For nearly four decades, Southwest Airlines had been in a
perpetual state of growth, entering new markets, undercutting network carrier
pricing and steadily spreading its brand across the United States. Although
that all stopped last year as the carrier for the first time in its history cut
annual capacity, Southwest once again plans to reignite growth through a
proposed $1.4 billion acquisition of AirTran Holdings that would bring it entry
to Atlanta and international markets.
Citing a "struggling economy" and stagnant
domestic air travel demand, Southwest CEO Gary Kelly said, "Our own growth
prospects in the near term are quite modest," claiming the acquisition of
AirTran would give Southwest "significant growth opportunities,"
something it hasn't had in a couple of years. "AirTran provides us a
unique opportunity, and that is to strategically expand our network by 25
percent and to do that profitably," Kelly said, noting that he does not
expect capacity reductions once integration commences.
If it wasn't already, the deal crowns Southwest king of the
domestic market, Advito vice president Bob Brindley said. "This is just a
continued expansion of Southwest. From a domestic U.S. perspective, they're the
new dominant player. Carriers like United-Continental, Delta and American have
de-emphasized the domestic market, as they've shifted a lot of domestic flying
to regional feeder carriers, and that's opened the door for Southwest and other
carriers to grow."
Noting "minimal" overlap with AirTran—only 20
nonstop routes, according to one airline analyst—Kelly said Southwest is poised
to grow in some key markets. "The big, gaping hole in our route system is
Atlanta," he said, noting AirTran's home base is "the largest
domestic market we do not serve."
While it would give Southwest 22 percent share of Delta Air
Lines' largest hub, analysts said Delta has little to worry about unless
Southwest begins to add routes from the hub.
Stifel Nicolaus analyst Hunter Keay said Delta and AirTran "have
both managed to coexist at Atlanta over the past 10 years, but AirTran has been
gradually reducing its presence" there, noting that this year less than 50
percent of AirTran's capacity will be at the airport, down from 90 percent a
decade ago.
The deal also allows Southwest to grow in markets it
recently entered but has yet to build anything beyond a modest footprint,
including New York's LaGuardia and Boston Logan, while also giving it entry to
Washington National Airport.
Keay said the deal offers "intriguing growth opportunities"
for Southwest, without adding capacity to the domestic system. "Southwest's
organic growth options have been limited in recent quarters," he said,
noting that before its capacity retrenchment of 2009, its most recent bursts of
growth came at legacy hubs, including Denver, Minneapolis-St. Paul and New York's
LaGuardia.
While the focus of the acquisition is the domestic market,
adding AirTran operations would give Southwest its first international routes
to some Caribbean and Mexican destinations. "We have made the decision
that we would like to have near-international service at Southwest Airlines,"
Kelly said. "We think that would be a natural evolution from the domestic
route system that we developed, but our priority is still to follow through
with our domestic expansion, and again, the AirTran acquisition is a very
significant step in that direction." Kelly added, "Several years from
now, we think we'll be ready for near-international expansion."
Minimal Impact On Corporate Market
The implications of a merged Southwest-AirTran would not
have the immediate impact on the corporate market as did the Delta-Northwest
merger or the Continental-United deal, which closed this month. "They're
both sort of dabbling in the corporate market," Brindley said of AirTran
and Southwest. "It's very different from how their systems are set up. It's
more than a test, because they're in the marketplace but still learning a lot
about the corporate market, so they're approaching it a bit cautiously."
Airline consultancy Boyd Group International head Mike Boyd
said that if some Southwest practices prevail, it could be at the expense of
business customers. "First, what is missed is that Southwest has higher
costs than AirTran," he said. "Second, Southwest probably won't offer
a business cabin, as does AirTran, which makes Southwest less competitive for
the business traveler. Third, Southwest most likely won't stray from it's
no-advanced-seat-selection program."
Though it long has touted itself as the preeminent low-cost
carrier in the United States, JP Morgan aviation analyst Jamie Baker said
Southwest's costs are about 14 percent higher than AirTran's. Also calling
itself a low-fare carrier, Southwest has higher fares than its acquisition
target, as its short-haul yields are 30 percent above AirTran's, with long-haul
16 percent higher, Baker reported. "As is typically the case with
consolidation, we expect costs and fares to be marked to Southwest levels,"
he said, suggesting an increase in fares once the carriers are combined.
Until the transaction closes, each company would operate
independently, with their own policies and procedures. "It's like being
engaged to be married. We're not married yet," Kelly said. "Until we
get married, we're going to continue to operate as independent companies."
Still, Kelly acknowledged there is a bit to reconcile
between the carriers. "There are clearly differences," he said. Among
them are AirTran's view of itself as a hub-and-spoke carrier with a hybrid
legacy/low-cost-carrier model, different labor structures, divergent approaches
to ancillary fees—particularly bag fees, which AirTran has embraced and
Southwest has shunned—and varied fleet makeup, though Kelly said the carriers
would be combining a "compatible all-Boeing" fleet, and several analysts
downplayed reconciliation challenges.
Despite all the possible changes, Kelly said Southwest would
continue to be Southwest.
"At this point, we haven't made any decisions about
changes to the Southwest brand," he said. "We have open seating. We
have no plans to change that. We don't charge for bags. We have no plans for
changing that. We have single-class service. We have no plans to change that.
In fairness to our integration team and in deference to a great company here in
AirTran, we'll want to look at and understand their business and their
processes and learn from them."
Regulatory Approval Expected
Approved by both carriers' boards, the deal awaits
stockholder and regulatory approval, though Kelly said he was confident of a
positive review from the U.S. Department of Justice. Still, the timing of that
review and closing schedule remains to be determined. "It's anybody's
guess how long that will take," he said. "I don't know if that's two
months or whether that's 12 months, but until we get that, we cannot close."
Upon closing, he said to expect at most an additional 24 months to integrate
and gain a single operating certificate.
"Southwest and AirTran overlap on 20 nonstops, versus
12 for Delta-Northwest and 14 for United-Continental," JP Morgan's Baker
said, "but that doesn't suggest a significant regulatory hurdle, in our
view. Given Southwest's well-documented consumer benefits and low probability
that any legacy would seek stepped-up competition, we do not envision any
DOJ-mandated divestitures."
Stifel Nicolaus' Keay agreed: "We believe it is more
likely than not that DOJ approves the acquisition based on broader consumer
choice and historical data showing 'The Southwest Effect,' which tends to show
fares declining materially when Southwest enters a new market."
Of the other pending approvals, AirTran CEO Bob Fornaro
said, "I think the shareholders will support it wholeheartedly."
Under the terms, each share of AirTran stock would be exchanged for $3.75 in
cash and 0.321 shares of Southwest common stock. Taking into account AirTran's
debt, to be assumed by Southwest, and the value of its capitalized aircraft
operating leases, that brings the deal's value to about $3.4 billion.
The combined carrier would have 43,000 employees, 685 active
aircraft and operate from more than 100 airports, mostly in the United States,
though AirTran also serves some near-international routes. Kelly said the
AirTran brand would be retired and folded into Southwest. The carriers
eventually would operate under a single Federal Aviation Administration
operating certificate and corporate functions would be consolidated, with
headquarters remaining in Dallas.
This report appeared
in the Oct. 11, 2010, edition of Business Travel News.