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Can Southwest Airlines shake the 'Elliott' curse?

Analysis

Southwest Airlines has been plagued with the curse of Elliott during the last couple of years.

First, the airline had a massive operational meltdown in Dec-2022 driven by the winter storm - 'Elliott'.

Now the airline contends with the moniker once again, this time a storm of a different kind - as the aggressive activist investor and new large shareholder Elliott Management demands a management shake-up and an overhaul of Southwest's Board of Directors in order to conduct a review of its business.

It is uncertain at this point whether Elliott will prevail in achieving its goals, but the attention generated by the hedge fund is casting a light on Southwest's strategy - or what, some may argue, is a lack thereof.

Summary
  • Elliott Management challenges Southwest’s adherence to the status quo.
  • The activist investor is scant on meaningful changes at the airline.
  • Elliott’s demands for a management upheaval appear to be more dramatic than pragmatic.
  • Southwest arguably needs to leverage its strong position in the US market more effectively.
  • Will Elliott's efforts result in a shift in Southwest’s thinking?

Elliott demands a management shake-up at Southwest due to lack of vision

Elliott Management disclosed a USD1.9 billion stake in Southwest on 10-Jun-2024 and declared that the airline needed "upgraded leadership," due to Executive Chairman Gary Kelly and CEO Bob Jordan's rigid commitment to the status quo.

Elliot also believes Southwest's Board of Directors needs an overhaul, with new, independent directors that have external airline experience.

Not surprisingly, Mr Jordan has said he has no plans to resign, according to Bloomberg.

After what it deemed as 18 months of extensive research, Elliot concluded (after years of aversion to change) that Southwest was simply outdated, and a new management must undertake a comprehensive business review of its business overseen by a new board-level committee.

Southwest needs to adapt without diminishing a brand built on simplicity

Other than its demands for new leadership and highlighting Southwest's flaws, including a drop in the airline's EBITDAR margin from 21% in 2018 to an estimated 8% in 2024, Elliott was short on specifics about the how the airline could improve its fortunes.

There's an argument to be made that Southwest is slow to embrace change, perhaps for good reason. Indeed, Elliott concluded that for its first 30 years in existence Southwest was an innovative leader, but after years of aversion to change, the company's strategy was outdated.

Elliott's conclusions are not novel. Southwest walks a fine line between not upending a strategy that's been replicated worldwide and by adapting to shifting industry trends.

The airline constantly fields questions about its commercial strategy, particularly as the penchant for a more premium experience shows no sign of weakening.

Earlier in 2024 Southwest Chief Commercial Officer Ryan Green concluded: "I think that there's at least some evidence out there today that [there is] demand for fares on the bottom end", and products on the lower end of the segment. "There may not be as much demand for those types of products today as what there once was," he noted.

However, he also noted that premium demand could be highly cyclical, and "before we take up that question…we would want to study that very closely…".

The airline's CEO Mr Jordan has stressed that the airline is not "stubborn in this area...that as you see demands change, we'll understand that and we will react if needed…".

See related CAPA - Centre for Aviation report: Southwest works to restore historical returns, approaches any product changes with caution

And although Southwest has refined its open-seat boarding model over the years, including creating an "Early Bird" check-in option for purchase, the airline's executives have stated that it has been "considering more transformational options" and "studying customer preferences for seating".

Southwest's brand, which largely still resonates well with customers, is built on a certain level of simplicity, so any refinements the airline would make are likely being viewed within that framework.

Does gutting management achieve long term viability for Southwest?

But for the new shareholder Elliott, and perhaps other stakeholders in Southwest, the airline is too slow in responding to evolving passenger preferences.

Perhaps Elliott needs to offer more specific remedies, rather than recommending a gutting of upper management and the airline's board.

That sort of disruption never bodes well for a company's internal culture, particularly one as strong as Southwest's. Although Elliott makes a valid point that most of the airline's executives are tenured at the airline with little or no experience at another airline, an abrupt management overhaul would diminish employee confidence.

Can Southwest leverage its market dominance in a more favourable manner?

Southwest remains one of the dominant players in the US market - its domestic seat share was essentially on par with American Airlines in mid-Jun-2024.

For the 11 months ending Mar-2024, Southwest and American were the second largest US domestic airlines measured by traffic, with a 17.3% share each. Delta Air Lines was the leader, with a 17.7% share.

Taking a snapshot of available domestic US capacity for the week commencing in Jun-2024, American is the market leader, just ahead of Southwest, with Delta third, United Airlines fourth and Alaska Airlines fifth.

US domestic seat share, by airline, week commencing 17-Jun-2024

With such a dominant position, Southwest arguably should engage in more initiatives to leverage that strength, but even as patience among some shareholders seems to be waning, activist shareholders rarely have an interest in a company's long term vision.

How will Southwest's management ultimately respond to Elliott's demands?

Elliott makes a valid point that a reality check at Southwest is necessary - which, again, is not an original idea that's just now being floated in the business environment at large.

The ultimate question is if Elliott's efforts will result in a shift in Southwest's strategic thinking among the airline's management, or if the status quo will remain in place.

This article was written on 14-Jun-2024.

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