Will Southwest and JetBlue Have a Field Day Courtesy of the DOJ?

According to the settlement reached between merger partners AMR (UNKNOWN: AAMRQ.DL  ) and US Airways (NYSE: LCC  ) and the Department of Justice, the merging airlines will need to sell off slots at Washington's Reagan National Airport and New York's LaGuardia Airport. The DOJ wants these slots to go to "low-cost carriers" to enhance competition at these two key airports.

AMR and US Airways will need to sell off slots at two popular airports as part of their merger. Photo: AMR.

Instead of specifying low-cost carriers, or LCCs, it would have been more straightforward to call out Southwest Airlines (NYSE: LUV  ) and JetBlue Airways (NASDAQ: JBLU  ) directly. Not only are they the top two LCCs in the U.S., they are also by far the most interested in expanding at Reagan and LaGuardia and have the greatest financial resources.

While it's always possible that a "dark horse" will emerge in the bidding, I think Southwest and JetBlue are likely to take all or nearly all of the slots up for grabs. They can make better use of them than any other potential bidder, and have shown a willingness in the past to pay up for key airport assets.

Tallying the low-cost carriers
On paper, at least, the U.S. still has a substantial number of LCCs that could potentially bid for the slots that American and US Airways are giving up. Beyond Southwest and JetBlue, privately held Virgin America and Sun Country Airlines fit the LCC designation. Even Alaska Air (NYSE: ALK  ) -- which is technically a legacy carrier -- markets itself as a "low-fare" carrier.

Additionally, there is a growing group of airlines that brand themselves as "ultra-low-cost carriers." This includes Spirit Airlines (NASDAQ: SAVE  ) , Allegiant Travel (NASDAQ: ALGT  ) , and Frontier Airlines.

Spirit Airlines is a rapidly growing "ultra-low-cost carrier." Photo: Spirit Airlines.

However, none of these other carriers is likely to make a competitive bid for slots at Reagan or LaGuardia. Part of that is due to geography and to cost considerations.

West Coast flights not welcome
Two of the carriers listed above -- Alaska Air and Virgin America -- are entirely based on the West Coast. Alaska operates hubs in Seattle, Portland, Anchorage, and Los Angeles, while Virgin America operates hubs in San Francisco and Los Angeles. However, LaGuardia and Reagan Airports both have "perimeter rules" that severely limit long-haul flights.

At LaGuardia Airport, airlines are not allowed to fly to destinations more than 1,500 miles away, except on Saturdays (with the exception of Denver). That rules out flights to any of the Alaska or Virgin America hubs. At Reagan Airport, the limit is 1,250 miles. Certain airlines have received exemptions covering a total of 20 round-trip flights beyond the normal 1,250-mile limit. However, the government does not seem likely to grant permission for more flights outside the perimeter at this time.

Virgin America's hubs are outside the LaGuardia and Reagan flight perimeters. Photo: Virgin America.

In other words, Alaska and Virgin America would be unable to fly to their major bases if they won slots at either airport. Unsurprisingly, Alaska has not expressed interest in any of the slots. While Virgin America is "studying" the matter, it is also unlikely to make a competitive bid. The company is in the midst of a growth pause, and it would be foolish to try to build a new market that would be isolated from Virgin America's hubs.

A costly proposition
Whereas Alaska and Virgin America are likely to be driven away by geography, the other LCCs -- save Southwest and JetBlue -- will be deterred by cost. The last time slots became available at LaGuardia and Reagan (in late 2011), JetBlue paid $40 million for eight slot pairs at Reagan and $32 million for eight slot pairs at LaGuardia.

JetBlue paid $72 million for slots at Reagan and LaGuardia Airports in late 2011. Photo: JetBlue.

Based on those relatively recent "market" prices, the slots becoming available now could be worth $200 million-$300 million in total. The slots are expected to be sold in bundles of six to 10 slot pairs, but those bundles will still cost tens of millions of dollars each. That probably takes Sun Country and Frontier out of the running: As smaller and less profitable carriers, they cannot afford to invest that much money in slots.

By contrast, Allegiant and Spirit both have the financial resources to buy slots at either airport, but doing so would run against the "ultra-low-cost" ethos. Both companies are single-mindedly focused on reducing costs in order to offer the lowest ticket prices while still earning big profits.

Investing tens of millions of dollars in slots does not seem to fit the ultra-low-cost carrier "profile." They are more likely to serve alternate airports where operating costs are lower. That's because ultra-low-cost carriers cater to leisure travelers who are very price-sensitive, as opposed to business travelers who will pay extra for the convenience of using a close-in airport.

Thus, while Allegiant is poised to enter the New York market, it is flying to far-out suburban airports rather than fighting for slots at the major New York area airports. Meanwhile, Spirit previously had two slot pairs at Reagan Airport, but it sold them to Southwest last year. Spirit then moved its D.C. area operations to Baltimore-Washington International Airport, where it has lower costs and ample room to grow.

Foolish bottom line
While there are theoretically a lot of LCCs in the U.S., only Southwest and JetBlue have a clear interest in paying top dollar for slots at Reagan Airport and LaGuardia Airport. Alaska and Virgin America do not have much use for slots that cannot be used for West Coast flights, while the ultra-low-cost carriers are more concerned with price than convenience.

In fact, of all the LCCs out there, the only one other than Southwest and JetBlue that might have a serious interest in slots is not even a U.S. carrier! Canadian LCC WestJet was the other winner of LaGuardia slots during the last auction, along with JetBlue. WestJet might want to buy a slot bundle at Reagan Airport (where it has no presence today) to serve its Toronto hub. Other than that, the battle for divested slots will largely be a two-way contest.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 16, 2013, at 9:50 AM, John95035 wrote:

    Low cost carriers? They are all low cost carriers now. Look at the prices for economy class.

  • Report this Comment On November 17, 2013, at 10:33 AM, BT3 wrote:

    Virgin America already flies to Reagan from SFO

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