Southwest: If You Can't Beat 'Em, Buy 'Em

DENVER ( TheStreet) -- Southwest's ( LUV) bid to buy out bankrupt Frontier ( FRNT) in Denver may be viewed as a sign of its failure in the market.

By nearly every measure, Southwest has underperformed in Denver. Among the big three Denver airlines, which also include hub carrier United ( UAUA), Southwest has been last in load factor, last in average fares and last in available seat mile, in every month, without exception, since it re-entered the market in 2006 after a 20-year absence.

"Southwest is losing money in Denver," says Denver-based aviation consultant Mike Boyd. "Last summer, they put out more red than Sherwin Williams.

"When Southwest came to Denver, Frontier stood and fought," Boyd says. "Frontier is a hometown team, they have a better product and people in Denver are enamored with them. They gave Southwest a bloody nose and a lot of heartburn." But Frontier also sought bankruptcy protection in April 2008.

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Southwest last week submitted a bid worth at least $113.6 million for Frontier, besting a $108.8 million bid by Republic Airways ( RJET). Although Southwest could not outperform Frontier, "this is a tactical move to take out a competitor," Boyd says.

The court's deadline for a binding proposal is Aug. 10, followed by an auction within a week. "It is unlikely that anyone can outbid Southwest, with its strong liquidity and balance sheet," said FTN Equity Capital analyst Mike Derchin, in a recent report.

Denver is Southwest's seventh biggest station, with 113 daily departures to 34 cities. In market share, United is first with 34%, Frontier is second with 21% and third-place Southwest has 14%.

A recent report by Avondale Partners analyst Bob McAdoo says Southwest has "overscheduled Denver, resulting in weak margins and high breakeven load factors." McAdoo estimates Southwest lost $38 million in Denver in the first quarter of 2009. In over half of its Denver markets, he says, Southwest produced revenue per available seat mile that was lower than its cost per available seat mile - and that was before it paid for fuel.

During the quarter in Denver, McAdoo estimates, Southwest lost $4.1 million on San Francisco service, $3.1 million on Los Angeles service, $2 million to $3 million on service to Chicago, Oakland, Seattle and San Jose, and more than $1 million in each of 10 other markets.

"If you look at the 15 worst markets in the entire Southwest system, six of them are in Denver," McAdoo says. "It goes back to the Southwest strategy of low prices to attract leisure passengers and lots of flights to attract business passengers. They put in lots of flights, but they carry 20 less passengers per aircraft than Frontier does."

Spokeswoman Brandy King says Southwest's Denver performance reflects the poor economy as well as the lag in passengers typically associated with new routes. Denver has had the fastest city growth in Southwest history, from 13 flights in January 2006 to 113 today.

" While we have been able to stimulate leisure demand and boost load factors with promotions and fare sales, our overall unit revenue results have been down dramatically due to the deep, prolonged recession," King says. Also, in newer markets, "there is an expectation that it could take some time before a market is performing in line with our more mature markets," she says, noting that first-quarter Denver load factor was generally in line with the system average.

The Frontier story has been something of a heartbreaker. The hometown favorite will lose out to a bigger, stronger competitor after surviving a four-year battle, fought against a backdrop of record fuel prices followed by a historic recession.

"Frontier was to Southwest is what the Spartans in Thermopylae were to the Persians, a small bunch of people holding off a hoard," Boyd says.

But if Frontier is so great, why is it in bankruptcy? Boyd says First Data, its credit card processor, got spooked by a combination of sharply rising fuel prices, the successive shutdowns of three privately held carriers, flawed Wall Street analysis of Frontier's prospects and damaging media speculation. In response, First Data sought to boost its "holdback" from ticket revenues, forcing a bankruptcy filing as a defense.

While Frontier has been profitable in bankruptcy, the continuing credit crisis has impeded efforts to secure financing that would enable it to emerge.

If Southwest does submit the winning bid for Frontier, Southwest and United are both likely winners. "By removing capacity from the market, Southwest should be able to improve its RASM numbers in Denver," says McAdoo. Meanwhile, for United, "this takes capacity out and gets rid of an unstable fare structure," he says.

-- Written by Ted Reed in Charlotte, N.C..

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