United's Biggest Hub Faces Attack by Southwest

HOUSTON ( TheStreet) -- Southwest ( LUV), while part of the U.S. airline industry, has always been an irritant to the legacy hub carriers that dominate it.

In the 1990s, Southwest attacked hub carriers with lower costs, enabling it to undercut their fares. By the 2000s, Southwest's labor cost advantage was diminishing, but it could undercut competitors' fares due to lower fuel costs, a result of its prescient fuel hedging strategy. Now, nearly all carriers hedge fuel.

In Houston, Southwest is at it again, riling the hub carrier with its emerging effort to fly internationally, and seeking to employ its historic model of utilizing a smaller airport that exists in the shadow of a big hub airport, in this case Bush Intercontinental.

But in Houston, Southwest has encountered unprecedented resistance. Not only is hub carrier United Continental Holdings ( UAL)fighting back, but also, after decades of having municipalities beg for its service, Southwest is hearing something quite different.

"Council rips study painting Hobby expansion as boon," was the headline in Tuesday's Houston Chronicle. The newspaper covered a Monday meeting at which the city council challenged a consultant's study extolling the benefits to Houston if Hobby Airport expands so that Southwest can fly to Mexican and Caribbean destinations.

The study contends that expansion could lead to 10,000 new jobs and add $1.6 billion to the economy. Southwest wants city permission to build five gates and a $100 million customs facility at Hobby, using passenger fee revenue.

Council members blasted the study, calling it "biased" and "custom-made just to satisfy the demand of Southwest," according to the Chronicle. Members grilled Houston's airport director, a backer of the study, for three hours.

"United had, perhaps, its finest day in the war over Houston's skies as council members expressed skepticism and sometimes hostility toward (the) study," the newspaper wrote.

Asked if Southwest took a hit at the meeting, spokesman Paul Flanagan responded: "It wasn't Southwest who took the hit, but the Houston Airport system." Southwest and United will both present their cases to the council on May 8, he noted.

"Houston is a market that is underserved and overpriced," Flanagan said. "We feel strongly that if given the opportunity to grow our operation in Houston, we would lower fares and stimulate international air travel across the board."

Bob McAdoo, airline analyst for Los Angeles-based Imperial Capital, said it is unlikely that Southwest's projected international operation in Houston would have a major impact on United, but it is understandable that United would be opposed.

"In terms of impacting United shares, it won't," McAdoo said. "It's such a small piece of the pie, strung out over many years because it will take Southwest a long while to build service. From a shareholder point of view, it's so far down the road that I'm not worried about it yet."

Still, he said, "If I open up a store across the street from a Starbucks ( SBUX), you never see it in the Starbucks numbers, but Starbucks would still prefer I wasn't there."

The airport's study projects that Southwest would initially serve five international cities from Hobby: three in Mexico and the capitals of Costa Rica and San Salvador. Longer term, the destinations would include six cities in Mexico, three in Central America, Bogota and Caracas. Currently, Southwest Hobby service includes 134 daily departures to 34 domestic cities.

McAdoo said questions remain about Southwest's intent because the airline has been evolving since it ran out of new U.S. destinations big enough to materially impact its earnings. Most Mexico-Houston markets seem small for Southwest's normal operational mode of providing frequent service on 737 jets.

"You don't know what Southwest is going to look like," McAdoo said. "They are learning to fly internationally. They now have different sizes of airplanes (after merging with AirTran). Maybe, in these markets, they will fly once a day. The point is, you used to know what Southwest was going to do, and I don't think you do anymore. They are trying stuff they've never tried before."

Whatever Southwest plans, it is clear that Houston faces a tough choice. Of course, new service is typically desirable for a city, and new service from Southwest can bring lower fares. But at the same time, a major airline hub airport is perhaps the most attractive asset a city can provide in terms of stimulating commerce.

US Airways ( LCC)President Scott Kirby has said that United's Houston hub is the third most profitable major airline operation in the U.S., in terms of profit margin. That means it is a place where the hub carrier will continually be willing to commit resources.

Giving Southwest international operations would spread the profit around. United, which currently offers 620 daily departures at Bush, its biggest hub, has said that if Hobby expands, it would reduce Bush capacity by 10%, halt plans to add new routes, cut 1,300 jobs and likely halt plans for a $700 million terminal improvement.

Possibly, United is bluffing. But it is worth noting that the airport's study cites as a desirable model the relationship between Miami International Airport, a big international hub, and Fort Lauderdale-Hollywood International Airport, a mid-sized airport with plentiful domestic service and some low-cost international service. In Miami, hub carrier American ( AMMRQ.PK)has 291 daily departures to 107 destinations, and only 46 of them are domestic.

In the case of Miami, competition from Fort Lauderdale means fewer passengers and fewer domestic flights.

-- Written by Ted Reed in Charlotte

>To contact the writer of this article, click here: Ted Reed

>To follow the writer on Twitter, go to http://twitter.com/tedreednc.

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