Southwest To Attack East Coast Markets

September 28, 2010

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Southwest Airlines, the largest US low-cost airline, agreed a deal to buy smaller rival AirTran Holdings for USD$1.4 billion, aiming to challenge bigger carriers in the East Coast market.

The merger, which was announced on Monday, would be the first between leading US low-cost airlines and prompted speculation of more deals to come as the industry cuts costs and carriers look to expand their networks.

The cash-and-stock deal needs government approval. The acquisition values AirTran at a 69 percent premium to its Friday closing price and would lift Southwest into fourth place in US air traffic rankings, from sixth place.

Southwest, with a market capitalisation of about USD$10 billion, said the deal would produce annual benefits exceeding USD$400 million by 2013. Its shares closed up 8.71 percent at USD$13.35, while AirTran shares rose 63 percent and closed at USD$7.34.

"The market approves of the deal and thinks Southwest is getting a great price despite paying such a substantial premium," said Morningstar equity analyst Basili Alukos.

"Southwest had been waiting to expand this past downturn, and I think this acquisition proves that substantial organic growth is a thing of the past."

Airline valuations have plummeted since 2008, when the oil price spike and global recession sharply hurt profits. Carriers responded at the time by cutting capacity, and Southwest put its growth plans on hold -- until this deal for AirTran.

News of the merger may pressure larger rivals to find merger partners of their own to beef up their networks and achieve cost and revenue benefits.

"It increasingly marginalises those network carriers who haven't consolidated," said airline consultant Robert Mann. "So I think the biggest impact is on American (Airlines)."

Shares of JetBlue Airways rose 7.11 percent as analysts said its strong presence in New York would make it a key player in any M&A activity. Shares of Republic Airways, another low-cost airline, rose 5.25 percent.

HIGH PREMIUM

The deal is the second notable airline merger this year after that of United Airlines parent UAL and Continental Airlines. Delta bought Northwest in 2008. US Airways was bought by America West Airlines in 2005.

Orlando, Florida-based AirTran is run by chief executive Bob Fornaro. AirTran was bought in 1997 by ValuJet, which abandoned the ValuJet name after a 1996 crash that took more than 100 lives.

Southwest chief executive Gary Kelly said the deal gives his company access to AirTran's extensive East Coast network, especially Atlanta, where AirTran competes head to head with Delta Air Lines. Delta shares fell 2.5 percent.

AirTran also has Caribbean routes that Southwest said would give it an international presence.

"What is an interesting opportunity to us is threefold: (AirTran hub) Atlanta, small cities and international," Kelly said. "The profit opportunity with this transaction is simply far greater than it is without."

While the deal premium that Southwest offered is among the highest of airline deals in the past three years, analysts noted that valuations had fallen sharply during the recession.

"It still represents a discount to what most airlines were trading at," said Jim Corridore, airline analyst at Standard & Poor's.

As of last Friday, Southwest's shares have under-performed the broader Arca Airline Index this year, rising about 7 percent against the index's 24 percent increase. AirTran has done even worse, falling 13 percent in the year to date.

LITTLE OVERLAP

The combined company would be based in Dallas, which is Southwest's home, and have nearly 43,000 employees and fly more than 120 million passengers annually. The all-Boeing fleet would consist of 685 active aircraft that would include 401 Boeing 737 700s.

Southwest, which operates from 69 cities -- including Las Vegas, Chicago and Dallas -- said the two airlines have very little overlap on their routes.

Kelly said the deal would allow Southwest to expand in markets such as New York LaGuardia, Boston Logan and Baltimore/Washington. It also allows access to leisure markets in the Caribbean and Mexico.

Southwest's acquisition of AirTran could lead to lower fares in East Coast markets currently dominated by larger rivals such as United and Continental. But experts do not see a shift in the balance of power on those routes.

(Reuters)