Daily Memo: Elliott, Southwest Each Want Their Way—Without A Fight

September is set to be a significant month for Southwest Airlines.

More details around the brand’s “new era” are expected during a Sept. 26 Investors Day, including the timing and revenue potential of changes that include a segmented cabin and assigned seats. But first it will face its next meeting with Elliott Investment Management, and both sides so far seem unwilling to compromise on what Elliott ultimately seeks—new leadership at the helm—as the rhetoric heats up.

“It is not an absolute monarchy,” Elliott writes in its latest letter to shareholders, less than two weeks after proposing 10 director candidates, including former CEOs of Virgin America, Air Canada and WestJet and the former deputy CEO of Ryanair.

“The reason we are seeking such a significant degree of board change is not because we want to be ‘in charge’ at Southwest—which we would not be,” explains Elliott in its Aug. 26 letter, “but because Southwest’s current Board seems so plainly purpose-built to serve the interests of [Executive Chairman Gary] Kelly and [CEO Bob] Jordan.” The fund has repeatedly called for the replacement of both leaders.

While the airline’s board has expressed continued confidence in its current leadership team and their ability to evolve the business, Elliott has scored management shake ups elsewhere; most recently at Starbucks which announced a new CEO in mid-August. Other companies who have instilled new leadership following sizeable investments by Elliott include real estate company Crown Castle and power supplier NRG Energy.

However, Southwest is “unique and nuanced” even within its own industry, analysis from the Swelbar-Zhong Consultancy notes, and Elliott’s approach should be similar. “The real proxy fight should be about winning the ‘hearts’ and minds of the Southwest employees,” says the consultancy’s chief industry analyst William Swelbar.

For a decade, costs and productivity have been going in the wrong direction, at a company that created its competitive advantage managing both, he adds. “So much in the marketplace has changed and has impacted Southwest’s approach to the market, which has not changed,” says Swelbar. “This is fundamental and why Elliott is right to challenge the company before it is too late to ever think of returning to its past performance.”

Approaching its next meeting with Elliott, Southwest says it welcomes the opportunity to discuss ideas that would drive shareholder value, as it works to reach a collaborative resolution. The carrier “has made multiple overtures to engage with Elliott, and we remain prepared to meet on Sept. 9,” an airline spokesperson said in reaction to the fund’s latest letter, adding, “During the past several months, our board and leadership have met with many of our shareholders to hear from them directly.” The airline has also engaged with Elliott on several occasions, the spokesperson confirmed.

Planning to evaluate the recently proposed director nominees as part of an ongoing board refreshment process, the carrier has described Elliott as dismissing its efforts to engage constructively. Elliott now counters that “Southwest’s leaders are trying to define ‘engagement’ to mean a dialogue in which the single most critical question facing the company today—who should lead it—is taken off the table and resolved in favor of the failed status quo.”

The back-and-forth since Elliott’s investment was disclosed in June has continued to position both sides as willing to collaborate—provided that concessions come from the other guy. The fund is now proposing that company-wide modernization could be supported by a new committee, working with new leadership.

“The process that we have seen work most effectively in such situations is the formation of a new board-level committee with a mandate to conduct a comprehensive business review and drive transformational change—and that is what we believe is needed at Southwest,” Elliott writes. While stating that it “shares the widely held belief that Southwest’s culture is vital to its continued success,” Elliott contends that it is “seeking to engage with Southwest to create a better future for the company, not for a fight,” and that it “much prefer[s] working collaboratively.”

Holding an approximate 11% economic interest in the company, the fund could soon call a special shareholder meeting as its beneficial ownership nears a 10% threshold.

“If we end up having to nominate directors to the board of Southwest and take this contest all the way to a special meeting, then it will be the first time we have had to conduct such a contest in the United States in more than seven years,” Elliott notes. “However, when we encounter corporate executives who believe that the companies they run are their personal fiefdoms and that they are entitled to run them ... unchallenged for as long as they want, no matter what results they deliver, then we are more than happy to provide a voice for those whose interests are being poorly served.”