Elliott activist marketing campaign at Southwest Airways puzzles shareholders

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

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

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

Whereas the corporate is affected by margin deterioration and has seen its inventory 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 totally understands Southwest’s insular tradition and the {industry}’s glacial tempo of change.

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

“We aren’t solely certain 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 score.”

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

Regardless of the potential wrinkle launched by Southwest’s newest transfer, historical past provides some clues as to how this may play out. A number of activism specialists pointed to 2 of Elliott’s previous targets for perception into the hedge fund’s technique for Southwest: Suncor Power 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 vitality firms. Whereas Suncor and Marathon resisted Elliott’s proposals, together with management change and enterprise evaluations, Elliott nonetheless received a lot of what it needed.

Elliott’s activist follow has helped it turn out to be probably the most profitable hedge funds on this planet, surpassing $65 billion in belongings. The agency, which moved its headquarters in 2020 from New York to West Palm Seashore, Florida, has solely had two shedding years in 5 a long time. It typically pushes firms to make dramatic adjustments, corresponding to promoting off companies, firing executives or abandoning strategic plans.

In recent times, nonetheless, Elliott has additionally proven it will probably work collaboratively with administration. Representatives have joined the boards of firms together with Pinterest and Etsy. Texas Devices CEO Haviv Ilan mentioned in Might that his firm was open to “constructive dialogue” with Elliott, and Salesforce CEO Marc Benioff mentioned he had “completely loved attending to know” the Elliott staff after the agency dropped plans to appoint administrators on the software program firm in 2023.

Southwest mentioned 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 mentioned it is assured in its technique and its staff and is “targeted on restoring our industry-leading monetary efficiency.” Jordan mentioned 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 individual in Dallas two weeks in the past, in line with folks accustomed to the matter. The discussions stay within the early phases, mentioned the folks, who requested to not be named as a result of the conversations had been personal.

The airline has tapped Financial institution of America and regulation agency Vinson & Elkins to advise it, one other individual accustomed to the scenario mentioned.

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 cautious of Elliott’s calls for, 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 firm quickly struck a take care of Elliott, providing three board seats to the hedge fund and conceding to a strategic assessment — that means a possible sale — of its Petro-Canada gasoline stations.

It was a middle-of-the-road decision. The corporate determined after the assessment to not promote its Petro-Canada enterprise. But it surely additionally introduced in as CEO an outsider, in longtime Exxon Mobil government Wealthy Kruger.

At Southwest, Elliott sees a high job that might be equally interesting to {industry} executives from different airways, in line with an individual accustomed to the agency’s pondering.

Whereas its Suncor effort led to 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 assessment and opted to remain intact, holding its Speedway gasoline stations as a part of the enterprise.

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

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

“Whereas the Firm assured shareholders that it was pursuing a full assessment of the Speedway enterprise, it had a unique agenda solely,” Elliott’s Pike wrote within the 2019 letter.

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

In March 2020, Marathon employed 38-year {industry} veteran Mike Hennigan as CEO. Speedway was offered to 7-Eleven’s father or mother firm 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 high 5 shareholder at each firms.

Elliott is now one of many high traders in Southwest. One main shareholder, Artisan Companions, has expressed its assist for Elliott’s marketing campaign. Southwest’s bylaws permit huge shareholders to name a particular assembly to interchange its board, one thing Elliott might contemplate doing additional down the highway, although the agency hasn’t mentioned if it plans to mount a proxy combat.

Whether or not or not shareholders determine to again Elliott’s push, historical past reveals they’ll profit. Elliott-targeted firms are inclined to outperform the market, in line with a 13D Monitor evaluation. The hedge fund holds on to its positions for 2 years on common, in line with the information. Elliott mentioned its plan can assist Southwest’s share worth leap 77% in 12 months to $49.

The poison tablet Southwest launched this week might complicate issues. It is usually adopted by firms warding off a takeover bid. On this case, it limits Elliott’s potential to amass extra management and likewise means that Southwest’s administration is not concerned about rolling over.

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

Elliott, which has handled poison capsules up to now, hasn’t made clear the place it plans to go together with its marketing campaign. The agency is not at the moment pursuing particular adjustments that might have an effect on issues corresponding to Southwest’s baggage coverage, in line with an individual accustomed to its plans. Southwest is the one home service that permits each passenger to verify two luggage totally free, a serious buyer perk, notably for individuals who fly with relations.

However a refreshed board and enterprise assessment might result in scrutiny of a few of Southwest’s fashionable choices.

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

One other potential hurdle is union affect, which makes it more durable for administration to implement vital adjustments, notably 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 least 11 unions, in line with the airline’s web site.

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

“In quite simple phrases, this has the potential to be probably the most vital 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 1000’s of cancellations and left hundreds of thousands of passengers stranded through the 2022 winter holidays.

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

Based on Elliott, it is all a part of a sample that justifies activist intervention.

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

— CNBC’s Leslie Josephs contributed to this report.