Southwest’s $1.4 billion AirTran deal pays for itself
Southwest Airlines’ $1.4 billion AirTran Holdings deal pays for itself.
The dominant discount airline’s takeover gives it valuable gates in Atlanta and several Northeast cities. While AirTran poses operational risk and comes at a 69 percent premium, the value of promised cost cuts is worth about $2.8 billion before accounting for the time value of money. Even if some savings disappear, the deal stacks up. Indeed, investors sent Southwest’s shares soaring 10 percent on the news, adding almost $1 billion to the company’s market capitalization.
For years, Southwest grew by basically repeating the same play. Offer basic service to second-tier airports at U.S. cities at discounted prices. Minimize ticketing costs. Put passengers at ease by having bubbly flight attendants make lots of jokes. Save money by flying only Boeing 737s. And try to keep planes full by sticking to short routes.
Purchasing AirTran mixes up the model a bit, however. For one, AirTran leases more Boeing 717s than 737s. The airline also has some international destinations. Southwest’s even saying the acquisition improves its ability to attract lucrative business customers. And it may be culturally difficult to integrate because of its size — AirTran employees would be close to 20 percent of the combined company’s workforce.
On balance, these risks appear worth taking. Buying AirTran gives Southwest access to Atlanta, where Delta has largely had a lock on the market. That makes the city a fat target for tightly-run Southwest.
The deal’s best attribute, though, looks purely financial. Southwest estimates cost savings of at least $400 million per year by 2013. The after-tax value of these savings would be worth as much as $2.8 billion. Unfortunately for investors, promised savings in the airline industry often disappear, transferred to customers in the forms of cheaper flights.
But only a fraction of the promised synergies need to show up to justify the $400 million premium that Southwest is paying. No wonder the company’s investors are acting as ebullient as one of the company’s flight attendants.