Elliott Sends Letter and Presentation to the Board of Southwest Airlines

Rhea-AI Summary

Elliott Investment Management has disclosed a $1.9 billion position in Southwest Airlines (NYSE: LUV) and sent a letter to its board urging leadership upgrades and a comprehensive business review. Elliott believes that poor execution and outdated strategies have led to Southwest's disappointing performance, including a 50% stock price decline over the past three years. The firm proposes enhancing the board, upgrading leadership, and conducting a thorough business review. Elliott claims these changes could lead to a stock price of $49 per share, a 77% return. Detailed proposals and the full letter are available at StrongerSouthwest.com.

Positive

• Elliott's $1.9 billion investment represents an 11% economic interest in Southwest Airlines.
• Elliott believes Southwest's stock can achieve $49 per share within 12 months, representing a 77% return.
• The Stronger Southwest plan includes enhancing the board with independent directors, upgrading leadership, and undertaking a comprehensive business review.
• Elliott is confident that the issues are addressable with the right leadership and strategy adjustments.

Negative

• Southwest's stock price has declined by more than 50% over the past three years.
• Southwest's 2024 EBITDAR is projected to be nearly 50% lower than 2018 levels.
• CEO Bob Jordan has overseen seven negative guidance revisions in the last 17 months.
• The December 2022 operational meltdown stranded over two million travelers and highlighted outdated technology and poor execution.
• No senior executives were terminated for their role in the 2022 operational meltdown.
• The board has reinforced an insular culture and outdated thinking, with no directors having external airline experience.

Insights

Financial Analyst

Elliott Investment Management's public letter to the Board of Southwest Airlines brings to light several critical financial and operational issues affecting the company. The disclosure of a $1.9 billion investment, representing an approximately 11% economic interest, underscores the significance of Elliott's stake and their interest in turning around Southwest's fortunes.

From a financial perspective, Elliott's claim that Southwest's share price has declined by more than 50% over the past three years is significant. This decline surpasses the general market performance and is particularly concerning given that peer airlines have reported strong profitability. The mention of seven negative guidance revisions in the last 17 months further highlights ongoing financial struggles. These revisions often suggest underlying issues with management's forecasting accuracy and can erode investor confidence over time.

Elliott's recommendation for a comprehensive business review, aimed at updating operational processes and technology, is notable. Such an initiative, if executed effectively, can potentially unlock value by addressing inefficiencies and improving margins. However, the execution risk is substantial and the market may remain skeptical until clear results emerge.

For retail investors, the suggested potential stock price of $49 per share, implying a 77% return, should be viewed cautiously. While the upside is attractive, the success of Elliott's plan hinges on significant management and strategic changes, which may face resistance and take time to materialize.

Rating: 1

Corporate Governance Expert

The letter from Elliott Investment Management makes a compelling case for enhanced corporate governance at Southwest Airlines. Elliott's critique of the current Board for lacking external airline experience and for its insularity is a serious concern. The claim that most of the senior management team has spent over 25 years at the company, with very limited experience from other airlines, suggests a potential lack of fresh perspectives and innovative strategies.

The recommendation to reconstitute the Board with independent directors possessing expertise in airlines, customer experience and technology could be a pivotal move. Boards that are diverse in experience and perspective tend to be more effective in challenging management and steering strategic direction. Furthermore, the call for new leadership from outside the company aims to break the cycle of entrenched thinking and introduce a more dynamic and competitive edge to Southwest's operations.

The absence of accountability, particularly highlighted by the response to the December 2022 operational meltdown, points to a governance failure. The doubling of executive compensation post-crisis without any senior terminations or tangible improvements could be viewed as a disregard for shareholder interests and employee morale. Such actions undermine trust and highlight the need for a governance overhaul.

For investors, these governance issues are critical. Effective governance can lead to better decision-making, improved risk management and ultimately, enhanced shareholder value. However, changes in corporate governance structures can be slow and met with resistance from incumbent boards and management.

Rating: 1

Aviation Industry Analyst

This situation at Southwest Airlines presents a fascinating case study in how corporate strategy and operational execution can impact an airline's competitive edge. Southwest's historical success was built on a low-cost carrier model that revolutionized the industry. However, as Elliott points out, the airline's inflexibility and reliance on outdated strategies and technologies have become a liability.

The December 2022 operational meltdown, attributed to outdated technology, is a clear example of how failing to modernize can have disastrous consequences. In the highly competitive airline industry, operational efficiency and reliability are key differentiators. Southwest's inability to keep pace with technological advancements not only affects its operational performance but also customer satisfaction and brand reputation.

Elliott's suggestion to update Southwest's IT systems and enhance customer choice reflects a necessary shift towards a more customer-centric approach. Modernizing these areas could significantly improve operational efficiency and customer retention. However, the airline industry is capital-intensive and such overhauls require significant investment, which could impact short-term financial performance.

The focus on bringing in new leadership and conducting a comprehensive business review indicates a strategic pivot. For investors, this could signal a potential turnaround, provided these changes are effectively implemented. The proposed $49 per share target price considers these strategic improvements but should be approached with cautious optimism considering the complexities involved in overhauling long-standing operational models.

Rating: 1

Discloses Approximately $1.9 Billion Position

Calls for Upgraded Leadership and Comprehensive Business Review

Believes Southwest Stock Can Achieve $49 per Share, a 77% Return

Full Letter and Presentation Available at StrongerSouthwest.com

WEST PALM BEACH, Fla., June 10, 2024 /PRNewswire/ -- Elliott Investment Management L.P. ("Elliott"), which manages funds that together have an investment of approximately $1.9 billion in Southwest Airlines Co. (NYSE: LUV) (the "Company" or "Southwest"), today sent a letter to the Board of Directors of Southwest.

The letter substantiates Elliott's view that Southwest's poor execution and leadership's stubborn unwillingness to evolve the Company's strategy have led to deeply disappointing results for shareholders, employees and customers alike. 

Southwest's rigid commitment to a decades-old approach has inhibited its ability to compete in the modern airline industry, Elliott said, and this ethos pervades the entire business with outdated software, a dated monetization strategy and antiquated operational processes. Elliott's letter asserts that the Company's failure to modernize is underscored by Southwest's December 2022 operational meltdown, which stranded more than two million travelers over the holidays.

Elliott noted that Southwest's share price has declined by more than 50% over the past three years and is now below the levels at which it traded in March 2020 during the depths of the COVID pandemic. The letter also highlighted that disappointing financial performance has cost each frontline employee tens of thousands of dollars on average in the form of lower profit sharing and declines in the value of employee-owned stock.

As a result of this poor performance, Elliott believes that new leadership is required at Southwest, which represents the most compelling airline turnaround opportunity in the last two decades, according to the letter.

As part of its "Stronger Southwest" plan, Elliott outlined three recommendations to improve the Company's performance:

1) Enhance the Board
2) Upgrade Leadership
3) Undertake a Comprehensive Business Review

By executing on the Stronger Southwest plan, Elliott believes the Company can return to its rightful position as an industry leader, including generating best-in-class margins and compelling returns for its shareholders. In doing so, Elliott argues that Southwest's stock can achieve $49 per share within 12 months, representing a highly attractive 77% return during the period.

Elliott is convinced that Southwest's issues are addressable with the right leadership and a comprehensive, unbiased evaluation of available opportunities, and looks forward to collaborating with the Company to restore accountability and best-in-class financial performance for the benefit of Southwest shareholders, employees and customers.

The full text of the letter follows:

June 10, 2024 

The Board of Directors
Southwest Airlines Co.
2702 Love Field Drive
Dallas, Texas 75235

Dear Members of the Board:

We are writing to you on behalf of funds managed by Elliott Investment Management L.P. (together with such funds, "Elliott" or "we"). Elliott has made an investment of approximately $1.9 billion in Southwest Airlines ("Southwest" or the "Company"), representing an approximately 11% economic interest and making us one of the largest investors in the Company.

Southwest is a legendary airline with a proud history. Since starting service in 1971, Southwest revolutionized the airline industry with an innovative business model built on operational excellence and a commitment to providing customers with a low-cost alternative to the legacy airlines. This winning strategy generated decades of success and allowed Southwest to become the premier U.S. domestic airline, with 47 consecutive years of profitability in a highly competitive and challenging industry. Along the way, Southwest became a beloved brand among customers and a motivating career opportunity for its employees.

Today, however, poor execution and leadership's stubborn unwillingness to evolve the Company's strategy have led to deeply disappointing results for shareholders, employees and customers alike. Southwest's share price has declined by more than 50% in the past three years and has now fallen below the levels at which it traded in March 2020, during the depths of the COVID-related travel shutdowns. And while the U.S. airline industry is seeing record revenues and peer airlines are enjoying very strong profitability, Southwest's 2024 EBITDAR is expected to be nearly 50% lower than 2018 levels. In addition to negative returns for shareholders, this disappointing financial performance has cost each frontline employee tens of thousands of dollars on average in the form of reduced employee profit-sharing and declines in the value of Southwest stock held by employee retirement plans.

After 18 months of intensive research, we are convinced that Southwest represents the most compelling airline turnaround opportunity in the last two decades. The significant investment we have made reflects our conviction that, with the right leadership, Southwest can regain its status as an industry-leading airline. In this letter and the appended presentation, we lay out our perspectives on how Southwest can reclaim its status and achieve the success that Southwest's shareholders, employees and customers deserve.

Southwest Today

Southwest's rigid commitment to an approach developed decades ago has inhibited its ability to compete in the modern airline industry; this ethos pervades the entire business with outdated software, a dated monetization strategy and antiquated operational processes. This failure to modernize is vividly underscored by the December 2022 operational meltdown that was caused by the Company's outdated technology, which led to Southwest stranding over two million customers over the holidays.

Southwest's Executive Chairman and its CEO, who have spent a combined 74 years at the Company, have presided over a period of severe underperformance, and they have demonstrated that they are not up to the task of modernizing Southwest. Since his appointment, Southwest CEO Bob Jordan has delivered unacceptable financial and operational performance quarter after quarter, resulting in seven negative guidance revisions in the last 17 months. Operational metrics are pointing in the wrong direction: Southwest's unit costs – a core priority for a low-cost carrier – have ballooned, while unit revenues have lagged peers. Even as the Company's performance has deteriorated, Jordan has demonstrated a surprising level of complacency, describing each quarter as "great" or "strong" while the earnings outlook continues to fall. Despite the management team's assertions that it is "absolutely committed" to bringing per-unit costs under control, management guided costs meaningfully higher for 2024 and revised cost guidance upward again in April.

Southwest's Board has failed to hold management accountable for poor execution and has been unable to catalyze (or permit) the necessary strategic evolution. Instead, the Board has reinforced an insular culture and outdated thinking in the face of indisputable evidence that change is required. The Board includes no directors with external airline experience, and a majority of the independent directors were recruited by Executive Chairman Gary Kelly. This Board has in turn selected a management team that, of the eight most senior executives, includes only one executive with experience at another airline; the rest have worked at Southwest for an average of over 25 years. The mandate from the Board has been clear: Keep doing things the way they have always been done.

The lack of accountability is best reflected in the Company's response to the December 2022 operational meltdown. In a clear display of poor leadership, CEO Bob Jordan declined to testify in front of Congress after the meltdown, despite attending a company rally just 40 miles away in Baltimore the prior day. No senior executives were terminated for their role in the meltdown. Most concerning, and in blatant disregard for the affected customers and employees, the Board nearly doubled the compensation of all key executives in the year after the incident.

We believe that new leadership is required at Southwest. While Southwest has a proud history, that history is not an argument for supporting poor leadership and sticking with a strategy that no longer succeeds in the modern airline industry. Rather, Southwest's legacy necessitates evolution and change to regain industry leadership for its customers, employees and shareholders. As one of Southwest's largest investors, we are committed to delivering the necessary leadership changes to achieve this goal.

A Stronger Southwest

In the accompanying presentation, "Stronger Southwest," we outline our views on the challenges the Company faces today and our recommendations to drive improved performance, which we summarize below:

(1)  Enhance the Board of Directors: The Board should be reconstituted with new, truly independent directors from outside of Southwest who have best-in-class expertise in airlines, customer experience and technology.

(2)  Upgrade Leadership: Southwest must bring in new leadership from outside of the Company to improve operational execution and lead the evolution of Southwest's strategy.

(3)  Undertake a Comprehensive Business Review: Southwest should form a new management and Board-level committee to evaluate all available opportunities to rapidly restore the Company's performance to best-in-class standards. This review would modernize Southwest's strategy and operations with a focus on increased customer choice, improved cost execution and updating outdated IT systems, among other opportunities, and it should leverage the fresh perspectives of the new directors to help formulate the optimal go-forward plan for Southwest.

By executing on the Stronger Southwest plan, we believe the Company can return to its rightful position as an industry leader, including generating best-in-class margins and compelling returns for its shareholders. We believe Southwest's stock can achieve $49 per share within 12 months, representing a highly attractive 77% return during the period. For the Company's frontline employees who have a meaningful economic stake in Southwest's success, we believe the plan would result in substantial incremental long-term value from additional profit-sharing payouts and appreciation of employee-owned stock.

The Stronger Southwest plan puts the Company on a path to more sustainable performance that will better serve customers, employees and shareholders. The plan modernizes Southwest's approach to ensure that its offering is aligned with customer preferences. It upgrades leadership to improve execution. It drives the efficiency required to continue offering low fares. And it facilitates the necessary investments to run the reliable operation that customers and employees expect.

Next Steps               

Southwest became a leading airline by innovating and executing. Today, Southwest's failure to execute and evolve has led to deteriorating performance, and the Company simply is not living up to its legacy of efficiency and top-tier results. Nevertheless, we are convinced the issues the Company currently faces are addressable with the right leadership and a comprehensive, unbiased evaluation of the available opportunities.

We look forward to collaborating with Southwest to restore accountability and best-in-class financial performance for the benefit of the Company's employees, customers and shareholders. To that end, we will make ourselves available for a meeting with you at your earliest convenience to discuss these issues in greater detail and to align on the changes that Southwest needs in order to deliver on its significant potential.

Sincerely,

John Pike                                                                   
Partner                                                            

Bobby Xu
Portfolio Manager

About Elliott

Elliott Investment Management L.P. (together with its affiliates, "Elliott") manages approximately $65.5 billion of assets as of December 31, 2023. Founded in 1977, it is one of the oldest funds under continuous management. The Elliott funds' investors include pension plans, sovereign wealth funds, endowments, foundations, funds-of-funds, high net worth individuals and families, and employees of the firm. 

Media Contact:         

Casey Friedman                                             
Elliott Investment Management L.P.                                     
(212) 478-1780                                              
cFriedman@elliottmgmt.com 

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SOURCE Elliott Investment Management L.P.

FAQ

What is Elliott Investment Management proposing for Southwest Airlines (LUV)?

Elliott is proposing to enhance the board, upgrade leadership, and undertake a comprehensive business review to improve Southwest's performance.

Why does Elliott believe Southwest Airlines (LUV) needs new leadership?

Elliott believes poor execution and outdated strategies have led to disappointing performance, including a 50% decline in stock price over the past three years.

What financial performance issues has Southwest Airlines (LUV) faced?

Southwest's stock price has declined by more than 50% in the past three years and its 2024 EBITDAR is expected to be nearly 50% lower than 2018 levels.

What impact did the December 2022 operational meltdown have on Southwest Airlines (LUV)?

The operational meltdown stranded over two million travelers and highlighted outdated technology and poor execution at Southwest.

What return does Elliott believe is possible for Southwest Airlines (LUV) stock?

Elliott believes Southwest's stock can achieve $49 per share within 12 months, representing a 77% return.