Southwest's Artful Approach

There are some things Southwest Airlines just doesn't want to do -- and now it's found someone else to do them.

A partnership with ATA Airlines, forged in a 2004 deal to acquire gates at Chicago's Midway Airport, is providing Southwest with options it never had before.

Through a code-share agreement, Southwest can put its passengers on ATA flights to congested airports like New York's LaGuardia, Dallas-Fort Worth International and Washington's Reagan National, on over-water flights to Hawaii and, potentially, on international flights, as well.

Privately held ATA gets something too -- passengers. Already, about 25% of all ATA bookings result from the Southwest relationship. "We have Southwest feeding us," says Joseph Loew, a senior vice president at ATA.

The deal is good business for both airlines. Southwest says its code-share revenue, derived from tickets that involve connections between the two airlines, was $50 million in 2005. Each carrier gets the revenue for flights on its aircraft. When passengers use the Southwest site to book ATA-only flights, ATA pays Southwest a fee for that service. Code-shares allow airlines to sell tickets on one another's flights.

ATA does things that can't be easily integrated into the Southwest model of quick turnaround times, high utilization of a Boeing 737 fleet and domestic-only flying, Loew says. "They have a very good business model, and they have been successful because they stick to it," he says.

Midway is the focus of the two airlines' partnership. Southwest has more than 200 daily departures from that airport, and spokesman Ed Stewart says the number could grow to about 300. That's more than Southwest has at any other airport.

ATA offers 17 weekday departures, including six daily to LaGuardia, five to Dallas and four to National. The arrangement "gives Southwest the ability to poke some people in the eye without being at these airports, which is vitally important as they try to preserve their quick turns and productivity," says aviation consultant Robert Mann.

ATA also flies to Hawaii from five West Coast cities, all of them also served by Southwest. Last month, ATA moved its Bay Area operations from San Francisco, where Southwest doesn't fly, to Oakland, where Southwest has 150 daily departures. ATA serves Hilo, Honolulu and Maui from Oakland.

ATA is better positioned than Southwest to serve Hawaii because it has bigger airplanes and over-water certification, which Southwest lacks. Its Boeing 757s seat 250 passengers, while its 737-800s seat 160. Southwest's 737 models seat a maximum of 137. Starting in September, Southwest passengers will be able to redeem frequent flier miles for Hawaii trips.

The third part of the arrangement is the international element. Midway serves Cancun and Guadalajara from Midway, and Southwest is readying its reservations system to accommodate international pricing and transactions by 2009. "Once that is done, an agreement will be in place to code-share on our international flights," Loew says.

ATA is contemplating an expansion that includes 20% annual fleet growth over the next few years and the selection of new international routes. "It's hard to say where it will go, but we have Southwest as a powerful distribution channel, and our expansion is going to be focused on taking advantage of that relationship," Loew says. Stewart adds that Southwest could also choose to fly international routes on its own.

ATA filed for bankruptcy court protection in 2004, the victim of a syndrome that included a series of new aircraft arrivals just as the airline economy entered a nosedive. Once exclusively a charter carrier, ATA had grown into the country's 10th-largest carrier, with a route system based at its Midway hub.

The airline's most valuable asset, its Midway gates, was sought by AirTran Airways (AAI:NYSE), America West Airlines and Southwest. Southwest out-muscled its rivals, buying six gates for $30 million and providing ATA with a $47 million loan, in that rare sort of deal that so far has exceeded the expectations of both parties.

"If there was ever a win-win, this is it," Stewart says. "The court was looking for the best deal for ATA, and we wanted to expand at Midway, and this was one of the best ways to do it. We knew that one of the things that would attract ATA was the possibility of a code-share. It's small for us, but for them it was important to have that kind of reach.

"Nothing precludes us from going to these airports in the future, but there are so many other opportunities, and we have a limited number of aircraft," Stewart adds.

Aviation consultant Darryl Jenkins said the deal resembles Southwest's successful fuel-hedging strategy in that it shows the carrier's ability to seize opportunities and run with them. "These guys think things out," Jenkins says. Additionally, the deal allows Southwest "to take risks, but not with their own brand."

ATA, in effect, "serves as Southwest's proxy" in places that Southwest finds attractive, but not from an operating profile, Mann says. The deal also "got ATA out of a morass and gave them a revenue boost from the portions of their business that they were able to save."

Indianapolis-based ATA, which spent 16 months in bankruptcy before emerging in March, has a fleet of 29 airplanes, down from 64 before its bankruptcy, and had 2005 revenue of about $1 billion. CEO John Denison, a former Southwest executive, recently told The Indianapolis Star that ATA could go public within two years, assuming that its business stabilizes. The principal shareholder is New York investment firm Matlin Patterson.

The successful partnership between Northwest Airlines (NWACQ:OTC BB) and KLM, part of Air France (AKH:NYSE ADR), provides a model for ATA and Southwest, says Loew, who spent seven years at Northwest.

The Northwest and KLM alliance "was set up with a mindset that 'it doesn't matter which side I sit on, I will be happy with the agreement,'" Loew says. "So when I worked with KLM, we both tried to make things work. This is the only basis for long-term growth. Anything else is an illusion."



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