Southwest Makes a Bid for Frontier

In an unexpected bit of news today, Southwest announced that it would make a bid for the assets of Frontier Airlines. Frontier, which is in the midst of exiting Chapter 11, received a bid from Republic Airways several weeks ago. It was not expected by many at the time that Republic would face much competition for Frontier, given that investors are hard to come by in this recession, particularly in the hard-hit airline industry. But Southwest announced that it would bid today, saying that, if it were to buy Frontier, it would initially operate the carrier as a Southwest subsidiary. Eventually, Frontier's Airbus planes would be ditched as Southwest received more 737s that it could integrate into the carrier's old routes. Some Frontier employees would likely be hired on by Southwest, but Southwest made no guarantees today as to how many Frontier employees would keep their jobs if its bid were accepted.

Southwest, has pushed aggressively in Denver, although Frontier has withstood most of the punches Southwest pulled, with United being the big loser in market share. Given that a Southwest purchase of Frontier would make Southwest the leading carrier in Denver, an unthinkable idea just a few years ago, United should be really scared. Southwest continues to run an efficient operation, and would present very tough competition to a weakened United. United is very popular with business customers, which Southwest is aggressively targeting. United's frequent flyer program, premium class service, and extensive route network are about the only things the carrier has to offer, but given the current weakness in the business travel market, those might not be enough to keep customers flying with United. This is especially the case if Southwest continues to lead the industry by offering no change fees, free checked baggage, and added amenities (such as Group A boarding and a free cocktail) to business travelers who book at the last minute.

As a result of this, don't be surprised if United makes a bid for Frontier, and this becomes a three-way bidding war. United has been a leader in Denver for years; it's only recently that the carrier has lost so much market share, and Southwest ownership of Frontier would create a huge headache for United. Unless United is willing to relinquish more market share, the carrier will either need to buy Frontier, or make aggressive changes in its scheduling, amenities, and pricing to compete.

But this deal is not a panacea for Southwest. Frontier has a different fleet of aircraft which it would dump, aircraft which are equipped with extremely popular (and revenue-generating) entertainment systems. Although Southwest is planning for in-flight Wi-Fi, the carrier lacks any electronic in-flight entertainment, and it may be hard to win over some Frontier loyalists who miss that, particularly on longer flights to the East Coast. But the flip side of this is that Southwest is more consumer-friendly when it comes to its baggage policies (Frontier currently charges for checked luggage), policies which would presumably be expanded to Frontier routes if Southwest's bid is accepted.

Another complication is that Frontier also has routes to a number of cities Southwest doesn't serve, and which don't make much sense in Southwest's current model. These cities are mostly distant, lower-frequency routes, some of which (eg. those to Mexico and Costa Rica) require additional turnaround time, hampering an efficient operation. Some of those routes generate very strong yields, but they might be ditched because of their incompatibility to Southwest's historic business model. Then again, given that Southwest has been making some unconventional moves of late, moving into busy airports they formerly shunned, it's certainly possible that Southwest would choose to keep these routes, even if they're to cities which would receive one daily, or a few weekly Southwest flights.

Southwest also has to deal with the issue of Lynx, Frontier's regional subsidiary. Lynx is Frontier's way of competing with United on short, regional routes from Denver, particularly to high-yielding destinations such as Aspen. Southwest has eschewed regional service throughout its history, and such service would of course generate added complications into Southwest's business. Like regional carriers at major airlines, it could also be the source of some labor tensions, since employees at regional carriers typically make less than their mainline counterparts. Southwest, known for being an employee-friendly company, might find it difficult to offer a different salary scale to its regional employees, which could potentially hurt the profitability of such a regional carrier. And unless Southwest were to scale up Lynx's regional operations to other cities, which seems unlikely during this recession, Lynx would be an anomaly in an otherwise efficient and simple airline.

And Republic, the regional jet contractor which allegedly bid for Frontier in an attempt to "diversify" its business model, may feel compelled to raise its bid. After all, it sees a lot of value in Frontier, and it's quite possible that if Southwest or United purchases the carrier, its opportunities to diversify and operate a mainline carrier will be limited. There are simply just few, if any, other small carriers which are available on the market right now, and Republic would have an extremely difficult time starting its own carrier given the checkered history of airline start-ups in this country. But then again, Republic doesn't have as much invested in the outcome of this saga as Southwest or United, they have profitable, albeit dwindling, contracts with major carriers, and they stand to lose relatively little in the short-term if they are unable to purchase Frontier. Therefore, I suspect that at the end of the day, they will not be interested enough in Frontier to win a potential bidding war with Southwest and United. However, they could still put in a revised offer or two, but I imagine that Southwest will follow suit.