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June 14, 2024

Breakingviews: Barbarians at Southwest gate overdo upgrade plea

by Breakingviews.

Southwest Airlines flew straight into treacherous territory. Under Bob Jordan’s tenure as chief executive since early 2022, the U.S. carrier’s persistently gloomy financial outlook has been at odds with a broader industry resurgence, leaving its stock to languish. His slow response makes him and the company easy targets for an agitator like newly checked-in dissident Elliott Investment Management. Resetting the course, however, is harder than the hedge fund manager suggests.

A travel rebound following the pandemic sparked a surge in Americans traveling internationally, little help to domestic-focused Southwest. Government-imposed production caps on Boeing, whose 737 planes the company uses, also stung. Together they have contributed to a steep decline in the airline’s profit margin, using adjusted earnings before interest, taxes, debt, amortization and rent. It is projected to be 8% in 2024, according to estimates gathered by LSEG, down from 23% in 2017.

The slump exposes Southwest’s resistance to generating extra revenue by charging for checked bags, assigned seats or premium classes. Since it pioneered the discount airline model more than 50 years ago, its “Bags Fly Free” and other perks have become mainstays of a corporate culture that produces higher job satisfaction and fewer customer complaints. Following the crowd on fees might seem obvious on a spreadsheet, and the company is considering such ideas, but increasingly resembling rivals also could jeopardize market share.

Jordan will have a tough time holding the line, and probably his job, too. Elliott disclosed its 11% stake on Monday, enough to singlehandedly call a special meeting of shareholders, and it wants him and some board members ousted. He says he has no intention of quitting, but will hear the fund out. Its vocal campaign, chunky $1.9 billion investment and detailed presentation indicate it won’t easily back down. Another firm, Artisan Partners, already has publicly supported the call for new leadership.

Elliott reckons a profitability rebound could boost the company’s stock price by nearly 90% in a year. Similar optimism about airlines has wrongfooted legions of backers, including even Warren Buffett, whose Berkshire Hathaway in 2020 booked losses on some $8 billion it invested in four U.S. carriers, including Southwest. There is undoubtedly more the airline can do to regain its previous altitude. It just might be a long and bumpy ride.

Context News

Southwest Airlines Chief Executive Bob Jordan said on June 12 that he would not resign despite a call from hedge fund firm Elliott Investment Management to oust him. Elliott on June 10 disclosed a stake of about $1.9 billion, good for roughly 11% of the low-cost carrier, and urged leadership and board changes. It also unveiled a presentation making its investment case for Southwest. “Our Board and Executive Leadership Team are thoughtfully reviewing Elliott’s letter and presentation and look forward to further conversations with Elliott to better understand its view on the Company,” Southwest said in a statement.

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