Southwest Airlines Plays Defense with Frontier Bid

Southwest Airlines (LUV), which for 30 years led the charge to change the airline industry, is now playing defense. With its bid to buy the bankrupt Frontier, Southwest is fighting to preserve the status quo, rather than fighting to change it.

The Frontier offer has a lot of people scratching their heads. Southwest has done three mergers or merger-like deals in the past, and none have gone terribly well. The first was Muse Air, which was done simply to eliminate its only competitors at Dallas' Love Field. After that transaction, co-founder Herb Kelleher once swore he'd never do another.

The second was Morris Air, which allowed Southwest to expand throughout the west. In that sense it was success, but it was plagued by internal integration issues that frustrated the airline for years.

The third was ATA, which never involved combining the two carriers, but was basically a way for Southwest to grab gates at Chicago's Midway Airport and prevent AirTran (AAI) from getting them.

But why, in a falling revenue environment, would Southwest want to buy a bankrupt rival? It's not about growth, and its not about sticking it to United (UAUA) in Denver. It's about playing defense.

As Bill Swelbar explains, Southwest now operates at a cost disadvantage to what he calls Midscale carriers - Air Tran, JetBlue (JBLU), Frontier. If Republic Airways (RJET), the rival bidder in the bankruptcy, succeeds in buying Frontier and keeping its operations in Denver, it poses a long-term threat to Southwest's profitability in that market, and possibly others.

After it bought Morris, Southwest left the Denver market because it was too expensive. It returned later when its need for growth superseded the cost concerns, but some analysts believe Southwest has been losing money in Denver since it returned.

If that's true, then it can't afford to allow Frontier to continue flying as a competitor. It seems the airline that helped redefine the industry runs the risk of getting beat at its own game by a new crop of upstarts.

Disclosure: no positions

Comments

[Positroll:]

Any thoughts about PNCL?
They finally got an agreement with the pilots union,
finance.yahoo.com/news...

and got a $ 25 mio financing,
biz.yahoo.com/e/090805...

basically assuring that they will be able to pay off their 2010 convertible notes ... cf. seekingalpha.com/artic...

Seems like the big boys are waiting for the Q2 coming out tomorrow (friday) before starting to buy ...

Aug 06 07:53 AM

[Positroll:]

Oh, and they just had a golden cross (90/200 MA) + their 200 MA slope turned positive.
Guestimate: If the coming Q2 looks ok with respect to cash flow, we might see prices above $4 next week, any insider buying should push it even higher ...

Aug 06 08:07 AM

[Charter Jet...:]

As a Chicago resident I am really hoping Southwest gets things right and is able to pull out of the trouble they seem to be in.

Aug 06 04:41 PM

[Stardusterboy:]

Cost disadvantage? SWA has the lowest ASM cost in the industry for a major player, while paying their employees higher wages than anyone else does. Denver has been on a terror, and is the fastest growing new city ever in SWA history. I think the real reason SWA bid is the slots at National (Reagan), LGA and the gates at DEN. Frontier is too underfunded to compete in the long run, and it puts SWA in a better position against UAL. As mergers/aqusitions go, Muse Air Pilots wouldn't agree to terms, so Herb shut them down to protect his own employees. Morris was a cakewalk compared to other mergers, and an unqualified success with pay protection and job security for all of the Morris employees. SWA doesn't do business stuff without doing their homework first, and I think they'll pass on the deal if the labor issues appear to be a problem at Frontier. Republic will gut Frontier just like they did Midwest, and sell off the planes as they replace them with RJ's. That's their history.

Aug 07 07:14 AM

[CMStar:]

Hey, Dude! You have your facts wrong. Southwest was out of the Denver market years before the purchase of Morris Air. There are many reasons Southwest needs to buy Frontier. Here are just a few: Access to Atlanta, Anchorage, Mexico and slots at Washington National and LGA. A reason to pickup traffic from DFW and operate the service via Froniter. Additional gates at SNA, MDW, DEN, LAX, SAN, SEA, MSP, MCO, TPA, MKE and SJC. To pickup another city in Ohio (Dayton). To gain experience with providing internationl service, before providing service to Europe. Aircraft that can fly to Hawaii and replace what ATA was providing. Aircraft that can offer a higher level of service to better compete with Airtran out of MKE. The bulk acquisition of employees at lower labor rates than Southwest employees. Leverage to get new additionl 737s from Boeing at a better cost, with the trade-in of the Airbus aircarft, over the next 5 years. Not putting Southwest assets at risk with new cities or service. Look at the full picture beyond Denver and that is where the true value at a very cheap price for the full deal!

Aug 08 12:56 AM

[Positroll:]

I admit it: I was wrong. When I last posted, PNCL was trading around $ 3.50. On friday, PNCL didn't go above $4 as guessed - it went to $5.15, thanks to Q2 numbers that translate to at least $3 FCF for the next years to come (it was $19 million (>$1 per share) in the second quarter alone) ! FCF is higher than net income because PNCL doesn't pay taxes due to accelerated depreciation of new planes ...

BTW: In the conference call, management indicated that there is a good chance they'll get their ARS situation resolved within a month. Oh, and after hours they also posted improved july numbers ...

Aug 08 04:38 PM

[User 472030:]

I really don't think that Southwest ever really intended to purchase Frontier . First off it was quite clear that all they wanted was the gates and landing slots . That right there was not attractive to Frontier employees . Putting in the requirement that the two pilots groups would have to come up with an acceptable seniority compromise in a few days is quite ridiculous, as talks of this type historically take years to complete . Now the failure of the bid, has been placed on an employee group . Southwest had access to Frontier's financial condition, while pondering whether to proceed with this transaction. So now it has all the information it needs to compete with a financially weaker competitor . After looking at the available information, they may have well come to the conclusion, that Frontier may well not survive after it emerges from bankruptcy protection . With Republic Holdings acquisition of Midwest Airlines being finalized within the last few days, Republic has it's hands full trying to bring all of it's airlines together in the company 'cultures', and the different types of aircraft it now operates, not even bringing up the possible union problems that may lie ahead for them.

Aug 15 03:12 PM