Frontier deal could create risks for Southwest

NEW YORK Fri Jul 31, 2009 6:47pm EDT

A Southwest Airlines plane takes off at Midway Airport in Chicago, Illinois July 24, 2008. Southwest Airlines Co's bid for bankrupt Frontier Airlines could reignite growth at the airline, but questions remain about how smoothly the famously no-frills company can integrate the two carriers. REUTERS/Jeff Haynes

A Southwest Airlines plane takes off at Midway Airport in Chicago, Illinois July 24, 2008. Southwest Airlines Co's bid for bankrupt Frontier Airlines could reignite growth at the airline, but questions remain about how smoothly the famously no-frills company can integrate the two carriers.

Credit: Reuters/Jeff Haynes

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NEW YORK (Reuters) - Southwest Airlines Co's (LUV.N) bid for bankrupt Frontier Airlines FRNTQ.PK could reignite growth at the airline, but questions remain about how smoothly the famously no-frills company can integrate the two carriers.

A successful bid would boost Southwest's presence in Denver, where Frontier is based, and allow it to explore some international routes. Frontier flies to five cities in Mexico and one in Costa Rica.

Buying Frontier would give Southwest new firepower to challenge UAL Corp's United Airlines UAUA.O in Denver, home to the tenth-busiest airport in the world by passenger traffic, according to Airports Council International.

Still, experts said an acquisition would be fraught with complications. Chief among them is how Southwest would blend the two fleets, labor forces and network operations.

"You have different unions, different types of aircraft. It's not going to be simple," said Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund, which owns Southwest shares. "That the biggest single risk in my mind -- will they be able to execute the plan?"

Southwest said on Thursday it was vying to buy Frontier Airlines Holdings Inc for $113.6 million, besting an earlier bid from Republic Airways Holdings Inc (RJET.O). Southwest executives said their company would, for a time, operate both fleets.

Frontier currently flies 51 aircraft, including 38 Airbus A319s, 10 A318s and three A320s. Since Southwest only uses Boeing 737s, Frontier's fleet could possibly disrupt Southwest's gate and ground operations.

"The reason (Southwest) is so efficient is all the gates are set up for the same exact type of aircraft," said Craig Hutson, senior bond analyst at Gimme Credit.

"You start to bring in different types of equipment, it potentially creates inefficiencies because you don't have the experience dealing with that aircraft."

Southwest said it was preparing to submit a binding bid by August 10. Should Southwest enter a bidding war with Republic, most analysts expect it to win. With Frontier, Southwest's control of the Denver market would jump to 30 percent.

GOOD TIME TO MAKE A MOVE

Airlines have been pressed by plunging demand and lower fares for more than a year. During an earnings call last week, Southwest Chief Executive Gary Kelly warned he could not forecast a third-quarter profit.

Even so, experts say now is the right time for Dallas-based Southwest to expand. They add that few other legacy U.S. airlines have the financial strength to go after Frontier.

"Quite frankly, at the moment assets are relatively cheap," said John Thomas, a consultant with L.E.K. Consulting. "They're probably picking up an asset for a lot less now than, say, in three or four years' time."

Southwest has a history of plucking choice assets from its weaker rivals. It took over bankrupt ATA Airlines' slots at New York's LaGuardia Airport last year.

The Frontier approach "fits into Southwest's strategy of taking advantage of opportunities and leveraging their strengths to grow while others are weaker," said S&P analyst Jim Corridore.

He added the value of Frontier's slots in Denver far exceeds the purchase price.

It also indicates that Kelly, who took the top job in 2004, is more willing to take risks to expand the company. Under founder Herb Kelleher, the company's approach was more tempered.

"He's not throwing out the Kelleher Bible," Wordell said, of Kelly. "But by buying another airline out of bankruptcy that doesn't fly the 737, it is a testament to he's going to do what it takes to grow the airline."

(Reporting by Deepa Seetharaman; editing by Andre Grenon)

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