First Step Toward LUV-AAI Merger - Analyst Blog

The shareholders of AirTran Holdings Inc. (AAI) approved its pending merger with the largest U.S. low-cost carrier, Southwest Airlines (LUV) for $1.4 billion.

Under the merger agreement, each AirTran common share will be exchanged for $3.75 in cash and 0.321 share of Southwest common stock. The proposed merger is expected to close in the second quarter of this year and is awaiting approval from the U.S. Department of Justice and other regulatory clearances. 

An airline consolidation trend began following the oil price hike in 2008 and economic downturn in 2009. This proposed merger, announced in September 2010, is the third in the last two years. The first was between Delta Air Lines (DAL) and Northwest in 2008. The other was between United Airlinesand Continental Airlines, which resulted in the new entity United Continental Holdings (UAL) in 2010.

We believe the absorption of AirTran operations represents a unique opportunity for Southwest Airlines to expand its presence in key markets. Southwest will gain a valuable market presence in Atlanta, the busiest airport in the U.S.

The transaction would also widen Southwest's network by 25% and provide its first international destinations in the Caribbean and Mexico. Southwest will also expand its presence in key markets such as New York LaGuardia, Boston Logan and Baltimore/Washington through this merger. Further, Southwest's strong balance sheet position will allow it to comfortably fund its cash portion of the deal.

The Southwest-AirTran merger pose major challenges to carriers, especially American Airlines, a wholly owned subsidiary of AMR Corporation (AMR) and US Airways (LCC).

Southwest Airlines is working on a number of initiatives to increase revenue and reduce costs over the next three years. The proposed transaction is expected to generate net synergies of approximately $400 million by 2013. This will also result in one-time charges in the range of $300 million to $500 million.

We are currently maintaining our long-term Neutral recommendation on the stock with the Zacks # 3 Rank (Hold).