it was an established airline with a market capitalization of over $1 billion. While Mr. Morgan was able to get financing for WestJet 20 years ago, the tightening of Canadian pension fund rules and current Canadian economic conditions have not yielded the same result of funding for Enerjet to start a ULCC airline. Mr. Morgan is currently down to a single aircraft and based on the public record, is flying that single aircraft for NewLeaf. The
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Parties submit that all three potential domestic air service entrants are experiencing the same challenge, namely, the lack of sufficient risk capital in Canada. NewLeaf goes on to note that despite the difficulties in finding capital in Canada, they have managed to start a ULCC airline. NewLeaf has not identified some Canadian source of capital that is available to fund the start-up of an airline under the current 25% voting interest limit. What NewLeaf has done is circumvent the financial fitness requirements of the CTA by operating through an indirect service provider (“ISP”) model. As you are aware under the financial fitness test, an applicant is required to demonstrate that it has sufficient funding in place, without taking into account any revenue from operations, to meet the costs, or in other words, the cash disbursements, associated with starting up and operating an air service for a 90-day period. For Jetlines, the CTA has determined that it must have $27M in available capital. Unlike Jetlines, NewLeaf does not need to have $27 million in available capital and therefore can start operations with much less capital. Further, as noted above, the Parties strongly dispute the claim that NewLeaf is a ULCC. For additional information on this point, please refer to the section of this letter below entitled “C. The Parties will Bring Lower Airfares and Stimulate New Passenger Growth - Jetlines is a True ULCC Bringing Lower Airfares”. Within the Air Canada submission, they make a statement that “there is no lack of access to capital for Canadian carries.” Air Canada has not provided any support for this proposition. Air Canada claims that the Parties would be given a competitive advantage if the exemption order were granted. The only advantage that arises from the exemption order is the ability to access foreign capital. Therefore, if Air Canada believes the exemption order provides an advantage and the only advantage is access to capital, it calls into question their unsupported statement that there is sufficient capital available for Canadian carries. Put another way, if Air Canada is convinced there is no lack of access to capital for Canadian carriers, why would they be concerned about an exemption that provides an entity with additional access to capital? Further still, the CTA Review Report entitled Pathways: Connecting Canada’s Transportation System to the World (the “Pathways Report”) notes that both Air Canada and WestJet have called for increased foreign ownership limits in the past when they were in need of investment.4 For ease of reference, the Parties provide below excerpts from reports prepared by the Canadian Chamber of Commerce, the Organisation for Economic Co-operation and Development (“OECD”) and Investment Industry Association of Canada in support of the Parties’ position.
Canadian Chamber of Commerce – “Entrepreneurs lack capital for Canada’s fastest- growing companies. One of the most critical determinants of competitiveness is access to capital, especially for start-ups and companies moving from innovation to commercialization. These fast-growing companies often depend upon venture capital
4 See Page 156 of Appendix 2 of the Pathways Report, available online at: < http://www.tc.gc.ca/eng/ctareview2014/canada-transportation-act-review.html >
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(VC) as the lifeblood needed to take a company from idea to market. Canada’s VC industry is still small and punching below its weight, particularly when compared to much larger VC industries in the U.S. During the course of 2014, the Canadian Chamber spoke with dozens of entrepreneurs leading fast-growing companies who say one of the biggest hurdles they face is securing capital to take their companies to the next level. In 2015, the Canadian Chamber will advocate a number of initiatives to boost incentives to expand the overall pool of capital and to attract more angel investors and international funds to Canada.”5
OECD – “Air transportation Competitive and efficient transportation services are crucial for Canada’s integration into the global economy, and their performance could be enhanced by improving regulation. Restrictive foreign-ownership limits are a key barrier, which probably raise financing costs and may lead to a slower adoption of new technology and know-how.”6
Investment Industry Association of Canada – “We are facing a crisis of available equity capital needed to finance the startup and expansion of small and mid-sized businesses in Canada, the engine of growth and job creation. Equity capital for small business accessed from public and private capital markets in the past two years is almost half the amount in the same period five years earlier, despite a larger economy and record low interest rates. This shortage of capital has translated to record low business startups in Canada, and to declining productivity levels.”7 In addition, attached as Appendix D to this letter is a letter from Mr. Robert J. Kokonis of AirTrav Inc. Mr. Kokonis was a participant in the Roundtable on the Traveller that occurred in May 31, 2016 in Ottawa. In his letter Mr. Kokonis provides further support for the proposition that there is insufficient risk capital capacity in Canada to properly fund direct air operator start-ups. Anti-Competitive Duopoly, High Airfares and Lack of Service to Secondary Markets Some of the submissions have claimed that Canada is one of the most expensive countries in the word to fly in and from. It is true that part of the reason for high airfares in Canada are the additional taxes and fees that Canadians have to pay when flying in or from Canada. A June 2012 Senate Report entitled The Future of Canadian Air Travel: Toll Booth or Spark Plug? Report on the Future Growth and Global Competitiveness of Canada’s Airports (the “Senate Report”) noted that the fare difference between a Canadian flight and an American flight was on average $428 roundtrip per person.8 However, Canadian taxes, fees and charges only account for between 15% and 33% of the difference. So after removing taxes and fees, Canadians are
5 See Page 3 of Report entitled Top 10 Barriers to Competitiveness 2015 prepared by the Canadian Chamber of Commerce 6 See page 46 of OECD Economic Surveys – Canada – June 2016 7 See Investment Industry Association of Canada News Release dated August 6, 2014 8 See Page 10 of the Senate Report, available online at:
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Page 10 still paying 67%-75% more than their American counterparts. The Parties submit that the main reasons for this are lack of competition and the high costs structure of the legacy airlines WestJet and Air Canada. The CAPA Centre for Aviation recently provided its analysis of the Canadian domestic capacity by airline in July 2016. It found that Air Canada and WestJet control about 85% (see graph below) of this market. The other airlines tend to concentrate on high yield specialized flying that does not create a lower airfare to the public.
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Between WestJet and Air Canada, WestJet has historically been viewed as the lower cost carrier, while Air Canada is a four star airline providing international long haul travel options. However, any notion that WestJet is a budget carrier offering lower airfares on a consistent basis needs to be dispelled. WestJet may have at one time offered discounted tickets to the Canadian public; however, it abandoned that business model behind many years ago. Around 2006, with the end of Canadian Airlines, WestJet changed its business model and has quickly moved to fill the more traditional airline role left by Canadian Airlines. WestJet has introduced initiatives that are in line with the legacy carrier model, such as premium economy seating, fare bundles, free in-flight entertainment systems, inter-airline agreements, a major airport network hub system, and a regional turbo-prop feeder airline. WestJet has been expanding its flight destinations with the acquisition of wide body aircraft to serve international destinations, while having to address labour challenges from employees who have been seeking union certification, as a result of these legacy-like initiatives. WestJet has also been increasing its base airfares and most often publishes airfares comparable to Air Canada on the same routes. In fact, it is not usual to find WestJet charging a higher rate than Air Canada on the same route. A key component of the Jetlines opportunity is WestJet’s corporate decision to abandon the discount airfare market, allowing Jetlines to address this vacuum by providing discounted airfare to Canadians who are not using air transportation due to high airfares. WestJet’s CEO and President, Greg Saretsky’s response October 2, 2015 to the Financial Post on the possibility of new ultra-low-cost carriers (ULCCs) in the Canadian market:
“We aren’t the same low-cost airline that we were in 1996. Our costs have gone up quite a bit and that happens when an airline matures. … So a brand-new ULCC would have costs that would be below us, and we always said that he with the lowest costs wins.
But there’s a question of whether or not you need to be the absolute lowest cost or whether you just need to be lower cost than another main competitor of yours, so we’re in a comfortable spot because we’ve got a domestic competitor [Air Canada] that’s got costs that are quite a bit higher than ours. Nevertheless, a new ULCC would probably create some havoc.”9
Clearly, WestJet is not a budget carrier, let alone a ULCC, and has no intention of filling that space in the Canadian market.
9 http://business.financialpost.com/news/transportation/the-quotable-gregg-saretsky-westjet-ceo-on-air- canada-competition-unionization-and-more
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Another result of the current regulatory environment is the lack of direct air service to secondary airports. WestJet and Air Canada operate hub and spoke networks, and customers living in secondary cities have to travel through Vancouver, Calgary, Toronto or Winnipeg to get to any other place in Canada. Numerous submissions for airport authorities have noted the lack of service and demonstrated the economic and other hardships that are endured as a result. The Jetlines business model is focused on providing direct air service to secondary airports and remedying this significant issue. Leakage of Canadian Passengers to U.S. Border Airports The Senate Report contained a supported estimate that 4.8 million people crossed the border in 2011 for the purpose of commercial air travel, mainly due to lower airfares in the United States.10 The report notes this means losses of $2.389 billion in economic output, $1.113 billion in GDP, 8,890 jobs, $511 million in employment income and $190 million in tax revenue. This trend is only going to continue as the disparity in airfares continues to exist. This is demonstrated further by the recent announcement that United States ULCC Allegiant Air is now offering non-stop flights from Ogdensburg, New York to Florida. The Ogdensburg International Airport is a 45-minute drive from Ottawa, less than 10 kilometres from the junction of Highways 416 and 401. Allegiant Air identifies airports on its website as “Ottawa ON/Ogdensburg NY” and “Vancouver, BC/Bellingham, WA”. Other United States ULCC’s use similar marketing campaigns targeted at Canadians. While Jetlines will not be able to repatriate all of the Canadians using U.S. border airports, it will be able to recapture a material portion and return the associated economic benefits to Canada. b. The Exemption is Compatible with Ongoing Policy Review
Legacy Carries Benefit from Status Quo In their respective submissions, Air Canada and WestJet claim that an exemption order should not be granted to Jetlines given that the federal government is currently conducting extensive public consultations that will inform its official air policy. In essence, they are advocating that the Minister of Transport (the “Minister”) not take any steps until such time that a definitive policy position have been articulated, regardless of whether the Minister has the ability to do so in the public interest. The position taken by Canada’s two major legacy air carriers (who collectively control approximately 85% of Canadian domestic air travel) is not surprising given that they have a strong interest in maintaining the status quo which (i) protects their favorable market position and (ii) ensures that barriers to entry for new Canadian competitor remain as high as possible, for as long as possible. In fact they have a fiduciary duty to their shareholders to maximize economic returns and attempt to reduce competition which could lead to lower airfares and
10 See Page 10 of the Senate Report, available online at:
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Page 13 smaller profits. As noted above, they are using the pretext of an ongoing consultation process to dissuade the Minister from using a statutory tool that grants him the ability to exercise his discretion to issue an exemption order that is clearly in the public interest. The Parties submit that 85% of the airline market being controlled by two entities that price within a tight band of each other is not in public interest. The current situation makes it critical for the Minister to act and the exemption order to permit the start-up of a ULCC is one of the tools at the Minister’s disposal. Policy Review Does Not Preclude Issuance of Exemption Order Jetlines recognizes that while an exemption order and the articulation of a definitive air policy by the federal government are two separate processes, one does not preclude the other and can coexist. There is no reason, legal or otherwise, why the Minister should be prevented from issuing an exemption order to Jetlines while he continues consulting with stakeholders in view of revising Canada’s official air policy. While some of the submissions contend that an exemption order would give Jetlines an undue advantage, the reality could not be further from the truth. Jetlines has consistently stated that should an exemption be granted, upon expiration of the exemption period, it would fall into compliance with whatever foreign ownership rules would be in place at the time. It has also agreed in principle to have conditions imposed on it (e.g., obtaining the Minister’s approval of any foreign investor investing in Jetlines, providing regular updates on financing status to the Minister, a commitment to service certain routes on a priority basis during the initial ULCC launch phase, avoid providing service to Pearson International Airport and Montreal Trudeau Airport, etc.), should the Minister deem it necessary. If anything, the imposition of these or similar conditions would provide legacy carriers with an undue advantage over Jetlines that will be required to dedicate resources to ensure compliance with the conditions. Nevertheless, given its commitment to the ULCC model (and the success of this model in other jurisdictions), Jetlines is convinced that once it overcomes the hurdle related to the lack of Canadian capital, it will be able to offer Canadian travelers competitive rates, create jobs and stimulate economic growth in many underserved or unserved communities. Jetlines also notes that its request for an exemption order is consistent with the 2009 amendments to the Canada Transportation Act (which raised the foreign ownership restriction to up to 49%) and the recommendations of the Pathways Report. Recognizing that the latter report is not binding on the Minister as he revises Canada’s air policy, it demonstrates that Jetlines took a measured approach by ensuring that its request was consistent with the work leading up to the 2009 amendments and Pathways Report. Put simply, Jetlines request does not seek to go beyond what the federal government and/or industry stakeholders have felt was appropriate in prior discussions and consultations. In any event, Jetlines has indicated that it is open and flexible in terms of what conditions may accompany an exemption order. Exemption Order is Appropriate Jetlines reiterates that subsection 62(1) of the Canada Transportation Act grants the Minister the ability to issue a domestic license to a non-Canadian where it is necessary or advisable in the public interest. Contrary to what some of the submissions suggest, there is no requirement
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Page 14 for the Minister to refuse an exemption order on the basis that a policy review is currently underway. Requests made under subsection 62(1) should be reviewed on a case-by-case basis. It is a mechanism designed to allow the Minister to review an application on its merits and exercise his discretion if the applicant can demonstrate a legitimate public interest would be advanced by the issuance of such an order. As articulated in its previous submissions, the public interest test would be would be met should an exemption order be issued and Jetlines is able to launch air operations. Given its business model, Jetlines would be able to: (i) offer better connectivity to underserved and/or unserved communities;
(ii) offer reduced airfare to Canadian consumers;
(iii) increase competition, thereby benefiting consumers;
(iv) encourage Canadian to fly from Canada;
(v) increase air travel in Canada;
(vi) create new jobs; etc.
Jetlines submits that given that the public interest test is met, the Minister should exercise his discretion an issue an exemption order to Jetlines. c. The Parties will Bring Lower Airfares and Stimulate New Passenger Growth
Jetlines is a True ULCC Bringing Lower Airfares
An ULCC, also known as a budget carrier or sometimes globally as a Low Cost Carrier (LCC), is a simplified air carrier business model that operates with a cost point well below larger hub and spoke airlines and thereby provides lower priced airfares and stimulates its own market. The ULCC model focuses on standardization of plane size and seating options, point to point flight patterns, using lower cost airports options, provides a business focus on cost control while ancillary revenue is achieved through customer up-sales for additional services. It has proven highly profitable throughout the world and is growing as part of the total airline market, except in Canada.
The standard used to classify an airline as a ULCC is the CASM-X (Cost per avaiable seat mile excluding fuel). Jetlines has forecasted a CASM-X of 6 cents and a CASM (with fuel) at 10 cents for its operations. Based on each airlines 2015 Annual Reports, WestJet’s CASM-X is approximately 9.5 cents and Air Canada’s CASM-X is approximately 11.3 cents. When Jetlines modelled the ISP (reseller) system it resulted in a CASM-X of around 10 cents. As a result, only Jetlines can be deemed an “ULCC airline” by industry standards.
To control costs ULCC airlines must:
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Use a reduced seat pitch; Refrain from interline agreements, code share agreements, use of travel agencies; Sell directly from their own web-site; Use only one or two aircraft types; Reduce FTE employees to around 65 per aircraft (European ULCC airlines state 45 employees per aircraft, but they don’t count outsoruced workers as FTE employees); Fly point-to-point routes in lieu of a hub and spoke system; Use mainly secondary airports; and Unbundle all items – nothing is free. The standard used to classify an airline as a Low Cost Carrier (LCC) is an airline that controls cost through using many, but not all, of the ULCC business model items. Argueably WestJet is still at the top range of the LCC model, but doesn’t price as a LCC airline. The other specilized airlines in Canada don’t offer reduced airfare. Thereby, Canada currently has no airline offering discount airfare as their defined business model. Therefore, the price simulation model to attract additional air passengers in not at play in Canada.
WestJet started in 1996 and they used their lower costs to produce lower airfares that allowed them to enter the market by stimulating new passengers. However, as discussed above, around 2006 WestJet changed its business model and generally doesn’t sell airfares at a discount. This shift in is its business model from a LCC airline to a hybrid (almost legacy airline) may have been a good business decision for expansion, but certainly WestJet is no longer a discount carrier offering airfares below those of Air Canada.
On the other hand, Jetlines will use the proven and profitable ULCC business model to lower costs to the level that Jetlines can attract new passengers with airfares that are 30 to 40% below the lowest airfares currently in the Canadian market.
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Jetlines Cost Advantage & Projected CASM of Each Airline in Canada
As noted above, the Parties also dispute the claim that NewLeaf is a true ULCC. The Parties have run financial models based on the prices announced by NewLeaf and concluded that there is no sustainable way they can maintain such a pricing model for routes into and from secondary markets. An in-depth analysis of NewLeaf’s route network and pricing demonstrates that NewLeaf would need a 90% passenger load with $50 of ancillary revenue per person to break even. Both the required passenger load factor and ancillary revenue amount are unrealistically high. ISPs also rely on a dual margin business structure – one at the air operator level and the other at the booking level. Building a dual margin into a discount air service for secondary markets and vacated, under-served, or unserved markets, cannot be maintained beyond the short or even near term. To the extent it is helpful, Jetlines would be willing to share its analysis and financial models in support of its conclusions. A legitimate ISP model will only be effective when there is a specific and limited destination profit point, for instance holiday trip packages that include a high ancillary fee structure through the sale of hotel rooms, recreation tickets and similar items. Ultimately, ISPs cannot maintain beyond a year an ultra-low fare pricing model in Canadian secondary markets and cannot offer fares viably discounted by more than 20-30%. ISPs also need to consider their initial pricing models as temporary and subject to change. NewLeaf observed this year their rates being matched within 24 hours by WestJet Airlines. Initial rates from NewLeaf were then lowered even further in response to WestJet’s pricing. As a result, NewLeaf offered base airfare for a two-hour flight at approximately $30 per passenger, which is not financially sustainable. Without the proper financial approval from the CTA, ISPs
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Page 17 such as NewLeaf are projected to be financially unstable given their pricing model and other airlines’ likely competitive response. On the other hand Jetlines intends to be Canada’s first true ULCC airline, operating its own aircraft and passing those saving onto Canadians. Its cost structure will allow it to sustain even under a significant competitive response from legacy airlines. In fact, NewLeaf has already abandoned certain routes, less than one month after re- launching.11 In addition the foregoing, the Canadian public is put at risk due to the fact that ISPs like NewLeaf can manage key aspects of an airline service without an airline licence, the same level of government oversight or knowledge of aircraft operations. For instance, the interaction between ISPs and their air carriers on key issues related to human resources can have a direct impact on flight safety. NewLeaf’s 2015 investor presentation states “NewLeaf will operate with lower human resources costs than traditional airlines because of lower base salaries and aircraft that have less cabin staff and seating than conventional airlines.”12 NewLeaf’s statement demonstrates a clear lack of operational knowledge as flight attendant staffing per aircraft is strictly set and regulated by Transport Canada for clear safety reasons. In February 2011, at the Cork Airport in the Republic of Ireland, the Fairchild SA 227-BC Metro III aircraft crashed at landing, leading to the death of six people including both pilots. The aircraft was owned by a Spanish bank and subleased on the AOC of Flightline S.L., based in Barcelona, Spain. However, tickets were sold by the ISP Manx2 based in the Isle of Man. The final accident report noted as contributory factors that there was an inappropriate pairing of flight crews, inadequate command training and oversight of the chartered operation by the operator. The concluding findings of the report state that the owner, which did not hold an AOC had made an arrangement with the ticket seller for the supply of an aircraft and crew according to its schedule. Jetlines Will Stimulate New Passenger Growth and Economic Benefits
Jetlines’ intention is not to start a new airline to compete head-to-head with the legacy carriers. Jetlines business models will create brand new passenger trips. Using Boeing’s analysis of the discount airfare market size, an analysis of the USA ULCC & LCC market share and the price stimulation model, Jetlines submits that a ULCC in Canada can bring millions of new passengers to the Canadian airline industry and establish a new market of approximately 10 million additional passenger trips annually by 2024. Please refer to Appendix C to this letter for a detailed analysis of this passenger calculation.
11 Available online at:
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Canadian Air Traveler Potential Market Response to ULCCs
Sources: Current Canadian Air Travel Market: Diio FMG database for the 12 months ended August 31, 2014 Leakage to US Market: 2012 Standing Senate Committee of Canada on Transportation and Communications IATA: The IATA Economics Briefing No 9: AIR TRAVEL DEMAND, April 2008 Hong Kong: YVR (2008) report Boeing: June 2013 Boeing Market Outlook Report
Of the projected annual 10,000,000 new air passenger trips per year available in Canada due to lower airfares and flights from underserved or non-served airports, Jetlines will fill approximately 50% (4.8M new passengers – 6M total passengers) of this market by year-8, or when Jetlines reaches 40 aircraft.
Jetlines has compared its eight year forecasts to WestJet’s 1996 start-up as a LCC airline and Spirit Airlines’ 2007 conversion into an ULCC airline. All data is in 2015 Canadian dollars converted with an inflation and exchange factor. Note Spirit’s 2nd year is 2008 that involved a major economic correction in the USA. Both of these airlines included discounted airfare into a market that was considered at full capacity by the established carriers. However, the effect of lower prices and flights from new location created a new market for both carriers.
Jetlines projected growth is much less than Spirit Airlines and very similar to WestJet’s as shown below:
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Years 1-8 - Start-up Comparison – Jetlines vs WestJet
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 YEAR 6 YEAR 7 YEAR 8 FACTORS Jetlines Westjet Jetlines Westjet Jetlines Westjet Jetlines Westjet Jetlines Westjet Jetlines Westjet Jetlines Westjet Jetlines Westjet AIRCRAFT6 4 116161121162722312736354044 LOAD FACTOR 61% 63% 65% 71.60% 67% 69.90% 71% 72.30% 72% 76.20% 73% 74.20% 72% 73.20% 73% 71% REVENUE $94.5M $56M $228M $109M $358M $175M $510M $279M $644M $449M $807M $620M $931M $868M $1,086 $1,065M EBITDA $2.1M $1.6M $18.2M 14.8M $44.5M $9M $89M $88M $110M $70M $143M $77M $161M $105M $188M $148M REVENUE/ AIRCRAF $15.8M $14.1M $20.7M $22.5M $22.4M $15.9M $24.3M $17.4M $23.80 $20.4M $26.0M $23.0M $25.8M $24.8M $27.1M $24.2M EBITDA/ AIRCRAFT $350K $400K $1.65M $2.5M 2.7M $818K $4.2M $5.5M $4.1M $3.2M $4.6M $2.9M $4.5M $3.0M $4.7M $3.4M
Years 1-8 - Start-up Comparison – Jetlines Vs Spirit
YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 YEAR 6 YEAR 7 YEAR 8 FACTORS Jetlines Spirit Jetlines Spirit Jetlines Spirit Jetlines Spirit Jetlines Spirit Jetlines Spirit Jetlines Spirit Jetlines Spirit AIRCRAFT 6 36 11 33 16 28 21 31 27 35 31 41 36 50 40 58 LOAD FACTOR 61% 81% 65% 79.90% 67% 80.7% 71% 82.10% 72% 85.6% 73% 85.20% 72% 86.60% 73% 87% REVENUE $94.5M $1,036M $228M $1,045M $358M $926M $510M $933M $644M $1,352M $807M $1,643M $931M $2,048M $1,086 $2,525M EBITDA $2.1M $44M $18.2M $25M $44.5M $148M $89M $90M $110M $182M $143M $217M $161M $347M $188M $465M REVENUE/ AIRCRAF $15.8M $28.7M $20.7M $31.6M $22.4M $33.1M $24.3M $28.9M $23.80 $36.6M $26.0M $40.1M $25.8M $41M $27.1M $43.5M EBITDA/ AIRCRAFT $350K $1.2M $1.65M $757K 2.7M $5.3M $4.2M $2.9M $4.1M $5.2M $4.6M $5.3M $4.5M $6.9M $4.7M $8.0M
Jetlines’ business plan is stressed for competitive response by Air Canada and WestJet. Although, actual forecasting of routes with lower airfares often predicts load factors in the 80+% range, Jetlines has used passenger load factors between 61 and 73%.
There are significant economic benefits to Canada that will result from the Jetlines business plan. These benefits are set out in the table below.
Years 8 (40 Aircraft) - Jetlines Projected Outputs – Total Route Structure
Year‐8 (40 Aircraft) Total Passengers New Direct Total Jobs14 Economic Passengers Jobs13 Output15
British Columbia 1,500,000 1,130,000 850 4,500 $850M Alberta 1,020,000 780,000 250 2,900 $585M Saskatchewan 180,000 140,000 60 500 $105M Manitoba 460,000 350,000 250 1,200 $260M
13 Based on 65 direct employees per aircraft 14 Based on 3.3 total jobs supported per 1,000 “new” passengers 15 Based on $250,000 per 1,000 “new” passengers
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Ontario 2,400,000 1,850,000 1,050 6,200 $1,400M Quebec 200,000 150,000 60 500 $115M Atlantic Canada 530,000 400,000 100 1,500 $300M CANADA 6,290,000 4,800,000 2,610 17,300 $3,615M
To calculate the benefits to Canada the following formulas are used:
New Passengers: Over the long term Jetlines determines that 80% of its passengers will be new as the result of lower prices, including bringing back passengers using a USA ULCC airline along the Canadian border, and by operating from underserved and unserved airports in Canada. This equals 4.8M new passengers by year-8 (6M total passengers) or when 40 aircraft are in service.
Annual Passengers Carried per Aircraft: A Boeing 737 aircraft in the Canadian domestic market will carry between 150,000 to 180,000 passengers per year. In Year-8 Jetlines has forecasted 157,250 passengers per aircraft per year. With 40 aircraft Jetlines is forecasting 6.3M passengers. As a gross error check refer to WestJet’s 2012 Annual Report. In that year WestJet operated 100 Boeing 737 aircraft (no other aircraft types). They moved 17.4M passengers with an 83% passenger load factor, or 174,000 passengers per aircraft16.
Total Jobs and GDP: Every 1,000 passengers carried results in $248,000 in total GDP and air transportation supports over 330 jobs for every 100,000 passengers carried or 3.3 jobs for 1,000 new passengers.17
Direct Jobs: Jetlines is using 65.25 FTE jobs per aircraft to determine direct jobs created (as part of the total job count). As a gross error check refer to WestJet’s 2012 Annual Report. In that year WestJet operated 100 Boeing 737 aircraft (no other aircraft types). They reported 7,742 FTE employees, or 77.42 direct employees per aircraft18.
Jetlines’ Benefit: Jetlines is able to create and transport passengers that WestJet and Air Canada simply can’t attract. As a result, by Year-8 (40 aircraft) Jetlines projects to fly 6.3 million passengers of which 4.8 million passengers will be “new” passenger creating 2,600 new direct jobs, supporting 17,000 total jobs, and adding 3.6 billion dollars into the
16 Page 22 available online at -
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economy. Despite claims by other airlines, these benefits can only be achieved by Jetlines entering the market place and creating its own new passengers.
Should you have any questions or wish to further discuss, please do not hesitate to contact the undersigned.
Yours truly,
Jim Scott Mark Morabito CEO CEO Canada Jetlines Ltd. Jet Metal Corp.
cc: Miller Thomson LLP Imran Ahmad, Partner
Officer of the Minister of Transport Jean-Philippe Arseneau, Chief of Staff, Officer of the Minister of Transport Alain Berinstan, Director of Policy Adel Boulazreg, Policy Advisor
Transport Canada Shawn Tupper, Assistant Deputy Minister Sara Wiebe, Director General, Air Policy Colin Stacey, Director, National Air Services Policy
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APPENDIX “A” RESPONSE TO SPECIFIC WESTJET COMMENTS
1. WestJet’s Comment: “Over the past 10 years alone we have initiated service on 189 new non-stop routes, almost doubled the size of our fleet to a total of 148 aircraft as of June 2016, and grown our domestic capacity by 75%. The combined effect of these growth activities has been demonstrably positive in reducing the cost of air travel and increasing consumer demand in every region of the country. As an example of the net positive effect of WestJet service, our WestJet Encore destinations in B.C. and Alberta have seen substantive fare reductions including between 20 to 40% since the introduction of our service, combined with net traffic increases at times in excess of 50% with some airports experiencing triple digit percentage growth.”
Jetlines’ Response: As WestJet has changed its business model away from being a discount airline it has enjoyed great growth as a result of capturing much of the old Canadian Airlines’ network, including establishing a regional turbo-prop airline to feed its hubs. Jetlines notes that WestJet is stating that their passengers are growing by approximately 1 million passenger trips per year. However, their business model still in no way helps or stimulates the millions of passenger trips per year in Canada that cannot afford the new WestJet model.
2. WestJet’s Comment: “Furthermore, our on-going expansion and launch of new city pairs and expanded frequency, has been fuelled by our profitable operations. Most recently we confirmed our full order for 45 Bombardier Q-400 aircraft. Thirty are already in operation in the fleet, with the remaining being delivered through to 2018. This represents a total list price of $US1.59 billion. This is in addition to the firm deliveries beginning next year of 65 Boeing 737 Max series aircraft, in total representing approximately $6 billion in capital expenditure in fleet renewal. The entire multibillion dollar capital investment and growth of WestJet over the past twenty years has been precisely predicated on our profitable operations, which in turn drives further connectivity, further competition and lower fares.”
Jetlines’ Reply: Jetlines calculates that very few of WestJet’s passengers will switch over to Jetlines. WestJet is growing in its own market out of its major hubs and is expected to continue to be highly profitable. Thereby, WestJet will be able to meet its funding commitments for new aircraft that Jetlines agrees will lower costs and reduce airfares.
Jetlines itself has up to 21 new aircraft on order worth US$1.78 billion. In addition, Jetlines is in discussion with Bombardier for the purchase of C-Series jets in lieu of many of the Boeing 737MAX purchase rights (16) that Jetlines has with The Boeing Company. Initial data has shown that the C-Series is more fuel efficient than the Boeing 737MAX aircraft. Provided Jetlines and Bombardier can come to commercial terms, Jetlines as a fully developed ULCC airline in Canada will be in a position to complete up to a US$2.0 billion order for Bombardier C-Series Aircraft.
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The purchase of new aircraft is shown in Jetlines’ financial model to lower its costs by 10%. Those savings will be passed on to consumers.
3. WestJet’s Comment: “Airfares at Six-Year Low -Furthermore, despite the applicant’s assertions airfares in Canada have remained at historically low levels. In fact, recent figures from Statistics Canada indicate that Canada’s overall airfare rates remain at their lowest levels in six years.”
Jetlines’ Reply: Since the time of deregulation, airfares have been decreasing as airlines become more cost efficient. This is not just a six-year tendency and has little to do with WestJet. It is market trend as airlines have become more cost conscious. The following charts19 indicate that trend:
In fact, according to WestJet’s 1999 annual report20 when WestJet first started operations in 1996 their CASM (reported as Operating cost per available seat mile) was 16.8 cents reducing to 13.9 cents by 1999. Adjusted for inflation, WestJet started operations with a 23.5 cent CASM reducing to 19.5 cents by 1999. A CASM at this level would bankrupt WestJet in the current market. Today, WestJet has a CASM around 12.9 cents, which is not low enough to be a ULCC and maybe not even a LCC. Thereby, the last twenty years of aviation has experience a true reduction in the cost of air travel, and WestJet just followed the industry trends.
19
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Regarding the drop in airfare in the last six years, this is the result of lower oil prices. Statistics Canada stated that the average domestic airfare, without taxes and fees, in Canada is $175.70. Arguably, airfares have not dropped in pace with the reduction of Jet fuel prices; thus, leading to record profits by the airlines around the world. Listed below is the type of feedback the media worldwide is placing on airlines21:
4. WestJet’s Comment: “Over the past year alone WestJet has brought numerous low fares to market, a small sample includes the following base fares: Ottawa – Toronto for $42, Kamloops – Kelowna for $43, Edmonton – Calgary for $45, Vancouver – Victoria for $50, Los Angeles – Vancouver for $64, New York – Toronto for $64, London – Toronto for $60, Hamilton – Halifax for $100, Kitchener-Waterloo to Orlando for $84.”
Jetlines’ Reply: This assertion is disingenuous. These airfare examples do not demonstrate that WestJet is a discount airline or indeed has any intention to fill that gap in Canada. These airfares are below their costs and no doubt were used to fill the last remaining portion of their aircraft as part of yield management computer program, or were introductory airfares to launch a new route. Very limited seats would ever be available at these rates and certainly the public can’t count on travelling at these rates. Assuming that WestJet is only speaking of its base fares (no taxes or airport fees), a simple check of airfares July 18, 201622 (6 days out) on the WestJet website shows that the lowest airfares available to the public are as follows:
Ottawa to Toronto - $177, not the $42 stated by WestJet; Kamloops to Kelowna - $160, not the $43 stated by WestJet; Edmonton to Calgary - $149, not the $45 stated by WestJet;
21
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Vancouver to Victoria - $160, not the $50 stated by WestJet; Los Angeles to Vancouver - $139, not the $64 stated by WestJet; New York to Toronto- $229, not the $64 stated by WestJet; London (Canada) to Toronto - $149, not the $60 stated by WestJet; Hamilton to Halifax - $160, not the $100 stated by WestJet; and Kitchener-Waterloo to Orlando - $346, not the $84 stated by WestJet. Jetlines' goal is to have base airfares (without taking into account any competitive response) that are on average 40% lower than the lowest airfare of WestJet and where applicable Air Canada. A comparison of Jetlines’ projected base airfares is shown below against the lowest airfare by either Air Canada or WestJet (note: often WestJet had the higher prices of the two airlines). The data was obtained in May 2015 and used the lowest airfare between November 18-25, 2015. November was used as it is a low-demand month for passengers.
Competitor Base Air Jetlines Base Air FROM – TO & RETURN 23 Fare Fare YVR (VANCOUVER) YEG (EDMONTON) $184 $74 YEG (EDMONTON) YHM (HAMILTON) $303 $182 YVR (VANCOUVER) YXS (PRINCE GEORGE) $152 $61 YYJ (VICTORIA) YLW (KELOWNA) $137 $55 YYJ (VICTORIA) YEG (EDMONTON) $183 $73 YVR (VANCOUVER) YXE (SASKATOON) $222 $89 YVR (VANCOUVER) YWG (WINNIPEG) $248 $99 YEG (EDMONTON) YLW (KELOWNA) $179 $72 YEG (EDMONTON) YMM (FORT MCMURRAY) $175 $70 YVR (VANCOUVER) YQR (REGINA) $212 $85 YHM (HAMILTON) YHZ (HALIFAX) $260 $104 YHZ (HALIFAX) YYT (ST. JOHN'S) $141 $56 YHM (HAMILTON) YOW (OTTAWA) $156 $62 YOW (OTTAWA) YYT (ST. JOHN'S) $205 $82 YHM (HAMILTON) YHU (ST. HUBERT) $109 $44 YHM (HAMILTON) YSB (SUDBURY) $110 $44 YHM (HAMILTON) YYT (ST. JOHN'S) $288 $115 YHM (HAMILTON) YWG (WINNIPEG) $248 $124 YWG (WINNIPEG) YOW (OTTAWA) $243 $122 YHM (HAMILTON) LAS (LAS VEGAS) $316 $237 YHM (HAMILTON) PUJ (PUNTA CANA) $440 $330 YWG (WINNIPEG) LAS (LAS VEGAS) $269 $202 YWG (WINNIPEG) YEG (EDMONTON) $204 $82 YWG (WINNIPEG) MCO (ORLANDO) $298 $224 YWG (WINNIPEG) YXE (SASKATOON) $181 $72 YWG (WINNIPEG) YYJ (VICTORIA) $256 $154 YVR (VANCOUVER) YHM (HAMILTON) $336 $202
23 Reference date November 18-25, 2015 – lowest Air Canada or WestJet airfare on their websites
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YVR (VANCOUVER) SAN (SAN DIEGO) $232 $174 YHM (HAMILTON) NYC (NEW YORK CITY) $162 $122 YHM (HAMILTON) YQM (MONCTON) $224 $90 YYT (ST. JOHN'S) YQM (MONCTON) $252 $101 YHM (HAMILTON) YAM (SAULT ST. MARIE) $150 $60 YVR (VANCOUVER) SJD (LOS CABOS) $335 $251 YVR (VANCOUVER) MCO (ORLANDO) $336 $252 YHM (HAMILTON) CUN (CANCUN) $250 $188 YHU (ST. HUBERT) LAS (LAS VEGAS) $250 $188 YOW (OTTAWA) CUN (CANCUN) $250 $188 5. WestJet’s Comment: “With respect to overall market stimulation, Jetlines proposal to “fly up to 10,000,000 passengers” is noted. WestJet was launched in 1996 and did not hit 10,000,000 passengers a year until 2006, while operating 63 Boeing 737 aircraft.”
Jetlines’ Reply: Jetlines’ position is that the missing market in Canada due to Canada not having a discount carrier is 10,000,000 passenger trips per year by 2024, with Jetlines forecasted to fly approximately 50% of this market in eight years. The growth to 40 aircraft in eight years is on average with WestJet having 44 Boeing 737 aircraft in their eighth year, and Spirit Airlines having 58 similar aircraft in their eighth year.
6. WestJet’s Comment: “With respect to WestJet, overall in 2016 as we continue to provide more service and frequency to consumers, we expect our system capacity to grow between 7% to 9% as we drive further competition in the marketplace.”
Jetlines’ Reply: Jetlines acknowledges that WestJet is expanding its network. However, much of this expansion is being accomplished by placing turbo-props onto routes normally operated by jets. There is nothing wrong with this approach to feed one’s hub, but Jetlines has heard the backlash to this approach in places like Prince George, B.C. and the Atlantic region of Canada that often lack a jet alternative to WestJet’s and Air Canada’s turbo-props on these routes. Jetlines’ plans to use only jets and will be able to give Canadian better aircraft choices in some markets, along with lower airfares.
7. WestJet’s Comment to the Minister: “Concerns raised over Canadians using U.S. airports are a result of high Canadian airport fees and taxes, not the lack of a ULCC in Canada as suggested by the applicant. U.S. border airports routinely launch media and advertising campaigns inviting Canadians to drive across the border and avoid Canada’s high taxes and fees, as well as various US taxes that are levied on trans-border airfares but are not levied on car traffic across the border. A clear disparity in costs between Canadian and U.S. facilities exists today, a fact underscored by both the proliferation of border airports siphoning traffic out of Canadian facilities, and by the striking fact that no low cost U.S. carrier flies to any Canadian city even though for 20 years they have had full authority to do so under the Canada – U.S. bilateral air agreement.”
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Jetlines’ Reply: Jetlines acknowledges that airport taxes and fees are higher in Canada than the USA. Indeed, the issues of fees is exacerbated by both WestJet’s and Air Canada’s practice of adding Air Transportation Fees to offset operating costs, which are costs that should be offset by the base air fare. However, by using a hub & spoke network system mainly based in the most expensive airport in Canada, WestJet can’t solely blame the government for the leakage of Canadian air passengers to the United States border towns. Jetlines intends to use airports like Kitchener Waterloo that has airport landing and terminal fees that are 20% those of Toronto Pearson Airport.
Also with the other ULCC business model techniques not used by WestJet, Jetlines can close the price delta to the point where many travellers wouldn’t see the total pricing benefit to drive the USA for air service. Jetlines will not match the USA ULCC airline in price, but will price much better than WestJet and will keep a good number of these passengers in Canada. As well, this cross border movement to find discount airlines has slowed with the change in the Canadian dollar exchange with the US dollar. As a result, Canadians are currently more likely to use a discount airline out of Canada.
8. WestJet’s Comment to the Minister: “The absence of the ULCC model is due to the high cost of operating a commercial carrier in Canada, as opposed to an absence of capital as asserted. To this end, it is worth noting that despite having a very liberal bilateral air access agreement with the U.S., American low cost carriers and ultra-low cost carriers do not fly to Canada. There are no limits on the number of flights a U.S. carrier can operate to a Canadian city, nor are there any limits on the number of Canadian cities a U.S. carrier can serve. Yet despite this open marketplace, the most successful low cost airline in the history of commercial aviation – Southwest – does not fly to Canada. Nor does JetBlue, nor for that matter do ULCC’s Allegiant or Spirit. This is a purposeful business decision being taken by these operators to avoid flying to Canada.”
Jetlines’ Reply: Jetlines believes that the American ULCC airlines will continue to use the US border airports to access Canadians. However, the current lack of US LCC airlines entering the Canadian market, specifically Southwest Airlines, has more to do with the low Canadian dollar, French language requirements, and the issues of operating in a foreign country, rather than a lack of opportunity. These US airlines need a rate of return per aircraft in USD and the Canadian market current disadvantages them by 30-40%. However, in 2014, prior to the decrease in the Canadian dollar Southwest executives were publicly speaking to entering the Canadian market to offer lower airfares (see portion of Global and Mail article below).
Jetlines believes that with both WestJet and Air Canada pricing in the same range, with Air Canada being a four star airline, as is Porter Airlines, that it is widely known that a discount airfare market space now exists in Canada.
Jetlines believes that it has 2- 3 years to establish a firm command of the discount airfare market in Canada, or when the Canadian dollar return to near parity with the US dollar, Southwest Airlines will enter the Canadian market operating out of airports like Kitchener/Waterloo and Abbotsford. The issue with Southwest Airlines is that when they
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enter a market they want to dominant the market with multiple flights to the same designation per day.
Senior executives of Southwest Airlines Co. are sending strong signals that they’re preparing to enter the Canadian market, although cities in Canada are among 50 new destinations the airline is still considering.
“We have visited Canadian airports and Canadian airports have visited us and they make a compelling argument as to why we should serve Canada,” Andrew Watterson, Southwest’s vice-president of network planning and performance, said in an interview at the airline’s headquarters in Dallas. He would not identify which airports are involved.
If Southwest expands to Canada it will bring lower fares, chief executive officer Gary Kelly said. “I’d be surprised if we weren’t in Canada at least by the end of the decade,” Mr. Kelly told reporters during media events at the airline’s headquarters.24
24
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APPENDIX “B” RECENT WESTJET AND AIR CANADA FINANCING ANALYSIS
Background
When a Canadian public company completes an exempt market financing (no prospectus filed), it is required to file a report of exempt distribution disclosing the details of the purchasers and the exemptions relied on. Specific purchaser information is retained confidentiality with the applicable securities commissions; however, general details about the financing are made available. These include the jurisdictions where each investor is resident, the number of investors in that jurisdiction and the amount purchased. Set forth below is a summary of recent financings completed by WestJet and Air Canada based on these public filings. What is demonstrated is that over 90% of these recent financings came from non-Canadians.
WestJet
2016
On June 13, 2016, WestJet completed an offering of US$400 million (Cdn$532 million) aggregate principal amount of 3.50% senior notes due June 16, 2021. The table below is taken from a publically available Report of Exempt Distribution filed by WestJet. 25 The table shows that Cdn$491 million or 92% of the financing came from investors located outside of Canada.
Jurisdiction of Investor Number of Investors Total Dollar Value Raise
Ontario 2 $49,427,100.00
United States 22 $490,341,600.00
United Kingdom 1 $1,304,100.00
Totals 25 $532,072,800.00
Air Canada
2014
On April 15, 2014, Air Canada completed a financing of senior notes due in 2021 and having an interest rate of 7.75%.The total size of the financing was Cdn$439 million. The table below is
25 Refer to the document filed June 27, 2016 available online at: http://www.sedar.com/DisplayCompanyDocuments.do?lang=EN&issuerNo=00010649
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taken from a publically available Report of Exempt Distribution filed by Air Canada. 26 The table shows that $409 million or 93% of the financing came from investors located outside of Canada.
Jurisdiction of Investor Number of Investors Total Dollar Value Raise
Ontario 9 $26,903,450.00
British Columbia 1 $3,294,300.00
United States 4 $409,042,250.00
Totals 14 $439,240,000.000
2015
In December 2015, in connection with the financing of three Boeing 787-9 and two Boeing 777- 300ER aircraft, Air Canada completed a private offering of three tranches of enhanced equipment trust certificates with a combined aggregate face amount of US$537. The three tranches of certificates have a combined weighted average interest rate of 4.044%. Based on publically available information from the website of the Ontario Securities Commission, only Cdn$6.8 million of this US$537 million was placed in Ontario to a single purchaser, representing 1.3% of the total offering.27
Company Date Amount Raised from Number of Investors Investors in Ontario
Air Canada 2015-12-14 6,866,500.00 1.00
26 https://eservices.bcsc.bc.ca/ViewDocument.aspx?docnum=E7C7R6D1J7S3E7OCS6X2E7C9B7K3 27 http://www.osc.gov.on.ca/documents/en/Securities/20160531_exempt_distribution.xlsx
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APPENDIX “C” CALCULATING MISSING CANADIAN PASSENGERS
1. Boeing Analysis of Discount Airfare Market Size – 16% Worldwide From Boeing’s Current Market Outlook 2014–2033, “The trend toward growth of the low-cost model is clear. Low-cost carriers have grown from 7 percent of the world market in 2003 to 16 percent today and are projected to capture 21 percent by 2033.”28 With no discount airline in Canada and at 16% of the current 62M Canadians flying domestically, trans border, to Mexico and the Caribbean, the Boeing market size analysis demonstrates that the discount market is for an additional 10,000,000 passenger trips per year.
2. USA ULCC & LCC Market Share The Amadeus29 forecast show that North America has 30% of its airfares being sold by either ULLC airlines or LCC airlines 30
28 Page 16 - http://www.boeing.com/assets/pdf/commercial/cmo/pdf/Boeing_Current_Market_Outlook_2014.pdf 29 http://www.amadeus.com/web/amadeus/en_1A-corporate/Airlines/1319628520825-Page- AMAD_IndustryHomePpal?industrySegment=1259068355670 30 http://www.amadeus.com/blog/16/04/travel-intelligence-in-the-digital-era-amadeus-air-traffic/
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This 30% analysis is confirmed through a review of the USA ULCC & LCC airlines that show 192.5 million passenger trips are conducted by these discount airlines, or approximately 28% of all domestic and trans-border traffic – Mexico ULCC airlines possibly makes up the remaining percentage given by Amadeus.
Market Annual Annual Percentage Domestic/Trans- Passengers Flown Penetration of Total border Passengers by ULCC/LCC Market by Airlines ULCC/LCC Airlines Canada 62M 0M 0% United 700M 193M 28% States
Allegiant Air (ULCC) – 9.3M revenue passengers31 Frontier Airlines (ULCC) -3.4M revenue passengers32 JetBlue (LCC) -35M revenue passengers33 Southwest Airlines (LCC) – 118M revenue passengers34 Spirit Airlines (ULCC) -18M revenue passengers35 Sun Country Airlines (LCC) – 1.8M revenue passengers36 Virgin America (LCC) -7M revenue passengers37 Total: 192.5 Million ULCC/LCC Passengers of 700 Million Domestic Passengers per Year (Source USA DOT)
Based on Canada having 10% of the USA population the USA discount market, adjusted to 90% for slightly less total movements, would be 193 X .10 X .9 or similar, market would have 17,400,000 discounted airfare passenger trips per year in Canada.
31 Page 23 - 2015 Annual Report - http://ir.allegiantair.com/phoenix.zhtml?c=197578&p=irol-reportsannual 32 Page 31 – 2015 Annual Report - http://files.shareholder.com/downloads/AMDA- OJWDG/2366321872x0x883785/1E594D05-3D8C-475A-9408-C29CC8912781/FTR_AR.pdf 33 Page 24 2015 Annual Report - http://investor.jetblue.com/~/media/Files/J/Jetblue-IR/Annual%20Reports/2015-ar- 10k.pdf 34 Page 40 – 2015 Annual Report - http://investors.southwest.com/financials/company-reports/annual-reports 35 Page 37 – 2015 Annual Report - http://files.shareholder.com/downloads/ABEA- 5PAQQ9/2414854393x0x875726/6C03279F-ADF1-4C6E-93EB-A61657F574CF/SAVE-2015.12.31-10K_- _FINAL.PDF 36 tp://www.transtats.bts.gov/carriers.asp?Carrier=SY&Carrier_Name=Sun%20Country%20Airlines%20d/b/a%20Mn%2 0Airlines 37 https://www.virginamerica.com/cms/about-our-airline/press/2016/virgin-america-reports-december-2015- operational-results.html
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3. Price Stimulation Model The price stimulation model is consistent with the following two independent sources which reviewed the impact of lower airfares on passenger demand:
I. The IATA Economics Briefing No 9: AIR TRAVEL DEMAND, April 2008, stated that the airline passenger demand price elasticity in North America is 1.5 on short haul routes and 1.4 on long haul routes. Given this level of price elasticity, a 25% decrease in airfare is expected to create a 35% (long haul) to 38% (short haul) increase in new passengers and a 40% decrease in airfare is expected to create a 56% (long haul) to 60% (short haul) increase in new passengers; and II. YVR stated in 2008 that based on Sabre MIDT between June 28, 2007 and May 2008, Oasis Hong Kong Airlines' lower priced airfares from Vancouver to Hong Kong showed a 65.2% increase in market demand. III. Recent actual airfare pricing variations in the Canadian domestic market have demonstrated a price to stimulation ratio of approximately 2 times.38 ULCC Airlines – Passenger Demand Profile
Source: European Low Fares Airline Association 2004 report titled
"Liberalisation of European Air Transport: The Benefits of Low Fares Airlines to Consumers, Airports, Regions and the Environment"
Under the price stimulation model it would create an additional 37,000,000 passenger trips per year in Canada.
38 Source: IATA PaxIS database, December 23, 2014
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4. Conclusion
Based on all of the foregoing models, including the price elasticity and market growth presented in the potential ULCC market data and average global discount airline market penetration of 16% as suggested by Boeing in the Boeing Market Outlook Report, the management of Jetlines believes there is potential for a ULCC in Canada to bring millions of new passengers to the Canadian airline industry and to establish a new market of approximately 10 million additional passenger trips annually by 2024.
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APPENDIX “D” LETTER FROM AIRTRAV INC.
See attached.
18662841.4 AirTrav Inc. | Affiliate Canada, ICF International Robert J. Kokonis, President & Managing Director
10 Delisle Ave, 14 th Floor, # 1402 Toronto, ON, M4V 3C6, Canada
Telephone/Fax: +1 289 346 0071 Toll-Free: 1 866 618 JETS (5387)
[email protected] www.AirTrav.ca | www.icfi.com
The Honourable Marc Garneau, P.C., M.P. Minister of Transport 330 Sparks Street, Place de Ville, Tower C Ottawa, ON K1A 0N5
Reference: Foreign voting interest limit and the start-up airline financing environment in Canada
Dear Minister Garneau,
Thank you kindly for inviting me to participate in the recent Roundtable on the Traveller on May 31, 2016 in Ottawa. I trust that my input will serve some use as your department considers how best to advance Canada’s future transportation system.
To refresh your understanding of my background, I am President of Toronto-based AirTrav Inc., an aviation consulting firm that practices in Canada and globally. AirTrav is the Canadian Affiliate of ICF International, a U.S. based firm with offices worldwide and whose aviation practice dates back to 1963. AirTrav also conducts frequent due diligence and business planning projects for the consulting division of the International Air Transport Association (IATA).
I am writing to you today concerning Canada’s airline foreign voting interest limit, a matter addressed in the 2015 Canada Transportation Act Review that was tabled in Parliament last February, along with the airline investment environment in Canada for start-ups. In particular, I am writing this note concerning how the current investment climate and foreign voting interest limit impacts potential start-ups such as Canada Jetlines Ltd. (“Jetlines”) of Vancouver, BC.
During my aviation career I have had the opportunity of working in Canada and abroad with air carriers ranging from start-ups seeking initial investment, to existing airlines looking to restructure and recapitalize their finances. I have been invited to conduct commercial and financial due diligence examinations on these carriers, have participated in investment “road shows” where prospective investors have been pitched on specific airline investments, and have also addressed foreign governments regarding proposed airline recapitalization efforts.
In Canada we have seen tremendous success from WestJet Airlines, which has become one of the world’s pre-eminent low cost carriers (“LCC”) and holds the enviable track record of being one of the most consistently profitable carriers found anywhere. Since WestJet’s launch much has changed in the world of airline start-ups, including the availability of airline financing to properly fund proposed LCCs such as Jetlines.
Page 1 of 4 AirTrav Inc. | Affiliate Canada, ICF International Robert J. Kokonis, President & Managing Director
10 Delisle Ave, 14 th Floor, # 1402 Toronto, ON, M4V 3C6, Canada
Telephone/Fax: +1 289 346 0071 Toll-Free: 1 866 618 JETS (5387)
[email protected] www.AirTrav.ca | www.icfi.com
Let me preface the remainder of my observations by stating my belief that Canada’s commercial aviation market has the capacity to take on the new breed of LCC referred to as an ultra low cost carrier (“ULCC”). Air carriers in this genre include Allegiant Air, Frontier Airlines, and Spirit Airlines in the USA, and in Europe, Ryanair, Norwegian Air Shuttle, and Wizz Air. In Canada, NewLeaf Travel Company Inc. (“NewLeaf”) of Winnipeg is due to start operations later this month using the indirect air service model. Canada is the last major national market globally in which no ULCC operates. That said, I believe demand in the Canadian market has the capacity to handle one or two ULCCs at most – Jetlines is one of three ULCCs that are looking to start operations in this country.
There are two critical factors faced by today’s potential LCC/ULCC start-ups in Canada. The first concerns aircraft type and fleet size, the second is access to risk capital.
Regarding the first factor, the mid-1990s saw the first major push of LCC’s as potential service markets represented virgin territory with almost limitless market opportunities. Most LCCs including WestJet (1996 start-up), Allegiant Air (USA, 1998), easyJet (U.K., 1995), and AirAsia (Malaysia, 1996) commenced operations with a small handful of relatively old aircraft, which became the initial formula for LCCs – reduce start-up costs by using older aircraft and reduce start-up capital requirements by initially acquiring a small handful of aircraft (i.e. WestJet commenced operations with three Boeing 737-200 aircraft that averaged 25 years in age). Only a few LCC’s in that decade were able to secure sufficient capital in their offshore bases to fund new aircraft (i.e. jetBlue Airlines, USA, 1999) owing significant domestic investor interest.
Since that time, the start-up landscape for LCC’s and the ULCCs including Jetlines’ proposed business model has changed. Largely speaking, passengers are no longer willing to settle for excessively aged aircraft and, to withstand competitive pressures, start-ups need to commence operations with reasonably sufficient market gravity (i.e. amount of deployed capacity through frequencies and number of aircraft) to make economic sense for their investors and to help withstand competitive pressures.
This reality has driven a demand for today’s start-ups to secure a greater amount of capital at start-up, to fund newer aircraft and to deploy a reasonable amount of initial aircraft capacity.
While Toronto-based Porter Airlines is neither a LCC or ULCC and launched just last decade, even it had to raise a significant amount of capital for its 2006 start-up. Porter was unique though in its ability to generate sufficient interest from domestic capital markets. The carrier
Page 2 of 4 AirTrav Inc. | Affiliate Canada, ICF International Robert J. Kokonis, President & Managing Director
10 Delisle Ave, 14 th Floor, # 1402 Toronto, ON, M4V 3C6, Canada
Telephone/Fax: +1 289 346 0071 Toll-Free: 1 866 618 JETS (5387)
[email protected] www.AirTrav.ca | www.icfi.com raised $125MM CAD through EdgeStone Capital Partners and the infrastructure arm of the Ontario Municipal Employees Retirement System (OMERS). Porter’s investors now include GE Asset Management Incorporated and Dancap Private Equity Inc.
Fast forwarding to today, one of the primary reasons that ULCC NewLeaf Travel Company Inc. (“NewLeaf”) pursued the indirect air service model was to reduce the amount of capital required at start-up and to speed its entry to market, thus enabling it to fulfill its lower investment requirements through domestic channels only. It is not clear as of the date of this note whether NewLeaf’s business model and the limited investment it secured will work.
The second factor affecting the ability of Canadian LCC/ULCC start-ups to successfully launch operations in today’s environment concerns access to risk capital. Canada has always been comparatively small on a global basis both in terms of aviation market size and in capital markets’ capacity. Back in 1996 at WestJet’s launch, and even in 2006 for Porter’s launch, there was sufficient interest in taking equity (or as the case may be, debt) positions in Canadian aviation start-ups. From my participation in investment road shows for several potential Canadian start-ups, I also know that participants in Canada’s oil and gas sector have traditionally been interested in aviation investment plays.
Over the last eight years a number of situations have impeded access by airline start-ups in this country to risk capital. First, the global economic slowdown triggered numerous airline collapses which made airline start-ups appear as riskier investments. Second, the recent collapse of oil prices has reduced the number of prospective investors in this country, and specifically those from the oil and gas sector. Third, owing the newer type 1 and number of aircraft required at start-up and within the first three years of operations, initial capital requirements are higher. Fourth, institutional investors in Canada today will not touch pre- revenue airline start-ups. They will only invest in a second or third round stage, requiring the start-up to first become cash flow positive and to achieve positive earnings on an EBITA basis. And fifth, there is no airline start-up fund in Canada and very few that exist globally.
Today there is insufficient risk capital capacity in Canada to properly fund direct air operator start-ups. There are a few investor groups outside Canada – for example in the USA and in Europe – whose speciality is investment in ULCC start-ups and support of ongoing operations.
1 I observe that lower oil prices have also eased the fuel cost burden for airlines and it has made it more affordable to operate older, less fuel efficient aircraft. My note about “newer” aircraft is more of a commercially driven factor (i.e. passenger preference when comparing a trip onboard a competitor’s newer aircraft) than a fuel cost factor. That said, operators of newer aircraft types can offset their higher capital cost (whether purchased or leased) through lower fuel and maintenance costs, and through generally higher aircraft operational reliability.
Page 3 of 4 AirTrav Inc. | Affiliate Canada, ICF International Robert J. Kokonis, President & Managing Director
10 Delisle Ave, 14 th Floor, # 1402 Toronto, ON, M4V 3C6, Canada
Telephone/Fax: +1 289 346 0071 Toll-Free: 1 866 618 JETS (5387)
[email protected] www.AirTrav.ca | www.icfi.com
Given the numerous difficulties encountered by operators in starting and running an airline – and indeed as witnessed through the low success rate experienced by airline start-ups in Canada following deregulation in 1988 – it is difficult to attract prospective investors to fund airline start-ups in this country regardless of who is promoting the start-up plan. The current structure of Canada’s foreign voting interest limit may be making it that much more challenging to attract the offshore speciality airline investor groups.
Absent the existence of an airline start-up fund in Canada, prospective carriers such as Jetlines need assistance from one of the few experienced airline start-up funds domiciled outside Canada who could act as lead investor. This observation is based on my recent involvement in several airline investment road shows – tapping offshore speciality airline capital and know- how seems very much to be the requirement today to get a significant ULCC airline funding venture going in Canada. I have been told time and again by Bay Street financiers that institutional funds and other large scale investors will join in, but not until an experienced lead investor is secured and ongoing operations are sustained.
AirTrav supports the issuance of a temporary exemption to Jetlines from the current 25% foreign voting interest limit and the permission to allow up to 49% foreign voting interest, subject to Ministerial discretion and conditions that may be placed on such an exemption, and with such temporary exemption providing the Minister additional time to develop overall foreign ownership policy. An upward revision to the foreign ownership limit through such a temporary exemption would increase the attractiveness of Jetlines as a Canadian start-up airline investment that in turn would likely facilitate the entry of capital from offshore speciality aviation investors.
Should you wish to discuss my observations further, please do not hesitate to contact me at the coordinates listed below. Thank you Minister for taking the time to review this note.
Yours truly,
Robert J. Kokonis President, AirTrav Inc. | Affiliate Canada, ICF International/Aviation Office +1 289.346.0071 | Direct +1 416.726.0722 | [email protected]
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