With his $3.5-billion takeover offer for Calgary-based WestJet Airlines Ltd., Onex Corp. founder Gerald Schwartz of Toronto is buying a gem.
All that’s required to make this deal a success is to cancel WestJet’s dubious expansion strategy.
Long one of the world’s few consistently best-run major airlines, WestJet has evolved in recent years into a complex, unwieldy enterprise.
The expansion strategy isn’t working. WestJet’s profits have dropped in each of the last three years, and in 2018 they were down 75 per cent from their 2015 peak. The airline’s stock lost an alarming 44 per cent of its value during that time. No established discounter has succeeded at what WestJet is attempting to do — transforming itself into a full-service global airline.
WestJet was, of course, modeled on discounter Southwest Airlines Co. of Dallas. Forty-one years after its launch, Southwest remains a strictly domestic U.S. airline, whose financial performance has improved while WestJet’s has weakened.
WestJet is early in its transformation process — the massive capital expenditures required have been planned but not yet made. Which means a course correction needn’t be drastic.
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And while Onex is paying a 67 per cent premium to the value of WestJet stock prior to the takeover, it’s paying a 9 per cent discount to WestJet’s peak stock price only four years ago.
Restoring WestJet to that peak value requires mostly that WestJetters re-embrace the airline’s original business model.
Here’s what needs to happen at WestJet for Schwartz to succeed with this investment:
Restore low costs
WestJet has been spending too much money to “buy” each new revenue dollar.
WestJet revenues are up just 20.5 per cent over the past five years.
During that time, the airline’s fuel consumption has increased by 25 per cent, its workforce by 34 per cent, its aircraft fleet by 45 per cent, and its number of destinations served, directly and through alliances with other carriers, by 60 per cent.
Growth in operating expenses has thus outpaced revenue growth 31.4 per cent to 20.5 per cent. Result: A plunge in WestJet’s operating profit margin, to last year’s abysmal 3.3 per cent from the 2015 peak of 14.1 per cent. Meanwhile, Air Canada’s 2018 operating profit margin was 6.5 per cent.
Air Canada is outperforming WestJet despite being a more diversified and complicated business, and set to become more so with its intention, also announced this week, to buy tour operator Transat A.T. Inc. for roughly $520 million.
Rein in planned capital expenditures
WestJet has visions of becoming a high-cost, high-fare international carrier serving major world centres, initially in Europe and later on other continents.
The costs of building such a network are astronomical, in aircraft purchases and leases, landing fees, gateway rentals, marketing campaigns and so on. On long-haul aircraft alone, WestJet has committed to buying as many as 20 Boeing 787 Dreamliners, at a staggering cost of as much as $6.5 billion (U.S.).
And the WestJet brand, not associated with premium-priced travel, would be competing with an Air Canada that is entrenched in that market, as well as the likes of Virgin Atlantic and Emirates.
Worse still, scaling that mountain would distract WestJet from attending to its core domestic market. WestJet has already suffered a defection of domestic travelers to Air Canada and other carriers. It has alienated travelers with inattention to needed changes in its domestic route network, confusing alterations to its fare structure and rewards programs, and bungled new-product launches.
Those aren’t capital crimes, nor are they unique to WestJet. But they’ve come at a time when Air Canada has been raising its game. And they have demoralized WestJetters – both employees and customers – unaccustomed to incompetence from WestJet.
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The argument against proceeding with the potential folly of globalizing WestJet is compelling.
Better to apply a more modest capital expenditure budget (capex) to recapturing domestic customers lost to other carriers.
WestJet could boost annual revenues by 20 per cent, to $5.6 billion, just by taking a five per cent bite out of Air Canada’s business.
Streamline the aircraft fleet
WestJet now uses four aircraft types. Recall that WestJet flew just one aircraft type, the Boeing 737, for most of its history.
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On page 16 of its latest annual report, Southwest explains why it has stuck with the 737 exclusively. “Southwest’s use of a single aircraft type allows for simplified scheduling, maintenance, flight operations and training activities.”
Boeing 787 Dreamliners, with a sticker price of $282 million (U.S.) per beast, are tough to justify for a WestJet that remains for now a domestic carrier, and whose global ambitions need a serious rethink.
Restore harmonious labour relations
WestJet executives still help out with baggage handling and cleaning aircraft cabins, to their credit. But there is otherwise a dialogue of the deaf between management and front-line workers, an especially crushing blow to long-term WestJetters who remember a WestJet that was a genuine family workplace.
Those portions of the WestJet workforce that have not already unionized in 2017 and 2018 threaten to do so, as extra unpaid work is loaded onto employees, and commonality of interest among employees is ruptured as WestJet has balkanized into several discrete businesses.
Both WestJet and Southwest suffered lost revenues in 2018 from threatened work stoppages, as customers cancelled bookings for fear of being stranded by a strike. Less high-profile damage is inflicted by a disgruntled workforce no longer providing the friendly “passenger experience” that was a WestJet hallmark.
Clarify the WestJet brand
For WestJetters and their customers, WestJet long had a razor-sharp brand identity. It was a passenger-friendly discounter.
Now it isn’t clear what the WestJet brand means.
Today, WestJet operates its core discount airline, two regional carriers (WestJet Link and Encore), an ultra-low-cost carrier, or ULCC (Swoop), and a charter business. WestJet now offers business-class products, has grandiose plans as an inter-continental carrier, and has confusing multi-tier rewards programs.
A second new strategy for WestJet would commit it to proving the world’s best air-travel experience in its core domestic business. And to leverage that new strength in a more robust charter business serving Western Hemisphere and European sunspots.
For now, senior WestJet management is in denial that today’s WestJet resembles the impersonal Air Canada to which WestJet was created as an alternative. That has to change for Onex to succeed with its investment.
WestJet also believes it has Onex’s buy-in to its flawed expansion strategy. In a television interview this week, WestJet CEO Ed Sims expressed his delight with Onex, “a like-minded partner who sees the value that we have always seen in the strategic direction we are taking.”
That’s difficult to credit, unless Schwartz has been wearing sunglasses while studying WestJet’s income statements.
My Star colleague Jennifer Wells has hinted at a new WestJet that takes on some of the attributes of the late, beloved Wardair Canada Ltd., in its heyday the Four Seasons of the skies.
That’s an excellent starting point in rethinking a current WestJet expansion strategy in place long enough to prove that it isn’t working and isn’t likely to. Having the advantage of competing with an unfocussed rival in Air Canada, WestJet has not chosen wisely in emulating AC.
Then again, with its new domestic-market “premium economy” products, WestJet is experimenting with a semi-Wardair passenger experience.
Schwartz might heap praise on that initiative as the way to proceed. He might also suggest an alternative to the airline’s current slogan, “Love where you’re going.”
Actually, we love Calgary and Quebec City no matter who flies us there.
How about this: “Love who you’re flying.”