Southwest Airlines' stock surges after activist Elliott says it can soar 77%

By Tomi Kilgore

Elliott discloses a large stake, says its plan for new management and strategy could lift the stock to $49 in 12 months

Shares of Southwest Airlines Co. surged Monday toward their best day in nearly fours years, after activist investor Elliott Investment Management L.P. disclosed a large stake in the underperforming airline.

In a letter to Southwest's board of directors, Elliott made suggestions that could boost the stock by 77% within a year, including an "upgrade" of leadership and a comprehensive review of the business strategy.

The stock (LUV) climbed 9% in midday trading, to put it on track for the biggest one-day gain since it shot up 9.7% on Nov. 9, 2020. It has run up 18.5% since it closed at a six-month low of $25.51 on May 29, highlighted by a six-week winning streak to start the rally.

But the stock was still down 10.5% since the company cut its revenue outlook in mid-March due to weak demand.

"We maintain an open dialogue with out shareholders and value their perspectives related to enhancing shareholder value," Southwest said in an emailed statement to MarketWatch.

Elliott said Monday that it has invested about $1.9 billion in Southwest, which represents about nearly 11% of the air carrier's current market capitalization of $17.67 billion, and is enough to make Elliott one of the largest shareholders. The announcement confirmed a report by The Wall Street Journal's of Elliott's large stake.

Elliott noted that Southwest's stock had lost more than half its value over the past three years, and was trading below levels seen in March 2020 when COVID-19 was declared a pandemic. The March 2020 closing low as $30.86.

"Southwest's rigid commitment to a decades-old approach has inhibited its ability to compete in the modern airline industry," Elliott said.

Management's "stubborn unwillingness" to modernize has left the airline with "outdated software, a dated monetization strategy and antiquated operations processes," Elliott said, underscored by the operational meltdown in December 2022.

If Southwest listens to its proposals, the stock can rally to $49 a share within 12 months, which would represent a gain of about 77% from Friday's closing price of $27.75.

In Elliott's letter to Southwest's board of directors, Partner John Pike and Portfolio Manager Bobby Xu urged Southwest to reconstitute the board with "new, truly independent" directors from outside Southwest.

Elliott also pushed for an "upgrade of leadership," also with people from outside the company, to lead the evolution of Southwest's strategy.

And third, Elliott said Southwest should form a committee to evaluate all available opportunities to improve performance, including updating information technology systems, improving cost execution, modernizing strategy to focus on increased customer choice.

Southwest responded by saying it was first contacted by Elliott on Sunday, and was looking forward to better understanding their views on the company.

"The Southwest board of directors is confident in our CEO and management's ability to execute against the company's strategic plan to drive long-term value for all shareholders, safely and reliably serve our customers and deliver on our commitments to all of our stakeholders," Southwest said.

Elliott acquired its stake in Southwest sometime over the past 2 1/2 months, as the investor's 13F form filed last month detailing its equity investments as of March 31 did not include any Southwest shares.

Before the Southwest-stake announcement, Elliott's largest equity investment by market value, according to FactSet data, was Suncor Energy Inc. (SU) (CA:SU) at $1.94 billion - about 4% of the energy company's market cap. Next was the $1.93 billion worth of Elliott-owned Triple Flag Precious Metals Corp. shares (TFPM) (CA:TFPM), worth about 63.5% of the precious metals company's market cap.

Melius Research analyst Conor Cunningham said it's "not all that surprising" to see an activist investor take interest in Southwest. He believes Elliott could see an opportunity to push for a more concrete view that the airline won't grow until the return on invested capital (ROIC) exceeds the weighted average cost of capital (WACC).

"[T]o us, a slower growing/more efficient Southwest would benefit Southwest, but it likely benefits the industry as well," Cunningham wrote in a note to clients.

He reiterated the selling rating on the stock and his $22 stock price target, which implies 21% downside from Friday's closing price.

Year to date, Southwest's stock has now gained 4.7%, while the U.S. Global Jets ETF JETS has tacked on 5.6% and the S&P 500 index SPX has advanced 12.2%.

-Tomi Kilgore

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06-10-24 1147ET

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