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The story behind the Southwest/Muse merger
By Scott Bennett |

FOR MONTHS, Southwest Airlines President Herb Kelleher had heard what seemed to him the death rattle of rival low-cost carrier Muse Air. Indeed, from its inception Muse had been a class idea unable to gain altitude, a never-ending story of poor decisions, bad luck, worse timing and revolving-door management. Now, due to a massive debt to service and rapidly shrinking cash reserves, the death of Muse seemed at hand.

But, as everyone knows, Kelleher didn’t want Muse to die; he wanted it to live on as a Southwest subsidiary. Whatever financial problems Muse had, it also had valuable gate space at several airports important to Southwest; a market share on key routes; a solid crew of dedicated, well-trained employees; a low operating cost and some excellent aircraft. Besides, Kelleher knew that once Muse died it would be only a matter of time until some other entrepreneur decided to take on the champ. Then he would have to fight the Muse battle all over again. By buying Muse, Southwest would be able to own its competition.

Still, for all the apparent advantages, Kelleher was reluctant to initiate negotiations. His concern was that Muse would use any approach for a buyout against him either in a public relations campaign or before government agencies. Fearful of being painted the bully (much as he himself had painted American and Braniff and Delta as bullies in battles past), Kelleher bided his time. Then one day toward the end of last year he saw a story announcing that Muse had hired an investment banking firm to locate a buyer. Muse, it appeared, was throwing in the towel.

Without finishing his morning coffee, Kelleher picked up the phone to call his old friend and sometime rival Lamar Muse. Although Muse, one of the pioneers of the modern aviation industry and a Texas legend, had been Muse Air’s symbol, he had actually been at the helm only on occasion. But in a last-ditch effort to bring his namesake airline safely home (and at the insistence of its latest financial angel, Dallas millionaire investor Harold Simmons), Muse was again in command.

Kelleher’s question to the familiar voice at the other end of the line was simple: “Lamar, would you rather be running Muse Air or fishing at your place in Canada?”

“Fishing,” came the reply.

At 7 a.m. the next morning, Kelleher, who had been recuperating from a bout of pneumonia, opened his front door to greet the tall, white-haired, mustachioed figure of Lamar Muse. Thus, in the waning days of 1984, began the negotiations that in July 1985 would culminate in the purchase of Muse Air by its long-time nemesis and archrival Southwest. The negotiations would be carried out almost entirely by Muse and Kelleher, although separate talks would be held between Southwest and investor Simmons after the Muse-Kelleher talks were completed.

Remarkably, during the two months the two CEOs were hammering out an agreement, no word of the impending merger leaked to the press. From the very start, both Muse and Kelleher had to inform the more than two dozen people sitting on their boards. Yet, no strange fluctuations in stock prices occurred; the media reported nary a word.

THE DEAL ULTIMATELY structured by Muse and Kelleher saw each Muse shareholder receive $6 in cash and, for each share of Muse stock held, one-eighth share of Southwest common stock and one-eighth of a warrant to purchase a single share of Southwest common during the next five years for $35. Although Muse was to become a subsidiary of Southwest, Southwest did not guarantee any of its new stepchild’s considerable debt burden. The total cost of the acquisition for Southwest was to be $40,480,108 in cash and 830,323 shares of stock, excluding stock ultimately required to cover warrant purchases.

The warrants were a key ingredient. Although initial attempts to have the warrants listed for trading on the New York Stock Exchange were turned down by that institution due to a lack of sufficient volume, the warrants have become an active item in the over-the-counter market. Bullish investors who believe Southwest stock will rise appreciably above the $35 sticking price are willing to pay premiums for the warrants, thereby giving ex-Muse shareholders a considerable stake in Southwest’s future.

Although the directors of both corporations unanimously approved the deal, the most difficult obstacle to its consummation lay ahead: The Department of Transportation had to give its seal of approval. Unfortunately, that department could take up to six months by statute to determine whether the acquisition was in line with federal policy. The picture was not encouraging: Transportation had handled only one previous airline merger, and in that case one of the airlines involved had already filed for Chapter 11 bankruptcy and had ceased operations. But Muse was still a going concern, albeit one living on borrowed time. Most parties involved believed Muse’s cash position would hit the critical mark in early June. The deal had to be closed by the end of May or Muse would die.

For those whose futures hung on word from Washington, the process seemed excruciatingly slow. But a decision was rendered in less than four months where the law clearly allowed six; an event nothing short of miraculous, from the government standpoint. The agencies did move with uncharacteristic swiftness. Instead of lengthy public hearings, the government traveled to Dallas to interview concerned parties. Still, the original fail-safe date at which Southwest had to cut bait, May 31, passed without the federal blessing.

Twice Southwest extended its deadline for action. But time and cash reserves were running out on Muse. Then, with Southwest and Muse representatives making clear they weren’t just posturing and that Muse was in its last hours without merger approval, the word came from Washington: All systems go.

THUS ENDED the latest chapter in the often turbulent history of aviation in the Dallas/Fort Worth area. From the birth of American Airlines at Fort Worth’s Meach-am Field in the Thirties, through the long-running legal battle to force the creation of a regional airport at either Fort Worth’s Carter Field or Dallas’ Love Field, to South-west’s multiyear court battle to operate from Love after the opening of the regional airport, to the soap-opera saga of Braniff’s rise and fall and resurrection, North Texas has been at the center of a great American industry’s growth pains and evolution.

As these battles have raged there has been a tendency to focus on the titans clashing at the top. There were all the elements of fine Greek tragedy in the crash of a Braniff weighted down by Harding Lawrence’s megalomania. There is a medieval romantic quality in pitting the Southwest-Muse battle as one between Sir Herb Kelleher and Sir Lamar Muse. There was an all-American quality of little guys fighting big guys when Southwest took on the big trunk carriers to win its place at Love. It often seems that the airline industry, more than most (with the possible exception of the oil industry), has been shaped by individual personalities. But while the oil giants of old have, for the most part, passed into the hands of bureaucrats, the airlines remain in the hands of colorful, strong-willed men like Kelleher, Muse, American’s Bob Crandall and Continental’s Frank Lorenzo.

WHILE IT IS true that Muse was to some extent hamstrung by the air-traffic controllers’ strike, which limited the number of landing slots available to new airlines in spite of deregulation, it was poor decision-making on the part of Muse executives that sealed the airline’s fate almost before it took to the air. Protestations to the contrary, Muse had not decided to purchase four new MD 80s before the strike, but reached that decision afterward, when its options were limited as to available new routes. That decision saddled the fledgling company with a debt burden from which it never recovered.

But there were other problems besides debt. When Lamar Muse’s son Michael first announced he was planning to launch a new low-cost carrier airline based in Texas, the plan was for medium-haul service from both Dallas and Houston. The initial route structure envisioned included such destinations as Chicago, St. Louis and Kansas City. But all that quickly changed. From the day the airline became operational it seemed its first priority was heads-up competition with Southwest, the most successful airline of its type in the nation. Given past bad blood between the Muse family and Southwest, industry insiders quickly dubbed this strategy the “revenge” factor.

The decision to compete with Southwest on such short-haul routes as Dallas to Midland and Dallas to Austin meant that Muse’s new super-quiet MD 80 aircraft would lose much of their fuel efficiency advantage, an advantage they would have held on the longer routes originally announced. And in a rapidly deepening recession that saw stagnation in market growth and even decline in some key routes, there were no new customers for Muse to lure. The fledgling carrier had to win Southwest’s customers away-a long-term project. And time was one thing Muse had little of.

The Muse marketing strategy was also flawed, though some of the flaws were slow to appear. The original advertising pitch of “Big Daddy’s Back,” built around Lamar Muse, proved a bust. For an airline attempting to build a base on customers willing to pay a few bucks more for a little more class, “Big Daddy” hardly seemed in step. The attempt to sell “class” also led the new company to invest in a sparkling office complex in the Turtle Creek area of Dallas complete with $70,000 in art selected by Michael Muse himself. The contrast was intriguing: Southwest had built its success on a management located at Love Field, close to the men and women in the trenches. Muse executives placed themselves far from the hubbub that is the airline business.

ANOTHER MAJOR selling point for Muse was that the airline would allow no smoking. In effect, Muse’s primary marketing gimmick was an attempt to put a stranglehold on less than 20 percent of the passenger market. Interestingly, most surveys show that that segment of the market which resents “no smoking” rules is larger by half than that portion adamantly opposed to being around smoke. Even if the non-smokers are a more determined breed, the vast majority of flyers either still preferred to smoke or could not have cared less.

The one decision that did seem to pay off for Muse was to have assigned seating. For years, Southwest had heard complaints from the huddled masses waiting to push and shove their way aboard Southwest flights. First-time Muse flyers, tired of Southwest’s every-passenger-for-him-or-herself, beamed about the Muse alternative. Indeed, South-west’s initial research seemed to show that Muse had scored a coup. But knowing that everything in the airline business involves trade-offs, Kelleher ordered new research to measure comparative advantages. The new stats showed passengers liked assigned seating, but not at the price of slower turnarounds or higher ticket prices. Accordingly, Southwest stuck by its guns, altering slightly its stampede approach to allow groups of 30, determined by boarding-pass numbers, to board at one time.

Perhaps the most difficult obstacle for Muse to overcome was its schedule. The airline simply didn’t fly at hours people wanted to travel. Nor did it offer frequency on the high-volume routes where frequency is a rule of the business. In part, this was because Muse was trying to stretch its 14-plane fleet to serve too many destinations. The airline couldn’t leave expensive planes sitting on the ground for an entire day waiting to pick up passengers at a reasonable embarkation time. Thus the planes were shuttled off to other points at odd hours. While Southwest was in peak travel hours with high flight frequency, passengers had to hunt to find a suitable Muse flight.

NOW IT IS Southwest’s turn to try to undo the tangle of bad management decisions at Muse. To run its new subsidiary, Kelleher chose Southwest’s Executive Vice President Bill Franklin, whose career began with the old Trans-Texas Airways in 1947. Franklin had been looking forward to an early retirement, but when Kelleher issued the call, his friend responded to the challenge. A near-ringer for Lamar Muse, Franklin has already altered Muse’s old “no smoking” policy. He’s labored to straighten out the airline’s garbled schedule, a process begun with considerable success by Lamar Muse in the final days of the old regime. Franklin is also moving to develop a route structure that will maximize Muse’s medium- and long-haul, fuel-efficient aircraft. Currently, Muse is developing a route structure stretching from the Los Angeles/southern California area through Phoenix to Austin; and San Antonio to Houston; then east to New Orleans and Florida.

Two other major changes are in the wind at Muse. The first is a change in name. “Everywhere I go I find people have heard of Muse in connection with ’no smoking,’” he says, “and we aren’t going to be the ’no smoking’ airline anymore.” There are other negative connotations with the name. For one, the stigma of Muse’s financial troubles. Many ticket agents believe passengers shy away from carriers known to have had financial trouble, fearing that unused tickets will not be good in the future and that they might be stranded should the airline go broke and cease operations. Franklin believes this another good reason to change names. But, he suggests, “the main reason for a name change is that I believe a name should reflect who you are and what you do. ’Muse’ says nothing about those subjects.”

The final move is one pregnant with possibilities for Dallas: Muse is planning to move to Houston. According to Franklin, any Muse expansion will be beyond the four contiguous states (Oklahoma, Louisiana, New Mexico and Arkansas) that Congress says flights originating from Love may have as destinations. “That means our growth will have to come from flights originating at Houston’s Hobby Airport.” Already, most of Muse’s west-to-east flights head to locations forbidden to flights originating from Love. Not only are maintenance operations more economically located at the Houston airport, but Houston becomes the more logical residence for pilots and flight attendants. As more and more of Muse’s operations focus on Houston, it only seems reasonable that the top decision-makers should be on hand.

If Muse heads south, it is possible-but not probable-that Southwest will follow. Current economic conditions make Dallas the stronger market for in-state flights, and Southwest is super-strong in the 14 markets served in Texas and the four contiguous states. Yet Southwest, if it is to grow, must look to markets like Denver and St. Louis and Chicago-with flights that will have to originate from Houston. Thus, like Muse, more and more of Southwest’s operations will be focused in Houston as the economics of remaining headquartered in Dallas become increasingly problematic.

There is another problem. Kelleher seems increasingly concerned about just how welcome his airline and its $400-million annual contribution to the Dallas economy is in the city. Increasing pressure to restrict flights and to lower noise levels could be an added factor in an early move to Houston (see “Inside Dallas/Fort Worth,” page 22). Certainly, economically ailing Houston would like nothing better than to lure a prize so long identified with Dallas Love Field. Houston civic and government leaders have made it clear they would offer some remarkable sweetheart deals to bring Southwest to town. One Houston city councilman points out that Houston’s Hobby airport has almost 80 acres available for development; Love has none. For an airline in need of expanding facilities, those acres could begin to look more and more attractive with the passage of time.