Southwest shows AirTran some LUV - $1.4Bn buyout announced

Apparently the airline industry is bored when there isn’t enough merger activity going on. Southwest and AirTran have ramped that pace back up again, with the Dallas-based carrier announcing a planned $1.4 billion buyout of AirTran this morning. The carriers expect the deal to close in the first half of 2011 with operations merging in 2012.

So those are the facts, at least as much as are available now in the early stages of the news discovery. What are the big open questions out there regarding the merger?

WHY?

OK, so this is both a very easy and very complicated question. Southwest has struggled of late to enter new markets, in part because it is harder to find underserved destinations and in part because there are significant barriers to entry in major markets like Atlanta, New York City and Washington, DC. With this purchase the carrier picks up – at a relatively bargain price – significant slot portfolios in all three of those cities. The slots at Washington’s National and New York’s LaGuardia airports are particularly valuable to Southwest.

Somewhat strangely, the Associated Press is reporting the move as an effort by Southwest as seeking “entry into a number of smaller markets.” That makes very little sense. Not only does Southwest already serve many small markets, including most that AirTran serves, but the value is in the larger markets. Southwest fought strongly to defeat the proposed US Airways – Delta slot swap at LGA/DCA in an effort to gain access to slots at those airports. When that failed they simply bought the slots they wanted.

The Atlanta market is nothing to sneeze at, either. While Delta has successfully fought off small entries on a few occasions (e.g. JetBlue’s efforts a few years back), AirTran has established themselves quite solidly in the market there. This move opens up that entire market to Southwest in one quick move.

International?

Southwest has historically only flown domestic routes. They’ve talked about code-sharing to gain international service but those deals have been delayed or canceled recently. This move gives them established service in Mexico and the Caribbean. CEO Gary Kelly stated in the analyst call that the carrier is committed to going international as part of this move. The destinations that AirTran serves should meld nicely with the Southwest operations so that decision isn’t such a surprise.

Fleet commonality?

Southwest is been a Boeing 737 customer and solely operated that type for a long, long time. AirTran operates a fleet of 737s and 717s. There was previously some discussion on retiring the 717s as they start to age – some are 10ish now – and it would seem that the new carrier could simply retire the type completely and keep most of their operations intact based on sharing in the Southwest 737 fleet base. The official statement today says that they will be keeping the 717s in the fleet but it would not be too surprising to see that stance change in the coming years.

In-flight products?

AirTran offers a first class product. They also offer in-flight entertainment. They offer food for purchase. Southwest offers none of those things. Both carriers offer in-flight internet connectivity, with AirTran having deployed the gogo product from Aircell fleet-wide. Southwest is in the early stages of rolling out Row44’s satellite-based system fleet-wide.

There are a lot of things that will need to be reconciled on that front. I expect that the gogo-equipped planes will convert to Row44 eventually. Once the 717s are retired there are not all that many 737s to add on to the Row44 deployment and Southwest holds quite a bit of pricing power on that front since they are the sole commercial customer for the product today.

On the seating front I expect that the first class sections will be removed from AirTran’s planes. Perhaps they will pursue a hybrid option comparable to JetBlue’s Even More Legroom product but that seems unlikely, particularly as Southwest seems quite satisfied with their open seating policy and their “fewer fees” marketing mantra, even if that isn’t completely true in terms of actual operations. Still, there doesn’t seem to be a sufficient demand in the business model to keep the first class seats around so those will disappear.

Loyalty Programs?

The loyalty programs of the two carriers are rather different and Southwest is long rumored to be working on a revised Rapid Rewards program expected to launch eventually. It seems highly unlikely that AirTran’s A+ Rewards will trump the Rapid Rewards program as part of this merger. Even with the uncertainty surrounding the timeframe for the revised Rapid Rewards, the program is bigger and more established than A+ Rewards.

Fares?

The quotes from Southwest are touting the “Southwest effect” and their intentions to bring lower fares to more customers. Unfortunately, that plan does not seem to mesh with the reality of the merger. AirTran already generally offers downward pricing pressure in markets which suggests that there is not necessarily a lot of room for fares to move with Southwest taking over. Connecting the two networks will offer a bit of expansion in potential for low fares but it does not seem conclusive that fares will be cut for consumers.

Moreover, it ignores the effect on airports where Southwest becomes the dominant carrier and sees little competition. In such cities, including Oakland and Albany, fares actually have increased faster than the average across the country.

Finally, any loss of competition almost certainly will lead to increased fares for passengers. Supply & demand doesn’t work perfectly in the airline industry but it is pretty close at the macro scale in situations like this.

Conclusions?

Unlike the United Airlines – Continental merger which was billed as a combination of equals, this move is most definitely a buy-out of the smaller AirTran by Southwest. The main attractions – NYC, Washington and Atlanta markets as well as the international routes – are likely worth more to Southwest than the purchase price paid. The fact that they also pick up a few extra airplanes, too, probably doesn’t hurt the situation, but not really critical to the deal. Southwest is dictating terms and nearly everything associated with the combined carrier will be based on the Southwest side of the operation.

There are plenty of other little things that will play out in the coming months. But the near-term view suggests that Southwest is going to be growing and spreading their wings just a bit further.

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