Key To An Airline Merger example essay topic

This paper evaluates the key financial challenges facing organizations in Risk Management, Managing International Acquisitions, and Managing Working Capital simulations. Secondly, an evaluation of Southwest Airlines (SWA) management of working capital and the optimal financial strategies employed is presented. Also evaluated are the potential improvements in financial performance along with long-term and short-term strategies. Lastly, considered in this paper is whether a merger or acquisition would affect SWA's employed strategic outlook. The financial challenges facing the company in the working capital management simulation showed how companies are able to play a balancing act with incoming and outgoing cash flow floats. Companies can juggle cash flows by withholding payments to retain capital or negotiate with companies that withhold payments to receive an incoming cash flow.

Either way, keeping as much cash to fund operations with out heavy financial leveraging was the greatest challenge. Another juggling act was to keep management and business partners happy. The decisions made were not always positive for everyone. The financial challenge facing the company in the managing international acquisitions simulation was to decide which bank presented the best choice for acquisition. Some criteria was finding the bank with the best fit, determining the financial stability of the country, and business valuation. The choice was not solely based on financial criteria such as assets, liabilities, and financial position but included other criteria such as the customer base, competitive position, number of branches, and product portfolio.

The use of discounted cash flows was then employed to arrive at a final bid price. The financial challenge in the managing risk simulation was to balance between preserving capital and capital appreciation in the investment of funds based on a persons' risk tolerance. The simulation targeted the stock mix for a client's aversion to risk and the ability of the investment portfolio to have an expected rate of return. The prediction of fund future prices acted as a hedge and had an impact on the rate of return depending on the changing financial landscape of a company. The overall effect was to juggle the mix based on past history and predict a future outcome. Working capital management is a critical function of the daily operations of SWA.

The ability to manage the day-to-day cash of the company which includes balancing things like collections, bad debt, disbursements, future revenues, borrowing, and loan repayments. Officially created in June 1971, Southwest Airlines (SWA) has become the nation's largest airlines in terms of domestic customers. Year-end for 2003 marked the 31st consecutive year of profitability based off previous financial income statements. SWA has been able to accomplish this by providing short flights, low fares, and city-to-city frequent flights. The chart provided below from Mergent Online provides details for the key financial ratios that are important to SWA's financial health.

When examining these key financial ratios it is very important to compare them against the industry average along with industry leaders. This will assist in determining the financial well being of SWA. One key trend observable when looking at these financial ratios will be the decline in performance because of the September 11, 2001 terrorist attacks. The working capital simulation had similar challenges to SWA in that both had to deal with the ability to manage both incoming and outgoing cash floats. The September 11, 2001 terrorist attack created a lot of financial problem areas for SWA. These included an overall decline in air travel demand, increased security costs, and aggressive airline industry discounted fairs.

Provided below is the airline industry comparison for 2003 relating to operating and net profit margin ratios from Mergent Online. Operating Margin Net Profit Margin Avr: (0.47) Avr: 12.66 Alaska Air Group, Inc. -0.54 1.73 America West Holding Corp. 1.46 2.56 AMR Corp. (DE) -4.84 -7.96 Expressjet Holdings Inc. (U.S.) 13.88 18.45 Federal Express Corp. 5.29 null FedEx Corp 5.83 7.28 Southwest Airlines Co 8.14 16.41 Trans World Airlines, Inc. -10.51 -10.65 UAL Corp -9.91 -20.46 US Airways Group, Inc. -13.49 106.58 SWA is second in the industry to Expressjet Holdings Inc. in both operating margin and net profit margin. The common denominator in both of these calculations is revenue.

2003 revenue reported at over 5.9 billion dollars made a big impact on both of these ratios. SWA's ratio of 8.14 for operating margin and 16.41 is well above the airline industry averages of -0.47 and 12.66, respectively. The trend for these ratios is again on the increase after the September 11 terrorist attacks. The greatest strength of the company is its ability to create a profit utilizing the short flights, low fares, and city-to-city frequent flights. The short-term financial strategies of SWA are to capitalize on these strengths. This will create increased cash inflows that will help with short-term goals of quarterly profitability.

SWA has been profitable for 31 consecutive years and must execute on short-term goals to remain profitable. The financial ratio for ROA and working capital divided by total assets are key to the long-term success for SWA. The table below from Mergent Online displays the 2003 airline industry comparison for liquidity indicators. ROA Working Capital / Total Assets Avr: 0.30 Avr: 0.01 Alaska Air Group, Inc. 0.35 0.04 America West Holding Corp. 3.53 0.08 AMR Corp. (DE) -4.19 -0.06 Expressjet Holdings Inc. (U.S.) 21.27 0.03 Federal Express Corp. 4.45 0.04 FedEx Corp 4.38 0.01 Southwest Airlines Co 4.47 0.06 Trans World Airlines, Inc.

-16.5 null UAL Corp -12.78 -0.09 US Airways Group, Inc. -2.03 -0.06 Return on assets (ROA) is a great indicator on how profitable a company is relative to its total assets. ROA also declined in 2001/2002, although has shown an increase in 2003 to 4.47%. With over 9 billion in total assets, SWA must efficiently utilize these assets with a focus on capacity planning. Purchasing too many planes with not enough capacity will cause planes to sit idle, thereby reducing revenues. SWA shows strength in ROA because its ratio is second to the highest at 4.47%, as related to other industry companies.

SWA is also far above the industry average of. 30. Another advantage for SWA on ROA is in reference to a note on SWA's homepage that they have reported 236 millions pounds of cargo and mail delivered in 2003. This fact shows that they are utilizing their assets beyond just delivering passengers. It uses measures such as time on the ground to improve its asset management.

Working capital divided by total assets is another liquidity indicator. SWA is second behind America West Holding Corp. at. 06. This value is still above the industry 2003 average of. 01. In 2001, SWA was able to turn this ratio into a positive and has been successful the last three years with an upward trend.

These positive ratios allow banks, investors, and businesses to see that SWA has the ability to sell assets in order to generate cash to pay bills. Mergers and acquisitions have become commonplace in today's global economy. Some of the reasons mergers and acquisitions have become so popular are that they allow companies to create cost synergies, consolidate resources, create economies of scale, and eliminate inefficiencies. The airline industry is in a state of flux and has seen a high percentage of mergers and acquisitions in the last five to six years. The events of September 11, 2001 sent the airline industry into a downward spiral. This caused a great number of airline companies to file bankruptcy, and / or look for mergers in order to stay competitive.

However, the airline industry was in trouble before September 11, and many major airline companies were looking for mergers prior to September 11. In February of 2001, American Airlines announced a deal to acquire TWA Airlines. At that same time, a merger deal was reported between United Airlines and US Airways. It was also rumored that Delta and Continental were working on a merger in February of 2001 (web). There were concerns that these mergers would hurt the industry and the consumers. On March 13, 2001 congress held a hearing to discuss new legislation that would reduce the adverse impacts of these airline mergers.

"The impact will be felt from one end of the industry to the other. It will make further consolidation not just predictable, but necessary for survival" (Hauenstein, 2001). Many felt that smaller airlines would be forced to merge in order to compete with these large conglomerates. "An inescapable lesson of 22 years of deregulation is that mergers and a reduction in competition often lead to higher fares for the American traveling public. We cannot stand idly by and allow the benefits of deregulation to be derailed by a wave of mergers" (Sen. Harry Reid, web). There are some who argue that airline mergers will not hurt consumers.

"Additional airlines can enter and leave this particular segment of the transportation market with minimal cost. The reason is that the relevant capital equipment - the airlines themselves - are highly mobile" (EconEdLink, 2005). Essentially, if one route is unprofitable, an airline can simply pull out and move its planes to a more profitable route. This idea of costless entry will force current airlines to provide transportation services efficiently and at normal market prices. US airlines are not the only ones considering or going ahead with mergers and acquisitions.

Recently, Air France and KLM announced a merger. In 2002, China reorganized its nine major airlines in to three groups. "The Beijing government sees the mergers as a way of tackling international competition and also reducing the large number of airlines within the country" (web). One of the major factors fueling the talk of mergers and bankruptcy today is the rising cost of crude oil.

"Jet fuel prices tend to move in line with crude oil prices and have jumped 46% so far this year" (web). Hedging has protected some of the airline companies in the short term. Qantas, a major airline company, is protected from rising oil costs because it hedged about 70% of its fuel needs at an average of $32 a barrel through June of 2005 (web). That is far below the average cost of around $50 a barrel today. However, SWA hedged 80% of its fuel cost for 2004 at just under $24 a barrel and 80% of its fuel costs for 2005 at just under $25 a barrel. SWA generated $63 million of hedging gains in just the first quarter of 2004.

They reported first quarter earnings of $26 million. So, without hedging, SWA would have had a first quarter loss of $37 million (swa 2004 annual report). The big question for SWA is whether or not it should look at mergers and acquisitions when contemplating the best way to grow its business. In addition to the legal issues that have already been discussed, SWA would need to explore the entire process of trying to fuse one airline with another. This process includes but is not limited to synergies, cost savings, moral issues, and employee issues. The graph below illustrates some of what would be involved if SWA was to merge with another airline.

"The fundamental issue in selecting a partner is not, Who's available now? , but rather, What airline can help me build sustainable competitive advantage?" (Hansson, Neilson, & Belin, 2002). The key to an airline merger, as with any merger, is finding two companies that are worth more together than they are independently. "Carriers that operate complementary national, regional, or global networks with some overlap are ideal. From a sales and marketing perspective, it helps if your prospective partner has a similar brand positioning" (Hansson, Neilson, and Belin, 2002).

Another major factor in a SWA merger would be employee unions. "Merging one airline with another is often a painstaking process that brings with it a lot of animosity and distrust among employees of both airlines. Both sides will wrestle over the arrangement of benefits, salaries, and positions as fusion of the two airlines takes place" (web). Most airlines have contracts in place with their employee unions. At least one if not both of those union agreements would need to be renegotiated in an airline merger. Mileage plus and employee alliance programs would also become a major issue that would need resolution in any merger.

Most airlines have agreements with partners that allow valued members to accumulate and use miles on any of the airlines in the agreement. SWA does not currently have any alliances with other airlines. So, any merger involving SWA would be extremely difficult in regards to negotiating alliance partners. SWA has carved out a unique market niche for itself. It mainly competes for low-fare, direct-flight customers.

This has proven to be an excellent strategy for the airline. This is displayed in its current financial position relative to the financial problems many of the major carriers are experiencing. It would be extremely difficult for SWA to find an airline with a similar corporate strategy and business model that would be necessary for a merger to be a success. In today's global marketplace change is the norm. Executives continually need to monitor the business environment in which their company operates.

However, at the current time it is not suggested that SWA look to merge with another airline. The company is outperforming the industry at this time and would be better served looking for ways to grow its business and market share internally. The executives at SWA should keep the option open for future discussions should its position or the market as a whole experience dramatic change. In conclusion, the paper has discussed the important financial challenges presented in the working capital simulation and followed that with how Southwest Airlines has been able to survive in a tough market through maintaining its working capital strength.

We also explored how deregulation has inspired changes in the airline industry. The 9/11 attacks presented problems to many airlines which brought on several airline mergers and bankruptcies. SWA's unique approach and business model in the airline industry may prevent it from being a good fit in any merger or acquisition, yet the airline has positioned itself for a long-term flight into the future.

Bibliography

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Senators consider impact of airline mergers. CNN. com, Retrieved January 14, 2005, from web (2005).
Airline mergers, software industry: Conte markets. EconEdLink, Retrieved January 14, 2005, from web T.
Neilson, G., & Belin, S. (2002).
Airline merger integration. Booz Allen and Hamilton, Inc., Retrieved January 14, 2005, from web G.
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