Elliott activist marketing campaign at Southwest Airways puzzles shareholders

After Elliott Administration revealed a $1.9 billion stake in Southwest Airlines in June, an preliminary rally within the inventory shortly fizzled. Relatively than sparking typical cheer on Wall Avenue, Elliott’s campaign, spelled out in a 50-page presentation, led to confusion and concern amongst buyers and clients.

The hedge fund has taken activist stakes in additional than 140 firms over the previous three a long time, in keeping with knowledge from 13D Monitor, however, like most activist buyers, it has by no means focused an airline.

Southwest, a Dallas-based firm that began flying in 1971, has a unique culture that is survived profitably for many years in a bruising {industry}.

Whereas the corporate is affected by margin deterioration and has seen its stock drop in every of the previous 4 years, Elliott’s demand that Southwest hearth CEO Bob Jordan and oust Chairman Gary Kelly has raised questions on whether or not the activist absolutely understands Southwest’s insular tradition and the {industry}’s glacial pace of change.

Elliott hasn’t publicly specified modifications it desires inside Southwest’s choices, calling as a substitute for a enterprise evaluation.

“We’re not completely positive what Elliott has in thoughts,” analysts at Melius Analysis wrote in a report on June 10, the day the agency launched its marketing campaign. “Till we all know extra, we’re sticking with our Promote ranking.”

Southwest has taken steps to defend itself. On Wednesday, the airline adopted a so-called poison pill that might activate if any shareholder acquired an curiosity of greater than 12.5%, limiting Elliott’s capacity to achieve extra management. Elliott says it at present has an curiosity of about 11% of the corporate.

Regardless of the potential wrinkle launched by Southwest’s newest transfer, historical past presents some clues as to how this may play out. A number of activism consultants pointed to 2 of Elliott’s previous targets for perception into the hedge fund’s technique for Southwest: Suncor Energy in 2022 and Marathon Petroleum in 2019.

Elliott companion John Pike, who’s now main the Southwest marketing campaign, was concerned within the agency’s actions at each power firms. Whereas Suncor and Marathon resisted Elliott’s proposals, together with management change and enterprise evaluations, Elliott nonetheless obtained a lot of what it wished.

Elliott’s activist follow has helped it turn into one of the profitable hedge funds on the earth, surpassing $65 billion in property. The agency, which moved its headquarters in 2020 from New York to West Palm Seaside, Florida, has solely had two shedding years in 5 a long time. It usually pushes firms to make dramatic modifications, corresponding to promoting off companies, firing executives or abandoning strategic plans.

Lately, nevertheless, Elliott has additionally proven it may work collaboratively with administration. Representatives have joined the boards of firms together with Pinterest and Etsy. Texas Instruments CEO Haviv Ilan stated in Might that his firm was open to “constructive dialogue” with Elliott, and Salesforce CEO Marc Benioff stated he had “thoroughly enjoyed getting to know” the Elliott crew after the agency dropped plans to appoint administrators on the software program firm in 2023.

Southwest stated in a short response to Elliott’s presentation that it is “thoughtfully reviewing” the June 10 letter from the hedge fund and appears ahead to “additional conversations with Elliott.” Southwest additionally stated it is assured in its technique and its crew and is “centered on restoring our industry-leading monetary efficiency.” Jordan stated he has no plans to resign.

Pike and portfolio supervisor Bobby Xu are main Elliott’s Southwest marketing campaign. Elliott and Southwest representatives met in particular person in Dallas two weeks in the past, in keeping with folks acquainted with the matter. The discussions stay within the early levels, stated the folks, who requested to not be named as a result of the conversations had been non-public.

The airline has tapped Bank of America and legislation agency Vinson & Elkins to advise it, one other particular person acquainted with the scenario stated.

Southwest shares are down barely since Elliott introduced its involvement, regardless of a 7% leap on the day of the disclosure. They fell 5.7% on Friday to shut at $26.94.

Southwest didn’t present a remark for this story.

Buyers had been initially wary of Elliott’s demands, which included promoting off Suncor’s Petro-Canada gasoline stations.

Little pushed again initially, however his boardroom assist evaporated when one other employee was killed weeks after Elliott introduced its stake. Little resigned, and the Canadian company soon struck a deal with Elliott, providing three board seats to the hedge fund and conceding to a strategic evaluation — which means a possible sale — of its Petro-Canada gasoline stations.

It was a middle-of-the-road decision. The corporate determined after the evaluation not to sell its Petro-Canada business. But it surely additionally introduced in as CEO an outsider, in longtime Exxon Mobil govt Rich Kruger.

At Southwest, Elliott sees a prime job that might be equally interesting to {industry} executives from different airways, in keeping with an individual acquainted with the agency’s considering.

Whereas its Suncor effort resulted in a comparatively fast victory, Elliott’s expertise with Marathon highlighted the agency’s willingness to be affected person.

Elliott first amassed a stake within the oil producer in 2016 and requested Marathon to “consider” breaking apart the corporate. Like Suncor, Marathon ran a evaluation and opted to remain intact, preserving its Speedway gasoline stations as a part of the enterprise.

However in 2018, a number of months after reaching an settlement with Elliott, Marathon introduced it was solely getting greater. The corporate agreed to purchase rival Andeavor in a $23 billion deal.

Elliott responded to what it considered as a damaged promise by reviving its activist marketing campaign in 2019, selecting up a brand new 2.5% place and proclaiming that it might make certain the “proper management” was in place. 

“Whereas the Firm assured shareholders that it was pursuing a full evaluation of the Speedway enterprise, it had a special agenda completely,” Elliott’s Pike wrote in the 2019 letter.

Weeks later, Marathon’s board said CEO Gary Heminger would retire and that the corporate would lastly spin off Speedway. Elliott reportedly insisted the board discover an outsider to exchange Heminger.

In March 2020, Marathon employed 38-year {industry} veteran Mike Hennigan as CEO. Speedway was sold to 7-Eleven’s parent company for $21 billion in 2020, months after Hennigan took the publish, and the corporate later introduced a $7.1 billion buyback program.

Years after its victories at Marathon and Suncor, Elliott stays a prime 5 shareholder at each firms.

Elliott is now one of many prime buyers in Southwest. One main shareholder, Artisan Partners, has expressed its assist for Elliott’s marketing campaign. Southwest’s bylaws permit huge shareholders to name a particular assembly to exchange its board, one thing Elliott may think about doing additional down the highway, although the agency hasn’t stated if it plans to mount a proxy struggle.

Whether or not or not shareholders determine to again Elliott’s push, historical past exhibits they may profit. Elliott-targeted firms are likely to outperform the market, in keeping with a 13D Monitor evaluation. The hedge fund holds on to its positions for 2 years on common, in keeping with the information. Elliott stated its plan will help Southwest’s share worth leap 77% in 12 months to $49.

The poison capsule Southwest launched this week may complicate issues. It is usually adopted by firms warding off a takeover bid. On this case, it limits Elliott’s capacity to amass extra management and in addition means that Southwest’s administration is not considering rolling over.

Within the press release saying the plan, Kelly stated the airline “stays open to any concepts for lasting worth creation” however stated adopting the poison capsule was a part of the board’s “fiduciary duties to all shareholders.” The measure would permit all shareholders, “aside from the particular person or group triggering” the plan, to purchase inventory at a 50% low cost to the market worth if any particular person or group acquired 12.5% or extra of the corporate’s excellent inventory.

Elliott, which has handled poison drugs up to now, hasn’t made clear the place it plans to go together with its marketing campaign. The agency is not at present pursuing particular modifications that might have an effect on issues corresponding to Southwest’s baggage coverage, in keeping with an individual acquainted with its plans. Southwest is the one home provider that enables each passenger to examine two luggage free of charge, a serious buyer perk, significantly for individuals who fly with members of the family.

However a refreshed board and enterprise evaluation may result in scrutiny of a few of Southwest’s well-liked choices.

There are some key differentiating components for Southwest compared with Suncor and Marathon. For one, Southwest hasn’t made a notable acquisition since 2011 and does not have any adjoining companies to spin out.

One other potential hurdle is union affect, which makes it more durable for administration to implement important modifications, significantly once they contain layoffs and different price cuts. Greater than 80% of Southwest’s staff belong to a union, and there are separate organizations for pilots, flight attendants and mechanics. In all, staff are represented by at the very least 11 unions, in keeping with the airline’s website.

Management from the 11,000-member Southwest Airlines Pilots Association met with the Elliott crew in Dallas in June. The group performed an “in-depth evaluation” on Elliott’s “actionable plans and timelines,” labor leaders stated in a message obtained by CNBC.

“In quite simple phrases, this has the potential to be one of the important occasions in Southwest Airways’ historical past,” SWAPA leaders wrote of the activist marketing campaign.

Southwest has beforehand acknowledged a few of the issues Elliott highlighted, together with system failures that led to hundreds of cancellations and left hundreds of thousands of passengers stranded in the course of the 2022 winter holidays.

However monetary challenges persist. Final week, Southwest minimize its second-quarter revenue forecast. The corporate cited “complexities in adapting” its enterprise to “present reserving patterns on this dynamic surroundings.”

In response to Elliott, it is all a part of a sample that justifies activist intervention.

“Southwest is led by a crew that has confirmed unable to adapt to the fashionable airline {industry},” Pike and Xu stated in a statement. “That is yet one more instance that elementary management change is urgently wanted at Southwest.”

— CNBC’s Leslie Josephs contributed to this report.