On The Air Show this week, Brian, Jon, and I dug deeper with a focus on how Southwest got to this point where Elliott swooped in. Come have a listen on Spotify/Apple Podcasts/Amazon/Pocket Casts when it goes live later today (June 20).
Activist investor Elliott has decided that Southwest Airlines is being run poorly, and it thinks changes can be made that will spike the share price from $28ish today to $49 in short order. We can all agree that Southwest does have serious problems, but I’ve already explained why I don’t think Elliott is all that interested in a sustainable fix. It just cares about getting the stock price where it needs it to be in the short-term regardless of long-term impact. (This company profile from 2018 really explains how this aggressively terrifying company operates.)
The overarching problem here is that Elliott seems to have a cursory understanding of the industry and an even more basic understanding of Southwest itself. It knows this, and that’s why it wants to bring in a new CEO from the outside to conduct a business review and implement changes. That alone isn’t a problem, but Elliott has already set goals for the airline based on its internal models which it says create “the most compelling airline turnaround opportunity in the last 20 years.” This means a new CEO is already hamstrung on having to reach these financial targets in short order, and that’s going to encourage short-term decision-making with long-term consequences.
Since Elliott isn’t an expert here, I’ve been looking for anything to suggest that its models are built on something solid. In some ways, we can only read the tea leaves, but there were a couple of slides in the company’s presentation that suggest Elliott’s model is incompatible with Southwest’s long-term success.
Elliott says it had “more than 130 conversations” with former employees, and it spoke with “leading industry advisors,” shareholders, and over 2,000 customers. It clearly has an idea of how much more money it thinks Southwest can generate. In fact, it says on slide 47 how it’s being conservative by using numbers that are in line with or slightly below those coming out of American, Delta, and United. That is still a questionable way to look at this.
Let’s start with slide 31 which I think probably sums up Elliott’s assumptions most succinctly.
This slide says that “industry-standard commercial initiatives” have been ruled out by Southwest. The implication is that Southwest should be doing these things and then… PROFIT! This, of course, assumes that Southwest is the same kind of airline as those legacy carriers, which it is not. For example, these are all airlines with large international networks that are responsible for producing the big returns right now. Southwest does not and will not have that anytime soon.
If “copy other airlines” is truly how Elliott is modeling this, then it’s a real mistake. It suggests no understanding of why Southwest is different and no nuance in terms of how Southwest should consider its options. Southwest has made a living with tangible differentiators since it first started flying. This money-grab would put an end to that, and there would be consequences in competitive markets.
Let’s talk about seating, because I think this shows why just copying the legacies isn’t the right thing to do. There is good work to be done here if Southwest can get out of its own way — it has already said it’s looking at seating and will tell us more in September at investor day — but it’ requires nuance’s not like it’s a simple flip of a switch.
This is one area where I think Southwest should partially follow the legacies, but it would certainly dilute the number of people buying Early Bird. So there is a tradeoff here. Also, Southwest shouldn’t do the whole “preferred seating” game where it charges for seats toward the front even though they are no different than the seats in the back. This could hurt revenue potential, but it doesn’t fit with the Southwest style. Save that for premium….
The quote on premium products says that Southwest doesn’t think curtains are the right thing for the airline. I agree. But an extra legroom section? That doesn’t need a curtain, and it would be a big improvement for the airline. People will absolutely pay for that. How much? I don’t know, but in 2023 Southwest had just shy of 1.5 million flights. If you sold 20 seats a flight at $35 a pop, that’s $1 billion a year.
If this were to happen, it has to go hand-in-hand with assigned seating. I can imagine a lot of angry people who paid for legroom and get stuck in the middle only to find they could have had an aisle or window in the back. It’s no small undertaking.
This doesn’t even address Basic Economy and checked bag fees, both of which I think would be a bad plan at this point even though they undoubtedly contribute significant revenue in Elliott’s model.
Nothing screams the opposite of Southwest Airlines more than Basic Economy. In fact, that would do tremendous damage to the customer-centric brand. And lastly, we have the checked bag fee. I’ve long thought that a second checked bag fee would make sense, but I also don’t know how much money that would even bring in. It might not be worth it. But in a world where Southwest’s biggest competitive advantage — lack of change fees — has disappeared, the airline needs one that it can hang its hat on. Free checked bags are the best differentiator right now.
The other piece of the analysis in the presentation is around network changes. From slide 36, we have two charts:
The one on the left shows Southwest’s load factor issues, but again, nuance rules the day. Yes, Southwest’s load factor has dropped overall. It really fell off after a great 2022. Remember the December 2022 meltdown? Yeah, right after that. There’s clearly still some kind of hangover there.
But I pulled my own numbers using T-100 data in Cirium to recreate the chart, and it was a little less than 12 percent, but directionally this is accurate. Southwest had a lot more routes — 151 by my numbers — that didn’t hit 70 percent loads in 2023. But here’s the thing, it’s not like Southwest has been sitting still.
- 27 of those markets were exited
- 89 of those markets saw reduced flights and/or seats in 2024 compared to 2023
- 14 of those markets were less than a year old, so they are developing
All those changes led to a nearly 10 point decrease in Q1 2024 capacity on routes with lower than a 70 percent load factor vs Q1 2023.
On top of those network changes, it’s important to remember that Southwest has not been able to take delivery of any 150-seat Boeing 737-7 MAXs since that airplane has not yet been certified. Instead, it has been taking 175-seat 737-8 MAXs to complement the 175-seat 737-800s. The mix is very different than it used to be with the number of small aircraft dropping from two-thirds of the fleet in 2018 to less than half now.
Southwest Fleet Composition by Year
Data via Southwest Airlines 10-K
With so many more big airplanes, it’s not really a surprise that load factors would be lower. There are parts of the network that don’t need an airplane that big.
It’s this MAX problem, by the way, that has caused such heartburn for Southwest on the cost side as well. It has hired to staff a lot more airplanes than it actually has thanks to Boeing’s delays in manufacturing and delivery. It might sound easy to just lay people off and call it a day, but that would really ignore what makes Southwest… Southwest. Besides, costs aren’t the real issue here, as we discussed on The Air Show this week. This is mainly a revenue issue.
And speaking of revenue issues, the right side of that chart above is the mess that is Hawaiʻi service with low load factors and fares on interisland routes. On the surface, yes, this looks terrible. But it’s really a rounding error for the airline. There are other reasons for keeping that service operating, but it doesn’t really matter. It’s just a tiny corner of the network with some strategic value.
Look, I hate completely defending Southwest here, because I think the airline has hemmed and hawed its way into this position. There is no good excuse for the glacial pace of change at that airline, frankly. But the point is that from the outside it looks a lot simpler than it is to fix this airline the right way.
Again, Elliott wants to bring in an outside CEO to “fix” this, but if Elliott has set these revenue targets based on a simplistic view of how the airline could fix its revenue problem, then that CEO will already be hamstrung by those lofty expectations. Elliott may claim it will rely on a new CEO to propose the fix, but it is already putting that person in a box.
Learn more about this on this week’s The Air Show podcast.
