When Elliott Management acquired an 11% position in Southwest earlier this week, the activist investor placed the airline's management in the crosshairs.
Elliott, a hedge fund with a history of forcing management changes at companies it targets, had acquired $1.9 billion in Southwest stock as of June 10, the day when Elliott confirmed its stake in the airline and called for the dismissal of CEO Bob Jordan and chairman Gary Kelly, Jordan's predecessor.
On Wednesday, Jordan said he will not resign, signaling that Southwest is prepared to dig in for a fight, defending a C-suite and board with numerous company veterans.
"The Southwest Airlines board of directors diligently oversees our strategy and leadership team and, based on the company's ability to overcome strong headwinds in the past, is confident in our CEO and leadership team's ability to fulfill our strategy to drive long-term value for all shareholders," Southwest said in a statement released shortly after Elliott's announcement.
Elliott says Southwest presents the most compelling airline turnaround opportunity in the past two decades.
While noting the financial ground Southwest has lost to competitors since 2020, Elliott also noted Southwest's strong brand, fleet, network and cash position. It boldly predicted it could drive Southwest shares to $49 over the next year, up from less than $28 before its stake in the airline became public.
Along with replacing Jordan and Kelly, Elliott called for the appointment of board members who are independent of current leadership and have outside airline experience. Elliott also wants a comprehensive business review toward determining what steps Southwest must take to modernize its commercial and operational models.
Brad Beakley, CEO of consultancy Hospitio, said that given the Southwest board's veteran makeup, Elliott is likely to face strong, continued resistance.
"If I'm Elliott, I'm going to have to come in and convince you that you've all been wrong and there's a different course for Southwest," he said. "That seems kind of difficult."
Still, the gambit on Southwest didn't come as a shock to all observers of the U.S. airline industry.
"We are not surprised by activist interest in Southwest given the very strong franchise with valuable tangible and intangible assets, such as brand (including loyalty program and co-branded credit card), fleet (current and order book), network and balance sheet (net cash position unique among U.S. airlines)," wrote Raymond James investment analyst Savi Syth.
She also wrote, "There are some (both inside and outside of Southwest) who believe sufficient change cannot occur without a change in leadership." Syth believes a board and management shakeup is "only compelling if management does not show the level of urgency to execute on various opportunities in a timely manner."
From first to worst in profit margin
Driving the discussion are Southwest's disappointing results in recent years.
In 2018, the carrier's profit margin was tops among the largest four U.S. airlines. It is projected to be the worst this year, trailing Delta, United and American. Southwest's stock is hovering at around 50% of its price before the pandemic.
Elliott says Southwest is reluctant to evolve while the U.S. airline industry overall has increasingly focused on premium flyers and ancillary sales. Though Southwest does earn ancillary revenue from early boarding, the carrier hasn't strayed from its unique approach of offering free checked bags, and it does not have seat assignments, a basic economy product or premium cabins.
In addition, Elliott accused Southwest of operating with dated technology that played a role in the airline's operational meltdown during the 2022 holiday season.
Southwest countered that it's already addressing tech shortfalls with a boost in IT investment. Southwest said its action plan for improving operations, announced in March 2023, helped it complete 99% of scheduled flights in the first quarter of 2024.
The carrier has also accelerated efforts to phase out flying in unprofitable markets and scaled back capacity plans -- in part due to Boeing delivery delays.
Southwest planes have just one cabin and aren't equipped with extra-legroom seats. Photo Credit: Southwest Airlines
Goodbye to open seating?
In April, Jordan said changes could be coming to the carrier's seating model and to its cabins, and during a one-one-one interview at an industry event hosted by Politico on June 12, Jordan again addressed seating.
"Customers' product needs are changing and will continue to change," he said. "We have spent months surveying our customers to understand what they want. You can't be stubborn."
Jordan noted that Southwest is the only U.S. airline doing open seating and that the longtime policy is under review.
"It could be that open seating worked really well when load factors were much lower. Planes are on average 90% full today. There is significantly more demand for things like extra legroom. ... We will adapt as customer needs adapt."
Out of all the possible revenue boosters, Syth wrote that Raymond James is most supportive of the introduction of assigned seating, "particularly given the success we have observed at Ryanair since it switched from open seating in 2011."
"Southwest has the technology to support it, and this is something that can be rolled out relatively quickly but would take time to optimize," she wrote.
A Southwest bag fee could be counterproductive
While Syth called assigned seating a "value-add," she said implementing a checked-bag fee would be a "value grab."
Southwest's free checked bags are a differentiator for the airline, Syth argued, citing an MIT study commissioned by Southwest's pilots union. The study showed a $400 million net revenue benefit in 2016 from not charging for bags, she wrote, with market share gains offsetting what Southwest would have collected in bag fees.
It doesn't have to be all or nothing, Syth added. Southwest could introduce a basic economy fare and charge a bag fee only to customers who purchase that fare.
Regarding a premium product, Syth says there is an opportunity to add extra-legroom seats on new generation Boeing 737 Max aircraft.
Hospitio consultant Beakley suggested that Southwest could configure aircraft with a premium seat similar to Spirit's Big Front Seat, saying it would not require enormous investment.
Beakley also sees an opportunity for Southwest to leverage its broad and robust domestic network by adding a fleet of regional Embraer aircraft to augment its Boeing 737s.
Jerry Limone contributed to this report.