Southwest Airlines: Not Just a Low Cost Carrier, But a Low Cost Acquirer

May.18.11 | About: Southwest Airlines (LUV)

When Southwest Airlines (NYSE:LUV) is discussed as being a low cost operator, more attention should be focused on its acquisitions activities rather than just the way it manages its air fleet.

Recently assimilating the assets of AirTran into its network, Southwest Airlines has a history of expansion through shrewd, low cost acquisitions. AirTran, acquired for a combination of common stock and cash amounting to $1.4 billion, takes Southwest Airlines into Atlanta and Ronald Reagan Washington National Airport, at a bargain price. Buying AirTran also gives Southwest a greater presence in La Guardia, Boston Logan, and Baltimore Washington International Airport at low costs.

By contrast, Delta Airlines (NYSE:DAL) has spent $2.35 for every $1.00 of shareholder value created through mergers/acquisitions. For Southwest Airlines, it has only cost three cents. Southwest prefers to expand from buying landing slots when small cap airlines encounter economic turbulence. It added 14 slots at La Guardia Airport that were purchased from bankrupt ATA Airlines, allowing for the first time flights to New York City. Through operating agreements with Volairs and WestAir Jets, Southwest now serves Canada and Mexico. Airtran routes will be the first international ones for Southwest Airlines.

Southwest is the largest domestic airline in terms of carrying passengers, over 100 million annually. Even with rising fuel costs, Southwest Airlines has recently reported record loads and passengers. Since 1987, it has ranked number one in fewest overall passenger complaints. The two are directly related as Southwest has been committed to passenger service since its inception in 1971.

This commitment can be easily seen in a variety of Southwest Airline policies. Notable is the lack of a change fee. While others charge up to $150.00 to rebook a ticket, Southwest does not. This allows for a passenger's flexibility, booking several flights knowing they will get their money back. Southwest is then the airline that seats the passenger when they do travel. It has never charged for beverages or blankets. Its frequent flier program, Rapid Rewards, is also more generous. This has created the customer loyalty that leads to the most passengers. As a result, even during The Great Recession, from 2007 to 2008, passenger revenue increased from 12.61 cents to 14.70 cents per mile.

Along with treating passengers better, Southwest attends to its expenses with greater care. Its fuel hedging saved $791 million in 2007; contracts for delivery are set through 2013. The only plane in the fleet before the AirTran acquisition was the Boeing 737, minimizing maintenance and repair costs. All crew members pitch in to have planes ready to leave the gate, allowing for more flights to be flown.

This loyal base and a commitment to low costs have resulted in Southwest Airlines being the only profitable carrier for more than 35 consecutive years. The AirTran acquisition will add $2 billion in earnings while banking $400 million in cost and revenue synergies. This total amount of $2.8 billion in increased annual revenues and savings is twice the purchase price of AirTran. As a result, earnings per share are expected to increase from $.65 in the last quarter of 2011 to $.95 in the last quarter of 2012, with revenues ascending by a projected average rate of 7.5 percent annually, above the industry standard.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.