Two years into merger, Southwest is taking a longer-term view of AirTran integration
Two years after it announced an intention to acquire AirTran Airways, remains on track to integrate the smaller carrier into its system by 2015. Dallas-headquartered Southwest closed on the AirTran purchase in May 2011 and was granted a single operating certificate for the two airlines in March.
“Unlike recent large legacy mergers, Southwest/AirTran is not a merger of similarly sized airlines. In this case, a much larger airline has acquired a much smaller airline,” says Duane Pfennigwerth, director for airline equity research at Evercore Partners in New York. Orlando, Fla.-based AirTran, he points out, was roughly 25% of Southwest's size when it was acquired. “What we have observed is AirTran effectively being absorbed into the Southwest mother-ship. AirTran's aircraft, brand and operating model are slowly being converted to Southwest's,” he says.
Pfennigwerth says that while investors have yet to see the payback from the acquisition, Southwest's approach has less execution risk to the existing Southwest customer side of the equation. “In a merger of equals, both airlines' labor, operations and customers must experience some change, which they typically do not like. In this case, Southwest's existing customers have been relatively insulated from merger-related integration pains.”
According to Southwest data, the airline boarded approximately 100 million passengers in 2011, while AirTran's passenger count was about 20 million. That same year, Southwest served 73 cites versus AirTran's 25.
The merger has had the advantage of “combining two companies that were a good cultural, cost and productivity fit,” says Bob Jordan, Southwest's executive vice president and chief commercial officer—and AirTran's president. In addition, it gives Southwest access to AirTran's Hartsfield-Jackson Atlanta International Airport hub, a location that had been on Southwest's radar for years.
“Atlanta was a glaring hole in our system, which we needed in order to grow,” Jordan notes. “Since it is a relatively constrained airport, it would have been difficult to get in there on our own.”
Jordan also points out that AirTran's profitable routes to Bermuda, Mexico and five Caribbean destinations brought added value. “Since Southwest had no cross-border routes, we are learning a lot from AirTran as we become an international carrier.”
There are plans to enlarge the merged carrier's international footprint, according to Jordan. All 20 of the-800s the carrier has on firm order will be Etops-certified and the Amadeus IT Group's Altea reservations system will handle international bookings as AirTran transitions into Southwest. Altea, slated to be operational in 2014, will replace AirTran's legacy Navitaire system. Asked about additional cross-border or other over-water destinations, Jordan says, “we are very interested in Central America. And Hawaii is a definite possibility.”
He adds that Southwest also will select a “new-generation domestic bookings product” to replace its current Sabre SAAS system within the next 18 months. Proposals by Sabre and Amadeus are under consideration. In the meantime, the airline is “developing the technological capabilities” required to permit code-sharing between Southwest and AirTran by the first quarter of 2013, using the existing reservation infrastructure.
When the merger was announced, AirTran had 138 aircraft: 52 737-700s and 86 717s. Another 51 737-700s, plus two more 717s, were on order. AirTran took delivery of the two 717s by the time its sale to Southwest was finalized, bringing the fleet to 140. Jordan says Southwest, given its considerable buying power, was able to step into AirTran's 737-700 delivery positions and negotiate better pricing for the aircraft, spares and maintenance support.
“Bothand [engine OEM] were fantastic partners in terms of renegotiating the acquisition costs of the aircraft, engines and maintenance contracts,” Jordan says. “They didn't have to do this.” He adds that as these aircraft come off the assembly line, they will be folded directly into Southwest's fleet.
As AirTran's currently operated 737-700s transfer to Southwest, they are repainted in Southwest livery and reconfigured with its seating, carpeting and Wi-Fi, after which they enter Southwest's maintenance program. Some changes to the flight deck also will be made for fleet commonality. Under current planning, 12 of the 737-700s will be cycled into the Southwest fleet this year. The reconfiguration process, which Jordan reports is on track, will take 40 days per aircraft. With the integration of the AirTran aircraft, the combined fleet's average age will be about nine years.
Southwest's all-737 fleet, which totals 552, is a mix of -300, -500, -700, and -800 models. When the AirTran acquisition closed, Southwest had 246 aircraft on order through 2021, including firm orders, options and purchase rights for the -700 and -800s. Since then, Boeing announced that Southwest will be the launch customer for the 737 MAX, with an order of 150. First deliveries are scheduled for 2017.
One result of the merger will be the gradual phase-out of AirTran's 717s through 2015, under a sublease plan with Boeing Capital Corp. and, announced in July. Jordan maintains that, originally, Southwest had no plans to dispose of them.
“The 717, with 117 seats, has about the same trip costs as a 737-300 with 143 seats,” he says. “But, since the 717 was designed for shorter trips, we would have been limited as to where we could fly them nonstop, which would have mandated maintenance support in more locations. Although we planned to use those airplanes, we concluded that if a deal that made sense came up to dispose of them, we would look at it.”
Under that deal, Delta will get the first batch of 16 717s starting in August 2013, while the next group of 36 will be delivered in 2014. Delta will receive the remaining 36 in 2015. Deliveries are projected at the rate of three per month. Southwest also agreed to pay conversion costs as part of the transition to Delta, in conformance with Delta's design specifications. For the total 717 fleet, that will run about $100 million, or about $50 million more than what it would have cost Southwest, had it decided to convert them to its own specs.
A Delta official confirms that the 717s were selected to replace the carrier's 50-seat regional jets.
In addition to a common fleet of 737-700s, the maintenance infrastructures of the merging airlines offered similar capabilities, according to Brian Hirshman, Southwest's senior vice president of technical operations. AirTran operated line-maintenance hangars at Atlanta and Orlando, but it outsourced all airframe and component work. Southwest performs heavy airframe work and intermediate level inspections (C checks) at Dallas Love Field. Intermediate checks are also carried out at Houston's William P. Hobby Airport, Chicago's Midway Airport, and Sky Harbor Airport in Phoenix—but Southwest contracts out “a large majority” of component repairs. (Emergency slides, crew seats, aircraft doors and on-wing composite repairs are among components maintained in-house. Both carriers outsource engine maintenance. Southwest expects to add line maintenance at Denver International Airport in October.
“As with Southwest, AirTran's support infrastructure was very strong, and we were able to integrate AirTran's maintenance team into Southwest's and some have assumed leadership positions,” Hirshman says.
Both of AirTran's Orlando and Atlanta maintenance hangars were working exclusively on AirTran's aircraft early this month mainly due to seniority integration issues. However, Hirshman anticipates this is about to change.
“We now have a single labor agreement on seniority integration, which is pending determination by the National Mediation Board. We expect that determination to be made sometime this month. Until then, neither union works on the others' aircraft,” Hirshman says. Right now, AirTran's mechanics are represented by the International Brotherhood of Teamsters (IBT), while the Aircraft Mechanics Fraternal Association (AMFA) represents Southwest's. AMFA is slated to be the union representing the combined group. Southwest employed 2,700 maintenance workers while AirTran employed 500 at the time of the acquisition.
To date, seniority agreements have been reached with seven of the nine unions representing AirTran and Southwest employees. Negotiations are still in progress with the stock clerks, represented by the IBT, and the customer service representatives, who are represented by the International Association of Machinists and Aerospace Workers.
Jeff Lamb, Southwest's executive vice president and chief people and administrative officer, says all AirTran employees were offered opportunities with the merged company. “We said that any opportunity we'd make available could involve a different job, and maybe in a different city. Of the 215 offers we made, 141 [were] accepted,” he says. “In most cases, the impact was on non-union, administrative staff.”
Lamb adds that the on the day the sale closed, the two airlines together accounted for 43,000 employees. “Today, I'd say we have closer to 45,000, since we added another 2,000 in the last 18 months.” He notes that AirTran outsourced all below-the-wing positions, which mainly included ramp agents, at its 11 locations. Those jobs has been brought in-house, with the addition of 100 employees.
The plan to retain all AirTran employees means that Southwest will incur another $100 million in costs, given the carrier's more generous pay rates, according to Bob Jordan. “But, we will more than make that up with the additional revenue the two companies—together—will generate. Given the expected synergies between the two companies, we are anticipating that will be in excess of $400 million yearly, on a pre-tax basis.”