As the world now knows,
Southwest is planning to buy AirTran for a mixture of cash and stock valued at $1.4b.Most of the aviation community was caught off-guard by the suddenness of the move, if not exactly surprised. You see, Southwest has been saying for years that it was keeping options open for an acquisition despite always staying a little distant from the merger game. AirTran has sort of done the same, except for attempts to buy Midwest a few years ago before Republic bought it (and dismantled it). [more]The move by Southwest (and the apparently non-controversial acceptance by AirTran) has raised a lot of eyebrows in the industry. Yes,
stock analysts are excited by the accretive value of the deal (especially for AirTran), but it seems at first glance that the deal doesn't make sense.I'll give my view by answering three key questions: Q1: Why is this acquisition silly? Q2: Why is Southwest doing it anyways? Q3: What does it mean for travelers?Response 1: All that is wrong with this acquisition1) Southwest is the most efficient airline operation in North America. Much of that is a product of its unified workforce, single fleet, and relatively benign airport mix. AirTran threatens all of that: New plane type, big workforce, major hub at ATL and expansion in the busy eastern corridor.2) Any merger past a certain size brings along risk of cultural and productivity issues. Southwest's culture is legendary, but AirTran is big enough that it is a major threat to Southwest's culture and consistency of service (especially since Atlanta and some other stations will likely be entirely ex-AirTran teams). These types of major integrations can kill a companies much more stable than airlines are, so Southwest better stay vigilant.3) 69% above market value? Woah. If they had made the offer 12 months ago, not only would the market value have been less, but the premium would have been less also. Good chance they're over-paying, simple as that (although every month they wait here on out will only drive up the price as long as the outlook continues to improve).
Southwest stock has been relatively flat since the announcement, showing the market is still unsure.Response 2: There must be some reasons why this is good, then, right?1) Southwest must continue to grow, and it's running out of room with its current configuration. The best way to keep your unit cost down is to keep growth up. And since Southwest can't grow by adding capacity to current routes (we know the negative cycle that creates), they must find new markets. But any new market in the US is either too small or impossible to get into profitably. AirTran solves both problems by bringing a smaller plane and major entry into ATL (and growth at many other lucrative eastern airports).2) AirTran is profitable. Always best to bring a winner into the fold rather than a loser. And they're profitable despite taking on Delta at ATL. They have a very impressive operation and leadership team with a great track record over the last decade.3) The time is now. Southwest has enough stability that they can credibly spend equity and money on an acquisition without any liquidity concerns that come with a big recession (even though Southwest has always had a good cash position, shareholders are going to be wary about spending during a prolonged downturn. Ironically, that's the best time to buy price-wise, but that's the way our markets work). Despite that, still enough uncertainty remains that the price is reasonable (although as I said above, still looks high to me).Response 3: What it means for Jo(e) Traveler1) Bye bye AirTran. Southwest means to incorporate AirTran fully into their system -- they have the best culture and economics, no room for anything else. AirTran's perks? Gone. Assigned seating...gone. XM satellite radio...gone. Business class....gone. Wi-Fi....eh, that's likely to stay.2) East coast, get ready for Southwest in a BIG way. ATL will never be the same. Expect major competition from Southwest with now a strong presence in key eastern markets. Southwest's position at BWI just got bolstered, and their slots/gates at LGA, EWR, BOS, etc. now make them a significant player. Delta and US Airways stand the most to lose here with major east coast networks. I foresee new-found price wars (good for the traveler) as the market share grab will be on as long as the recovery lasts.3) Some airports are going to lose service. Actually, many will. AirTran services a lot of eastern airports with its 717s -- airports Southwest might not have any interest in serving anymore (e.g. My hometown White Plains is at risk, although probably less so than places like Knoxville and Asheville). You see, once Southwest gets its hands on that smaller aircraft, it will look at ALL airports nationwide where they can make the most money, not just those that make good connection points out of ATL. My guess is that will open up some great opportunities for Southwest all over the country at the expense of some of the smaller AirTran stations.Overall, I find this merger a lot more palatable to the consumer than the legacy carrier combinations. Those mergers were far more about building scale (and yield superiority) for the major global alliances, not tapping into new markets and growth opportunities. For Southwest, this isn't about scale nearly as much as it is about growth and access to markets they can't get into otherwise. That means just serving more people on more routes, NOT growing market power on existing routes. Southwest just can't grow on its own into the places AirTran is big -- I don't think they'd have any aversion to competing with them (and the legacies) if they could. In fact, I bet they'd prefer it so they didn't have to risk their culture. But they're willing to put that aside for the growth imperative.In closing, who's the biggest loser of the week? Sun Country, of course (bet you didn't see that one coming!). Sun Country recently had its bankruptcy plan approved and has been actively looking for a buyer. The price is cheap, also (~$20mm).
Lots of people thought Southwest might swoop in to grab it -- giving it a growth platform in MSP and some 737-800s (Southwest recently got permission from some of its unions to add them to the fleet). It would have been a nice small acquisition for Southwest, and one that made lots of sense. Instead, they went much bigger in size of acquisition with AirTran, yet got smaller planes instead of larger ones. I'm guessing one purchase is enough for the time being, so Sun Country will have to find another suitor or hold off as a solo operation for a while.Let the chess game continue, never a dull moment in the airline industry!
Evan Konwiser is co-founder of FlightCaster. These thoughts are excerpted with permission from his blog.