Southwest’s Technology Is 30 Years Out Of Date… Invest Here To Profit
Southwest Airlines (NYSE: LUV) has always flown against the crowd with pick your own seats and free checked bags. The company was even forward thinking enough to buy oil futures when oil prices were still in the $50s back before the 2008 financial crisis and the subsequent spike of oil prices above $100 a barrel.
#-ad_banner-#But there is one key area where the airline isn’t as progressive as its competitors: technology.
“For most of its 45 years, Southwest Airlines Co. has operated with a kludgy hodgepodge of technology systems, mainly built in-house. It was generally a cheaper approach that better fit the needs of its network, radically different from those of hub-and-spoke airlines.”
Kludgy… That’s one way of putting it. Falling behind its competition is another.
Because there’s a line between cost efficiencies and being cheap enough that you sacrifice other efficiencies.
And Southwest crossed that line quite a bit ago, according to the company’s CEO Gary Kelly. Apparently, the company hasn’t updated its reservation system in 30 years… an unheard-of amount of time for a technology.
One has to ask if they’re still using dot-matrix printers, too.
The main reason for this update is the need for more flexibility. Its current passenger service and scheduling system means a fixed schedule and clunky interfacing with international flight options, among other issues.
The upgrade has a price tag of $250 million, but the company is expected to double its investment by increasing annual profits by $500 million by 2020. That’s not an insignificant boost. Its roughly 10% of quarterly revenues that are climbing at a rate in the low single digits year over year.
This isn’t beginning of a cultural overhaul, though. Customers should still expect open seating and free baggage check — two fairly big revenue generators for other airlines.
So what kind of impact will this move really have on LUV share prices?
I expect it to be a slow burning boost to revenue and cost efficiencies… but that won’t translate to a huge windfall for investors.
That’s why investors should take a look at the company Southwest has tapped to build its new passenger service system.
That company is Amadeus IT Holdings SA (OTC: AMADY, Madrid: MCE).
Headquartered in Madrid, Spain, AMS provides transaction processing solutions to the global travel and tourism industries. The company brought in €3.91 billion in 2015, a 14.5% jump over 2014. In fact, AMS revenue has grown at a CAGR of 8.6% between 2010 and 2015.
Analysts expect this year to be another double-digit growth year, with revenue growing to €4.329 billion, then to €4.644 billion and €4.934 billion in 2017 and 2018 respectively.
Southwest will begin to move its operations over to the new passenger service system in the first half of 2017, so that could mean next year will be a substantial year for AMS. Transaction fees have been slowly but steadily increasing over the past decade or so, and that trend is expected to continue.
AMS share prices have been hit by the Brexit vote, just like everyone else, but this could be a great entry point for investors, as shares have tried to move sharply higher since early February 2016.
Ambitious analysts are targeting a share price 29% higher than current prices. A move like that would put shares above €50.60 or $53.87, an all-time high.
Risks To Consider: As with any new adoption of technology, there’s the potential for glitches, particularly since Southwest has to overhaul everything.
AMS seems to be an old hat a these systems, though, and it’s a go-to company in the industry. In other words, the company knows what it’s doing.
It even won a Red Hat award for its innovation in open source technology.
Another risk to consider is that tourism may slow down in the face of global terrorism. The latest horrific bombing in Turkey shows that there is considerable real risk for travelers. This isn’t going away anytime soon.
As AMS makes a lot of its money off of transaction fees, this is nothing to sneeze at.
That said, there are lots of regional travel that’s remained unaffected by these risks, and AMS has its hand in most of these areas.
Action To Take: The $250 million investment might not be more than 10% of Southwest’s quarterly revenues, but it’s well over 10% of AMS’s annual revenues.
Amadeus IT Holdings SA (OTC: AMADY) could climb 29% to fresh all-time highs through 2017 with this deal with Southwest. Investors can also take a look at the pinksheet as an alternative to the Madrid listing. It’s rather lightly traded, though, so proceed with caution.
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