ATP Grads at Airlines

Southwest Airlines to Buy AirTran and Expand into New Markets

Published Sep 29, 2010 on Pilot Jobs

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Southwest Airlines, the nation’s biggest low-cost carrier, said in a surprise announcement on Monday that it had agreed to buy its smaller rival AirTran Airways for $1.4 billion. The planned merger would be the third in the last two years in the battered airline industry, after Delta Air Lines bought Northwest in 2008, and the tie-up between United Airlines and Continental, due to be completed on Friday.

Southwest Airlines

The Southwest deal comes as the demand for air travel remains sluggish. Even with the airlines holding down capacity, industry executives say, there are still too many planes chasing too few passengers. Airline analysts and some executives said the market would eventually center on just three or four major airlines.

Southwest has traditionally managed to offer low fares by flying out of smaller airports where it is cheaper to operate and relying on a single type of Boeing 737 plane to reduce its operation costs. But while Southwest was promoting the deal as an expansion of the low-fare model, it was unclear how much effect on prices it would have as the carrier moved into major hubs like Atlanta and Washington and bolstered its minimal presence at La Guardia in New York.

Still, by expanding Southwest’s network, especially in the Northeast, the deal would put pressure on the major airlines that have well-entrenched and dominant hubs there.

The deal poses a particular challenge to the carriers that have not bulked up recently, especially American Airlines and US Airways.

American, in particular, could now face more pressure to find a partner. Analysts have long suggested a tie-up with US Airways, but some also raise the possibility of bidding for Alaska Airlines or JetBlue Airways. Either would bolster American’s presence on the West or East Coast.

“American and US Air must be in panic mode as Southwest continues to grow,” said George Hobica, who runs, a consumer Web site. “What next? An American-US Air marriage? Frontier-Midwest combine with USAir? JetBlue and American? The Southwest-AirTran merger came out of the blue, so anything and everything could be on the table.”

The deal would expand Southwest’s network by 25 percent and give it its first international destinations in the Caribbean and Mexico. The combined networks of Southwest and AirTran have little overlap: each serves about 70 airports, but they compete directly on just 19 routes.

“Southwest is following the trend in the industry: merge or acquire in order to stay alive and competitive,” said Brett R. Gordon, a marketing professor at Columbia Business School. “From an economic perspective, this makes sense due to the economies of scale inherent in operating a large airline fleet.”

Southwest said the purchase had been approved by the boards of both companies, although it still needed regulatory and shareholder approval. The deal is valued at $3.4 billion when AirTran’s debt and aircraft leases are included. Southwest has 547 planes while AirTran has 138.

The acquisition is only the third for Southwest in three decades and its most ambitious to date, said the company’s chairman and chief executive, Gary C. Kelly. “It is a huge piece of our strategy to grow Southwest over the next decade.”

The deal comes at a strategic juncture for Southwest, which had been looking for new ways to grow in recent years. The company had already been considering starting international flights to neighboring countries like Mexico. It has also been thinking about buying a longer version of its workhorse Boeing 737 that can accommodate more seats and carry more passengers on its existing routes.

Still, Mr. Kelly admitted that without the purchase, the company’s growth prospects would have been “modest.”

Investors welcomed the deal. Southwest shares rose 9 percent, at $13.35. Shares of AirTran Holdings, the airline’s parent company, leaped 61 percent to $7.34 a share, to nearly match Southwest’s offer.

Southwest has been one of the nation’s few consistently profitable airlines, building success on a simple business model, which has remained relatively unchanged since the Texas company was founded in 1971 to serve Dallas, Houston and San Antonio. That low-cost formula allowed Southwest to quickly gain market share and overtake its higher-cost rivals. Even as the rest of the industry struggled amid steep losses that pushed several airlines into bankruptcy, Southwest overtook other airlines to become the top domestic carrier in the last decade. But with the prospect of a sluggish demand for air travel, the strategy showed its limits.

With opportunities to grow drying up, Southwest had clamored to get access to markets that it had once shunned, especially as it sought out business travelers who were asking for flights to the main airports in New York and Washington.

Southwest said the acquisition would open the door to Atlanta, the biggest hole in its network. Hartsfield-Jackson Atlanta International Airport, the nation’s busiest airport, is Delta’s hub; AirTran is the second-largest operator there.

Southwest has been stymied in its efforts to break into the New York market until recently. It has a few landing and take-off rights, called slots, at La Guardia Airport. Only in August, as part of the federal approval of the United-Continental merger, had Southwest obtained some slots at Newark Liberty International Airport. Southwest also flies to Long Island MacArthur Airport, and AirTran serves Westchester County Airport.

Still, the acquisition poses risks to Southwest’s “keep it simple” strategy, analysts said.

AirTran’s fleet, for instance, includes 86 Boeing 717s as well as 52 Boeing 737s. AirTran sells tickets through electronic reservation systems over the Internet, like Expedia, whereas Southwest relies solely on its own Web site to keep costs down. And AirTran has some agreements to sell tickets on other airlines, while Southwest generally does not.

But Southwest has recognized the need to adapt.

“What worked in 1971 or in 2001 is not what they need to grow in 2011,” said Henry H. Harteveldt, the airline analyst at Forrester Research. “Taking on a certain degree of complexity can lead to a stronger business.”

For the moment, however, Mr. Kelly said the company had no plans to change its most distinctive customer policies, including free checked bags. The company also plans to continue operating a single class of service with open seating.

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