UAUA Ual Corp. (MM)

Southwest Airlines Co. (LUV) on Monday announced plans to buy discount rival AirTran Holdings Inc. (AAI) for $1.4 billion in a move that would revive its growth strategy and intensify pressure on network carriers on the U.S. East Coast.

The agreed plan promises to be transformative for Southwest, the nation's largest domestic carrier, by taking it into Atlanta, smaller cities and international destinations for the first time.

"This absolutely changes things," said Gary Kelly, Southwest's chairman and chief executive officer on a call with analysts.

The definitive agreement marks the first combination between major U.S. low-cost carriers and is only the second large acquisition by Southwest after it failed to capture Frontier out of bankruptcy protection last year.

Kelly said Southwest would retain its distinct existing brand, avoiding bag fees and offering a single-class service. "This fits in beautifully with the strategy we've laid out, probably for the next decade," he said.

Southwest executives said it would take two years to integrate the airlines, though they have to navigate meshing contracts from both carriers' unionized workforces. Southwest has yet to take the plan to employees--80% of its staff is unionized, compared with 50% at AirTran. The deal also needs to be approved by shareholders and competition authorities.

Kelly said there was little overlap between the two networks, allowing Southwest to expand after halting its rapid growth during the recession. Atlanta--a key business market where AirTran competes with Delta Air Lines Inc. (DAL)--is one priority, as are smaller cities where it could use its target's Boeing 717s. Southwest plans to keep the 717s and utilize AirTran's orders for Boeing 737-700s, which mirror its own core fleet. Southwest is also looking at larger 737-800s that would be aimed at more congested airports. AirTran shares opened up 59% at $7.24, and Southwest was 2.6% higher at $12.60.

Southwest's business model has changed in recent years as it focused more attention on larger cities and sought access to international markets and pacts with other airlines. However, growth has been trimmed during the recession, and some of Southwest's expansion efforts have faltered.

Acquiring AirTran would provide access to the Caribbean and Mexico and provide a tougher challenge for network carriers, notably those such as Delta and US Airways Group Inc. (LCC) with a large East Coast presence.

The announcement comes days before United Airlines parent UAL Corp. (UAUA) and Continental Airlines Inc. (CAL) are due to close on their merger creating the world's largest airline.

Southwest and AirTran overlap in a number of cities, notably in the northeast and in Florida, though they said this represents less than 1% of total domestic industry capacity. A deal would require approval from competition authorities.

Under the proposed deal, AirTran shareholders will receive $3.75 in cash and 0.321 Southwest share for each share of AirTran, valuing it at $7.69 a share, a 69% premium to Friday's closing price.

After the deal closes, expected in the first half of next year, AirTran holders would have about 7% of the combined company. Including AirTran's net debt and capitalized aircraft-operating leases, the transaction is valued at about $3.4 billion.

The airline expects the acquisition to add to be accretive net of charges after three years, with one-time acquisition-related costs of $300 million to $500 million. The company sees cost savings of more than $400 million by 2013.

-By Doug Cameron and Tess Stynes, Dow Jones Newswires; 312-750-4135; doug.cameron@dowjones.com

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