Southwest Airlines Under Activist ATTACK!

- Southwest Airlines could be in for some major changes. - A huge story like this in the aerospace and the airline industry. Do you think Elliott will be successful?

- Southwest Airlines is right now under attack from an activist investor, but what does that actually mean? Can anyone just buy a chunk of an airline, get rid of its leadership and then completely change the way it works? Stay tuned.

(playful chime) Southwest Airlines has been in the news a few times over the past few years and not always for the best of reasons. - Southwest Airlines is back in the spotlight, this time on Capitol Hill where lawmakers grilled the carrier over the major meltdown that left millions grounded during the holiday season. - Probably the most memorable of those was the airline's complete meltdown around Christmas in 2022, when around 16,700 flights had to be cancelled over one single week, a very undesirable world record.

Now I'll get back to that meltdown a little bit later, but while an aviation audience like you guys are probably familiar with Southwest, you might not know a lot about the activist investor who is now attacking the airline. So what is an activist investor then and what are they really after here? Well, what companies like these do is that they buy a substantial stock position in a company that they have decided to target.

And once they have done that, they use that ownership stake as a leverage to try and force substantial changes to the company in a practice also known as shareholder activism. Now I want to point out here that this is not like a hostile takeover because an activist investor usually only takes control of a minority stake in the company which is a much less costly process than an outright takeover. And usually the motives behind it is simply to make a lot of money by causing the value of the stock that they buy to increase significantly.

But the motives aren't always financial. These companies or sometimes individuals also sometimes have other goals which is why they have the word activist in their description. Some of them might want to force changes to how a company is treating the workers or stop them from working in parts of the world that has problematic human rights records or sometimes they want to force them to abide by certain sustainable practices.

But these days those non-financial activists are definitely the exception, not the rule. Now whatever their motives might be, since they only have a minority stake in the target company, they need to also get broad support for their actions from other shareholders in order to succeed. To do this, they could take advantage of various company rules that force shareholder meetings and votes under specific conditions.

Or alternatively they can also make themselves into such a big nuisance that the company managers just give them what they want in order to get them off their back which can be really tricky if one of the things that the activist wants is to get rid of the company's CEO or loads of board members. But ultimately, what the activist investors must do is to make a convincing case to other shareholders that they know how to fix the company and that they know so better than the company's own management. That can be quite a hard sell, especially in the case of a long-established company like Southwest Airlines.

Now Southwest weren't the first low-cost carrier in the world but they certainly have worked out how to scale the concept massively and today, a lot of other airlines around the world are following in their footsteps which means that the legacy of success is definitely there. So who is the activist investor that decided to take on Southwest then? Well, it's a company called Elliott Investment Management who specializes in managing investments, unsurprisingly.

And they are one of the biggest activist investor funds in the world. The list of companies that Elliott Investment has previously set their sights on is pretty long and it includes household names like Cabela's, Etsy, Texas Instruments and most recently Starbucks. They have also bought majority stakes in other well-known companies like Waterstones in the UK, Barnes & Noble in the US and they even bought and sold the Italian football team AC Milan some years ago.

They have even taken on sovereign debt of several countries including Argentina who they once took to court over the value of Argentinian bonds and won. Now I hope it's obvious what all of this means. When someone like Elliott Investment takes an interest in a company, you can be pretty sure that they have done their homework and have likely learned everything there is to know about that particular company.

So last June, Elliott revealed that they had invested $1. 9 billion in Southwest Airlines which they claim amounts to an approximately 11% economic interest in the company. Now not all of that money is Southwest shares but gradually Elliott has converted enough derivatives to own a 10% stake in Southwest common shares.

That percentage is enough for Elliott to be able to call a special meeting of shareholders where they could vote on things that can't wait for the more usual annual shareholder meeting which would normally come next spring in 2025. So what is Elliott actually after then? What kind of changes do they want to force on Southwest?

Well, in short, basically everything or nearly everything. From the very start, Elliott made it clear that they wanted Southwest Chairman Gary Kelly and Southwest CEO, Bob Jordan, to be kicked out as well as replacing 10 of the 15 board members. In order to support this, Elliott released a highly-detailed 51-slide presentation explaining their reasons.

Again these guys aren't new at what they do. They have clearly done their homework even if they haven't been involved in the aviation industry before. But this presentation isn't only impressive because of all of the details it includes.

It's also quite interesting to note one pretty important thing that it leaves out and that will tell us something about what Elliott's strategy might be here. See if you can spot the giant elephant in the room in this detailed presentation after this. Imagine that you're out traveling and when you land you want to immediately catch up on the latest emails and headlines but you don't have any data plan in this country so now you're left chasing after dodgy Wi-Fi hotspot just to get online.

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Elliott Investments presentation recognizes that Southwest is a truly impressive airline that offered a workable alternative to the legacy carriers for a lot of travelers during a truly transformative time in the aviation industry in the United States. They also highlight that Southwest was very innovative in its early years where they, among other things, created the quick turnaround concept enabling them to get more use out of the same aircraft, something that today is key in making low cost carriers work. Elliott also points out that Southwest was the first airline in the United States to create a website which generated over a billion dollars in revenue by the year 2000.

And today they are the airline that carries the highest number of passengers in US domestic flights. On top of this, Southwest also have one of the largest aircraft fleets in the world and it's a young fleet too, younger than their competitors and they fly these jets on a truly impressive network. But Elliott also argues that the innovation that characterized Southwest in its infancy was only there for its first 30 years or so.

More recently, the airline has remained complacent, sticking to the same commercial strategy which slowly has become dated and less successful. In other words, the airline has let the industry pass them by. Elliott uses a JP Morgan quote in its presentation which says that out of all of the US airlines, Southwest has evolved the least since 9/11, relative to an industry that has undergone a massive profit transformation.

Now that's an item that I'm going to take a small issue with here. I'm not saying it's not true but mentioning that out of context is quite misleading. Because it is also true that Southwest was the only major US airline to not go either bankrupt or undergo restructuring or a merger in the decade following 9/11.

So I mean I guess that would technically mean less change but not in a bad way. Southwest also absorbed another airline, AirTran, after this difficult period but crucially, Southwest actually remained profitable through 9/11 and the years that followed while the other US carriers had to undergo a massive profit transformation in one way or another just to survive. So it's hard to fault Southwest for being conservative during that period since it clearly worked really well for them.

And they weren't just profitable after the 9/11 period. They had actually been profitable for 47 consecutive years, ending that incredible streak only in 2020. But anyway, Elliot's presentation also points out that Southwest's customer loyalty program is highly successful and boasts a great reputation for good customer service.

They've also recently made new contract agreements with their employee unions which should ensure stability. But even though this sounds quite rosy, there is, unfortunately, also plenty of bad news for Elliot to point out. - It's time now for our Stock of the Hour, a closer look at Southwest.

The shares right now are having their worst day since 2009. - For one thing, the airline has lost more than half of its market value just in the last three years. And in the 17 months before Elliot publicized its plans for Southwest, the airline had been forced to revise its performance forecast downward seven times.

Now moves like that doesn't inspire confidence in shareholders since it's suggesting that the company's management didn't plan ahead very well and Southwest then revised their forecast down again this summer after Elliot's move. But I'll get back to all of this shortly. Elliot explains that despite the turbulent post-pandemic situation and Southwest's strong destination network, other American carriers have recently been performing way better than Southwest have, at least during the last three years.

This has resulted in a huge drop in the airline's value. Now, of course, COVID-19 is probably responsible for some part of that but Southwest value has declined 44% since 2019 when the values of American's other big three, Delta, American and United, have only dropped around 5% in the same period. Similarly, the earnings of these other carriers for this year are expected to be as good or better than in 2018 but Southwest is expected to be around 48% lower, which is partially because its costs are now way higher than its competition, something that just shouldn't happen to a low-cost carrier.

And then we get to that operational meltdown for an entire week back in December of 2022. Elliot breaks down the losses the company suffered, the two million customers that were affected and the fact that nobody in Southwest's upper management was later axed as a result. That is a little bit of a sore point for the airline.

You see, at its core, that meltdown happened because Southwest was using software that simply wasn't up to the task. Now it could work okay when the skies were blue and there were no major disruptions but in more difficult conditions, for example, when bad weather hit one of the airline's biggest hubs and a second problem then happened somewhere else at the same time, the system had to be robust enough to recalculate how and where 800 aircraft and tens of thousands of pilots and cabin crew would fly that day. And on top of that the system also had to take into account where these people and planes actually were and whether or not the pilots and cabin crew were legal to fly based on their previous flight schedules.

Now there is much more to this story and if you want to dive into it further, I've actually made a detailed video explaining the causes of this event and how Southwest's differences from other airlines made it even worse. But the point for this story is that Southwest's systems just could not cope with this. And many in the industry, including both analysts and even the airline's own pilot union had tried to raise the alarm about this for a long time but no one had listened.

So in short, this meltdown reflected quite badly on Southwest's management because in its younger days, Southwest was seen as an innovator, someone that would lead the development of these kind of systems, not fall behind them. Elliot also notes that despite all of this happening, Southwest's leadership is actually playing down the company's troubling performance even suggesting that things are getting better, which they really aren't. The activist investors are really laying into Southwest management in this presentation, accusing them of only making incremental changes or no changes at all in order to combat all of these issues.

So obviously, the changes that they want to see in the airline are radical including those leadership changes that I already mentioned. Southwest Chairman Gary Kelly and CEO Bob Jordan have both been with the airline for decades but Elliot argues that they have no experience with how other more successful airlines operate nowadays. In Elliot's opinion, the same also goes for much of the airline's board which is why they want two thirds of it changed and finally, they also want to see a comprehensive business review once there is enough fresh blood in the airline's management.

Now I know this was a little bit long-winded but like I said, this is a very detailed presentation which you can also find in the video description here below if you are more curious. But like I also said, something big is definitely missing in it. Did you figure out what it is yet?

Well, I have done a few videos about Southwest on this channel already and I don't think that I've gone more than a couple of minutes in any of those videos before mentioning the Boeing 737 MAX. But today I didn't because Elliot's 51-slide presentation doesn't mention 737 or MAX anywhere. Not even once.

Now you might say, "So? Why does this matter? What does the 737 MAX have to do with any of this?

" And it turns out that it actually matters a lot. You see, Southwest's fleet has changed during the last few years which it has done against Southwest's own wishes and plans. And the fact that it has changed so dramatically is mainly because of Boeing's ongoing delays in certifying the smallest 737 MAX variant, the MAX-7.

In another recent video that I did, I explained that back in the 1990s, Southwest was the launch customer for the 737-700 and a decade earlier, they had also launched the 737-300 and those two planes are basically in the same size category as the new 737 MAX-7. Southwest's 737-700 have 143 passenger seats and when Southwest finally starts getting its MAX-7s, they will probably add another row of seats on top of that, but not more than that. By contrast though, Southwest's bigger 737-800s all have 175 seats and so does Southwest's newer MAX-8s.

Southwest started picking up those MAX-8s back in 2017. So let's have a look at the airlines fleet before that. In 2016, Southwest had 723 jets in total.

Of these only 142 or 19. 6% were 737-800s with 175 seats. But if you look at 2023, the airline had then grown to 817 jets of which the 175-seaters, the 737-800s and the new MAX 737-8s add up to 430 aircraft in total.

That's a full 52. 6% of the entire airline fleet. So what this means is that in the space of just seven years Southwest's 175-seaters went from less than 20% to well over 50% of its fleet and why is that?

Well when Southwest saw that the MAX-7 certification was getting pushed back again and again, they elected to start taking deliveries of the bigger MAX-8 instead since they would eventually get many of those as well so they thought that it makes sense to swap them. But Southwest also assumed that the MAX-7 would only get delayed by a year or two, not the nearly five years it has suffered so far. And this is a big deal because Southwest's extensive well-thought-out domestic US network relies on using smaller aircraft to a great extent.

So in short, Southwest aircraft are now too big. They have too many seats for the network that they have painstakingly developed over the last few decades. But Elliott makes no mention of this in the presentation.

But what they do mention is a metric called Revenue Per Available Seat Miles or RASM. So what's that about? Well, let's say an airline can fill up just 75% of a plane's seats for a given flight.

That's not great because the empty seats are basically lost revenue. A smaller plane with the same number of full seats would then be much better because it's lighter and would therefore burn less fuel and was also likely cheaper to both buy and lease. Alternatively, the airline could stick with the bigger plane and offer tickets at a lower price in order to try and fill up those 25% of empty seats.

But that's a compromise and if they go down too far, well then they won't earn more money than they did before. These factors are what shapes an airline's revenue per available seat mile, RASM and its cost per available seat mile or CASM which Elliott has obviously studied extremely carefully. Some commentators have suggested that Elliott just doesn't have the experience needed in the aviation industry and therefore, maybe doesn't understand the significance of the MAX.

But I don't think for a moment that one of the world's biggest activist investors would ever dive into an investment like this without understanding perfectly how significant the 737 MAX 7 is for Southwest and what its absence means for the airline. Because actually the main reason why Southwest had to revise its guidance so many times in recent months is primarily because of the constant pushback of the MAX-7's introduction and because of Boeing's production delays in delivering even the MAX-8's on time. So what do I think about this?

What is Elliott really up to here? Well, I think Elliott recognized the bind Southwest is in with its fleet renewal problems and they realized this many months or probably years ago. At the same time, they listened to what many in the industry have been saying about Southwest's management and how their conservative choices have now started to cause real problems for the airline.

So Elliott likely knows that even with all of Boeing's problems, the MAX 7 will eventually come and in their presentation, Elliott claims that their strategy for a stronger Southwest will boost the airline's share price to $49 in 12 months. Now that 12 month countdown hasn't started yet but with any luck, the MAX 7 could actually enter service a year from now or maybe a little bit later and that could in itself start relieving some of the pressure on Southwest and with that, raise the share price. If I'm right about that, Elliott didn't just do their homework on Southwest, they also had to pick just the right time for their attack.

But to be clear here I'm not saying that Elliott is simply being optimistic. No, many of Elliott's ideas really do make a lot of sense. For example, they highlighted the fact that Southwest still didn't offer assigned seats, premium seating or charges for checked-in bags.

You see offering premium seating is another way to raise that revenue per available seat mile metric. And if you think about it, it makes perfect sense. If your planes are too big for your network, then removing some of those seats and charging more for seats with extra legroom obviously seem pretty smart.

That's why most airlines are already doing it. And that's probably also why Southwest is now slowly responding. In July, they announced that they will start offering assigned seats from 2025 and at the same time, they will offer premium seats with extra legroom and also start flying overnight or red-eye flights, which actually as a pilot I'm not really a fan of but that's not the point here.

Elliott immediately commented that those changes weren't enough. So just now, in September, after meeting with Elliott's representatives, Southwest chairman Gary Kelly announced that he will retire early after spending nearly four decades at the airline and 18 years as CEO. In the same announcement, Southwest also stated that six board directors will retire voluntarily in November and in their place, Southwest plans to appoint at least four independent directors of which three could be people that Elliott has proposed.

Finally, the board has already set up a committee that will oversee financial, operational and other aspects of the company which was another Elliott demand. This seems to be how these negotiations will continue. Elliott's response to this was obviously positive, saying that they are pleased that the board is beginning to recognize the degree of change that will be required at the airline.

In the end, I think that even if Southwest aren't going through their best time right now, they will bounce back from this. And if you read through the lines, I think that Elliott is expecting that too. After all if they didn't do that, they wouldn't have invested in them in the first place.

And that by the way, is an important point here. You see, if Elliott gets what they want and the stock price starts to rise, either by the MAX 7 finally arriving or because of some of their other policy changes, well then, they will likely sell their shares at a great profit and move on because that's what they ultimately came for. But what do you think?

Do you think Southwest is in need of all of these radical changes or would a more gradual approach maybe have been better? Let me know in the comments here below. Now if you've missed it, I recently released a video where I introduced my entire wonderful team and the plans that we all have for the future.

The main point in that video is that we want to expand our team, create more and better quality content and be less reliant on AdSense income from YouTube. But in order to do that, we need you. If you want to help us achieve this, please go to patreon.

com/join/mentourpilot or click in the link here below. Have an absolutely fantastic day wherever you are and I'll see you next time. Bye bye.