Investment firm Elliott Management has taken a $1.9 billion stake in Southwest Airlines and is calling for the removal of CEO Bob Jordan and chairman Gary Kelly, who was Jordan's predecessor.
Bob Jordan
"After 18 months of intensive research, we are convinced that Southwest represents the most compelling airline turnaround opportunity in the last two decades," Elliott partner John Pike and portfolio manager Bobby Xu wrote in a Monday letter addressed to the Southwest board. "The significant investment we have made reflects our conviction that with the right leadership, Southwest can regain its status as an industry-leading airline."
Elliott said its stake in Southwest amounts to 11% of the company, making it one of the largest investors. According to the Wall Street Journal, Elliott has a reputation for forcing major changes at the companies in which it takes a position, including management changes. NRG Energy, Goodyear and communications infrastructure firm Crown Castle are among the companies that have replaced CEOs after Elliott became involved.
In the letter and in an investment presentation, Elliott portrayed Southwest as a longtime airline industry innovator and overperformer that is now foundering under a deeply entrenched management team that has failed to evolve.
As other airlines have made significant changes to their commercial models in recent years, Southwest hasn't strayed from its unique approach of offering free bags while not offering paid seat assignments, basic economy or premium cabins, Elliott noted.
In the meantime, Southwest has seen its earnings margin drop from best among the largest four U.S. airlines in 2018 to the lowest, trailing Delta, United and American. The carrier has also lagged its three largest rivals in terms of unit revenue growth, defined as revenue per available seat mile flown (RASM). And its stock is hovering at around 50% of its pre-pandemic price.
In its Monday presentation, Elliott emphasized that Kelly and Jordan have been at Southwest a combined 74 years, while four of the airline's six other senior leaders have been at Southwest at least 20 years. Among the eight senior leaders, only COO Andrew Watterson has experience at another airline.
In addition, the board has no members with outside airline experience, Elliott said.
The investment firm's play on Southwest comes as the airline's leadership has recognized that significant changes are necessary. During an April earnings call, Jordan hinted that changes could be coming to the carrier's unique seating model, in which seats aren't assigned, as well to its cabins, which are configured with just one class and do not have extra-legroom seats.
Southwest does earn revenue by charging premiums for early boarding positions, but its commercial model nevertheless limits its ancillary revenue potential. The airline just increased prices for its early-boarding products.
In a statement Monday, Southwest said that it was first contacted by Elliott on Sunday and that it looks forward to better understanding Elliott's views.
"The Southwest Board of Directors is confident in our CEO and management's ability to execute against the company's strategic plan to drive long-term value for all shareholders, safely and reliably serve our customers and deliver on our commitments to all of our stakeholders," the airline said.
Elliott has sketched out a four-part plan that it argues can drive Southwest shares to $49 over the next year. Shares were trading at around $30 just past noon on Monday, up approximately 9% on the day.
The plan would involve the immediate removal of Jordan; the appointment of more board members who are independent of current leadership and who have outside airline experience; the hiring of a new CEO along with the implementation of a plan to replace Kelly as board chairman; and the undertaking of a comprehensive business review geared toward determining what steps Southwest must take to modernize its commercial and operational models in order to restore industry-leading profitability.