Southwest Puts Its Money to Work – Announces Intention to Buy AirTran

In March of this year, I wrote a blog titled:   Dear Southwest: Grab Your Bag of Fiction; It’s On.  This widely-read piece was about Southwest’s role in the proposed US Airways – Delta slot swap transaction. “If Southwest wants to gain entry to the few remaining slot controlled airports,” I wrote at the time, “Then it should make the incumbents an offer – one that provides the slot holder a return on that carrier’s prior investment.”

Well today, Southwest announced an investment – a $1.4 billion investment – in purchasing AirTran Airways, lock, stock and landing slots.  And that is what I was pining for in that post.  That is, I believe Southwest should pay, not get something for free or at some rock bottom price for assets the incumbents paid dearly for over the years. With AirTran come slots at New York’s LaGuardia and Washington’s Reagan National Airports.  Along with slots, Southwest gains meaningful entry into the one remaining legacy carrier hub where it offers no service – Atlanta.  It also gains entry into Charlotte, a US Airways hub.

Should Delta at Atlanta and US Airways at Charlotte be concerned with this transaction?  No, and there are a number of reasons why not.  First and foremost, the network carriers already compete with the low cost sector for nearly 85 percent of their domestic revenues.  Whereas AirTran serves 37 markets that Southwest does not serve, some of them smaller, there will be some new competition for passengers in those markets.  But for the most part, those cities already enjoy the low fares delivered via AirTran’s initial entry.  A second consideration is that while Delta and US Airways depend on local traffic at Atlanta and Charlotte, each are major connecting complexes and are not solely reliant on originating passengers.

If you ask me, the losers in this announcement are not the network carriers but rather Frontier and Spirit.  jetBlue will survive just fine.  But Frontier is now confined to one [maybe two] traffic base for all intents and purposes.  And that makes them vulnerable.  As for Spirit, which just announced its intentions to launch a $300 million Initial Public Offering, it is one thing to have a highly fragmented market competing inside their network.  It is a totally different animal to have Southwest and AirTran focused on carrying traffic to the Caribbean. The investment thesis necessary to market the IPO just got tougher.

Southwest Needs A New Reference

In its press release Southwest said: “Based on an economic analysis by Campbell-Hill Aviation Group, LLP*, Southwest Airlines’ more expansive low-fare service at Atlanta, alone, has the potential to stimulate over two million new passengers and over $200 million in consumer savings, annually. These savings would be created from the new low-fare competition that Southwest Airlines would be able to provide as a result of the acquisition, expanding the well-known “Southwest Effect’” of reducing fares and stimulating new passenger traffic wherever it flies.”

So where is the “Southwest Effect” in Akron-Canton?  AirTran serves the market and Southwest serves Cleveland up the road.  There should be significant stimulation in that market area? And in Dayton and Columbus, OH?  Perhaps Southwest is looking far back to a 1993 study.  Ding: the “Southwest Effect” as we knew it is dead.  The truth is today’s stimulation is largely diversion from another market or another carrier.  Fares may still be reduced in certain AirTran markets where the network carriers rely mostly on regional jets, but some markets will more than likely just recapture certain traffic from an airport in the catchment area that offered better fares to a unique geography.

Labor Issues

Some have questioned whether the acquisition will lead to labor troubles down the road. But one thing is for sure: If I was an AirTran employee the first words out of my mouth upon hearing the news would be:  “Ding, cha-ching!”  Like employees at United who are looking forward to enjoying the feel of a new culture, one can be sure that the AirTran employees feel much the same.  For them it is an opportunity to join one of the most admired and beloved companies, not just in the airline industry, but in the entire country

There will need to be union representation elections as a result of the merger as pilots and flight attendants are represented by different unions at each airline.  But it’s hard to imagine any vote going the way of the AirTran unions.  The main difficulty then becomes seniority list integration.  Southwest CEO Gary Kelly told investors that “equitable and fair” will rule the integration process.  That sounds like the words in the Allegheny-Mohawk Labor Protective Provisions and should be music to the ears of AirTran employees.  The question is whether each union will have it’s own definition of what is equitable and fair.  That was the case in Southwest’s most recent acquisition attempt, when the Southwest Airlines Pilots’ Association could not find a formula to integrate Frontier Airlines pilots – and the deal failed.

The integration process has evolved over the years since the Allegheny-Mohawk Labor Protective Provisions were enacted. Over that time, there have been more failures than successes in adopting fairness and equity. But it is incumbent for Southwest labor and management leadership to ensure that career expectations are met for all employees. Simply put, this concept means that the relative seniority in a combined list is not significantly different for any respective employee than it would be in their respective entity today.

Concluding Thoughts

Southwest will celebrate its 40^th birthday next year. It is a mature and maturing carrier operating in a mature domestic environment where it is no longer THE innovator. What I find most interesting in Southwest’s potential bid for AirTran is that the carrier is being forced to act just like the network legacy carriers in seeking a consolidation scenario that would lead to an improved revenue line systemwide.

Let’s give credit where credit is due.  Southwest put its money where its route system was weakest and made a very smart acquisition -- one that recognizes that two carriers will accomplish more together than either carrier could on its own.  The two carriers offer a combined network with minimal overlap that ensures that new revenue synergies will be generated.  With the deal there also will be new international opportunities derived for Southwest’s loyal passenger base.  Multiple fleet types are not an issue as the smaller airframe will allow Southwest to serve some smaller communities.

But I can’t wait to hear the arguments Southwest uses in Washington to gain regulatory approval, particularly as it will be hard pressed to make the argument that acquiring AirTran would further lower airfares in the US domestic marketplace.  After all, Southwest is not the only airline offering low fares, no matter what its boosters in Washington may think.

To make its case, the little ol’ Texas carrier that flies only to secondary markets will probably use the very same arguments to gain approval as did Delta/Northwest and United/Continental used.  Interesting indeed.   

In the Spirit of LAN: Another Emerging Strategy?

Airline and Air Service Thoughts -- Again

Never did I think I would write about LAN Airlines and Spirit Airlines in the same story, let alone refer to them in the same title. Never! On Sunday, Benet Wilson with Aviation Week’s Things With Wings blog asked: Has Spirit Airlines bought Air Jamaica? Benet was following through on an Associated Press story reporting that Spirit had indeed bought forever-struggling Air Jamaica, albeit citing unnamed sources. Today, it appears true.

Ms. Wilson first reported on the bizarre nature of Air Jamaica’s privatization in December 2008. On July 4, 2009, The Gleaner in Jamaica went so far as to suggest the new name for Air Jamaica might be the Spirit of Jamaica. Then I started thinking.

LAN

An airline that I rarely mention, but have a deep admiration for, is LAN based in Santiago, Chile. LAN’s strategy of taking equity stakes, and in effect becoming a surrogate flag carrier for a country in a continent’s economic woes by filling the gap left by an airline's corporate failure in South America, has been brilliant. The strategy has allowed the former Lan Chile to diversify its traffic base away from Chile-only, and grow to become the defacto flag carrier for other countries in the continent. LAN’s ability to take advantage of non-Chilean country bilaterals has produced growth opportunities where a reliance on Chile-only would have only led to diminishing returns – much like the US carriers are realizing today.

The carrier began as Línea Aeropostal Santiago-Arica in 1929 before becoming Línea Aérea Nacional de Chile (Lan Chile) in 1932. The Chilean government privatized Línea Aérea Nacional de Chile in 1989, and the carrier absorbed Chile’s second carrier, Ladeco, in 1995. Today, the LAN umbrella covers LAN Chile; LAN Peru; LAN Dominicana; LAN Ecuador; LAN Argentina; LAN Cargo; and LAN Express, among others. Some said LAN refers to Latin American Network. LAN is a brand!

Spirit’s L-A-N (Local Area Network?)

Born during the global recession in the early 1990’s, Spirit, a perpetual “bottom feader”, then based in Detroit, focused on providing ultra cheap flights to popular leisure destinations and gambling meccas. It took advantage of the failures of Eastern, Pan Am and others to build a cheap fleet staffed by cheap labor, offering few amenities in exchange for fares that were often 70 percent or lower than those offered by the competition.

As many legacy carriers began to recover in the mid 1990’s and the wave of new low cost carrier growth accelerated, Spirit had several brushes with financial disaster. Written off for dead many times, the company pushed ahead and adapted its strategy to the competitive environment. It moved from Detroit to South Florida in 1999 and pursued new growth built on its ultra low-cost roots. Like most of the industry, Spirit struggled after 9/11. But in the process of adapting and taking advantage of its new home base, Spirit received an important injection of $125 million from OakTree Capital and landed as its CEO Ben Baldanza, who previously held executive posts at US Airways, American, Continental and Northwest.

With capital raised, a fleet renewal plan in place, and a new CEO, Spirit began to think less about Detroit, Flint and Atlantic City and more about the Caribbean and Latin America. The carrier continues to seek route authority into many of the northern South American countries like Colombia and Peru. Today the company boasts that it is the leading low cost carrier to the Caribbean, the Bahamas, Central and Latin America. In fact, more than half its 43 destinations served are to the Local Area Network called loosely – Latin America. Its model looks more like RyanAir and Air Asia and Allegiant than it does the more traditional carriers serving North America.

Air Jamaica?

The Local Area Network of Latin America is highly dependent on tourism. Most island economies are incapable of raising sufficient capital to fund their own airlines. If Air Jamaica is losing tens of millions of dollars then imagine what airlines in other, less developed, island economies must be experiencing.

In Ms. Wilson’s first piece, she quotes an economist friend’s take on why would anyone want to buy Air Jamaica, noting that the carrier was "the classic case" of an airline’s importance to a region’s economic health.

"From a pure privatization play, Air Jamaica has a value of zero," Wilson said, quoting the economist. Yes there are short-term gains to bolster [Air Jamaica’s] the bank account, but in the long term, a perpetually losing airline stands a high risk of becoming extinct as it holds little to no value for any financial player. The value of Air Jamaica to me seems to only lie with the Jamaican government and the Jamaican tourism industry.”

I concur. And the Jamaican government might finally be realizing just that. Island economies absolutely need airline(s) service to enable economic activity. In a piece I wrote last October, I challenged whether airlines should be bearing the cost of providing service to certain communities, or the other way around.

As an example - and let's think for a moment - (these are not actual numbers), if Air Jamaica is losing $100+ million per year and yet is responsible for enabling $1 billion in economic activity, then what amount of the sum total of direct, indirect and induced economic activity should the Jamaican government be willing to spend to keep critical airline service? The answer lies somewhere between $0 and $100+ million – at any figure a good investment to keep a billion dollars in economic activity that supports the island economy. But total cash outflow is not directly timed with direct, or even indirect, let alone induced inflows.

Without a doubt, Spirit can be that airline at significantly lower cost than Air Jamaica is today with its legacy issues.

Spirit Could be On to Something

Like many other industry observers, I have serious doubts about Spirit’s future as a sustainable enterprise in its current form. On the other hand, LAN discovered there are many opportunities within the Local Area Network of Latin America where a Spirit of Jamaica brand could be duplicated if successful.

Island Economies and US Small Community Air Service

In the US, small community air service is a lot like small island economy air service. It is not for the faint of heart.

Not unless, and until, island nation governments appreciate the fact that if I have a runway, a terminal building and security that I am forever entitled to receiving air service. No one is entitled.  Moreover it is wrong to think that a country can support an airline because that country has a flag; a currency or a dialect.

Just ask the people in Peru, Argentina, Dominican Republic and Ecuador if the air service they receive from the LAN brand leaves them disadvantaged on the global map. My guess is that they have been enhanced from a service provider that can do it better. May(be) the Spirit be with those island economies dependent on tourism to find a similar alternative to their own fledgling flag carrier. Or maybe Spirit has finally found a niche.

I only hope that Spirit, and its investors, are being supported in this Jamaican investment by a government that understands the correlation between direct cash outflows and economic activity. If not, run Spirit run.

Why not the Spirit of Aruba? Why not the Spirit of Trinidad and Tobago? Why not ……… ?