In one of its smartest moves to revive stalled growth, Southwest Airlines Co. (LUV) the largest U.S. low-cost airline, agreed to buy AirTran Holdings Inc. (AAI) for $1.4 billion. The acquisition is expected to close in the first half of next year and will be fully operational by 2012.
The total transaction value is approximately $3.4 billion, including AirTran’s debt and capitalized aircraft-operating leases. AirTran shareholders will receive $3.75 in cash and 0.321 Southwest share for each share of AirTran, whereas Southwest will pay about $670 million in cash and will assume $2 billion in AirTran debt.
The merger enables Southwest to expand its presence in several markets including Atlanta, Washington D.C., Boston, Baltimore and New York City and gain access to more traffic, revenue and passengers.
The merger may result in increase in fares, elimination of jobs and might pose major challenges to carriers, especially American Airlines, a wholly-owned subsidiary of AMR Corporation (AMR) and US Airways Group Inc. (LCC).
According to the Wall Street Journal, Southwest will have cost synergies of more than $400 million by 2013. Southwest expects the acquisition to be accretive to earnings after three years, with one-time acquisition-related costs of $300 million to $500 million.
As per the agreement, all the airplanes will adopt the Southwest logo and the Southwest policy on fees. A combined Southwest-AirTran will boast a fleet of 682 Boeings. After the merger, Southwest will pose a greater threat to its competitors Delta Airlines Inc. (DAL) and US Airways.
Previously, Southwest failed in its attempt to buy Frontier Airlines, which was in bankruptcy. The airline was eventually bought by Republic Airways Holdings Inc. (RJET) for almost $108.8 million.
With the strongest balance sheet in the industry, competitive strength, low costs, various revenue initiatives and network optimization, we believe the company sustained even in a difficult operating environment and will continue to do so in the near future. However, Southwest Airlines is investing heavily in technology to code share with other airlines and to fly to international markets.
Ticket prices are the major concern as the company has been discounting heavily to stimulate demand. In addition, the lack of international and business travel exposure will likely keep revenue growth in the near term under pressure.
We maintain our long-term Neutral recommendation on Southwest Airlines. It is currently a short-term Zacks #3 Rank (Hold) stock.
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