Alaska Air Group cited gaining a strong foothold in California as the primary driver in its proposed $4 billion acquisition of San Francisco-based Virgin America, which theSeattle-based carrier said gives it the opportunity to become the leading domestic-services airline on the US West Coast.
The merger deal, announced April 4 and still needing regulatory approval, calls for Alaska to buy Virgin America for $57 per share, or $2.6 billion. Alaska, parent of Alaska Airlines and Horizon Air, will additionally take on $1.4 billion in debt and aircraft lease obligations from Virgin America, creating a $4 billion enterprise value for the transaction.
“We’ve been thinking about this for a long time,” Alaska president and CEO Brad Tilden told analysts and reporters in an early morning April 4 conference call. “We originally reached out [to Virgin America] in October or November of last year. I don’t think of this as defensive … We feel we’ve done really well with the footprint we have in Seattle, Alaska and the state of Oregon and we just wanted a little more canvas to work with. I think this just makes our company much, much stronger … California has 39 million people. We think we can generate the loyalty throughout the whole US West Coast that we have now in the [US] Pacific Northwest and Alaska.”
New York-based JetBlue Airways later joined in the pursuit of Virgin America and the competition for the California carrier was “hard fought,” Tilden said. Alaska CFO Brandon Pederson said that “an auction-type atmosphere” ensued as Alaska and JetBlue bid for Virgin America, with Alaska ultimately prevailing. Alaska executives would not comment on how much the bidding drove up the $57 per share acquisition cost. (Virgin America’s share price stood at $38.88 when markets closed on Friday, April 1, though it quickly shot up when the merger deal was announced on April 4.)
Alaska is aiming for Virgin America’s shareholders to approve the transaction by June, to gain approval from the US Department of Justice (DOJ) in the 2016 third quarter, close the deal by Jan. 1, 2017, and move to a single operating certificate by early 2018.
Alaska anticipates that the merger will generate $225 million in annual synergies, with 80% coming on the revenue side and 90% of the synergies in place by 2019. One-time integration costs are expected to be between $300-$350 million, according to Alaska. A combined Alaska/Virgin America projects annual revenue of around $7 billion. Alaska said it “expects the transaction to be accretive to adjusted earnings per share in the first full year, excluding integration costs.”
The combined fleet would number about 280 aircraft (including Horizon’s regional fleet), but Alaska’s mainline fleet has long been all Boeing 737s while Virgin America is an all-Airbus A320 family aircraft operator with 60 A320 family aircraft in its fleet currently. It also has 40 A320neo family aircraft on order with deliveries starting in 2017, though most of the neo deliveries are slated for after 2020.
“We have no experience with the Airbus fleet, so that will be a challenge,” Alaska EVP and COO Ben Minicucci said. “Although we love having the single fleet [of 737s], we’ll be learning about the Airbus fleet.”
But Pederson indicated Alaska could move away from the Virgin America fleet if it chose do so. “Essentially all of the [Virgin America] fleet is leased and those leases start to roll out starting in 2020,” he said, adding that there is a “favorable cancellation provision” on Virgin America’s neo order.
Pederson described the Virgin America fleet as “a great fleet of fuel efficient young aircraft” that Alaska officials are “going to get to know.” It will be “probably years” before Alaska makes a decision on whether to retain any or all of Virgin’s A320 family fleet, he said.
Indeed, Virgin America’s aircraft were not the primary attraction for Alaska. Being able to have a major presence in Seattle (SEA), San Francisco (SFO) and Los Angeles (LAX) was the key for Alaska. “Los Angeles and San Francisco are very, very constrained [airports],” Alaska EVP and CCO Andrew Harrison said. “We couldn’t have done this [kind of growth at SFO and LAX] organically for several years.”
Harrison noted that Alaska has a “significant loyalty base already in California,” but didn’t have access to the infrastructure needed to properly serve those customers. “California is a very large state with a lot of carriers in there and a lot of competitors,” he said. “Credit to Virgin America: They have done a very good job at building a network from slot-constrained airports” in California to the US East Coast.
“I think this acquisition gives you a foothold [in California] that would be very, very difficult to build organically,” Tilden added.
Alaska noted that the transaction will also “open up growth opportunities” at slot-constrained East Coast airports, including Washington National, New York LaGuardia and New York JFK.
Tilden emphasized that Alaska has no ambitions to become a transpacific or transatlantic operator, but noted that having a footprint at SFO, LAX and SEA gives it “more leverage” with international airlines already partnered with Alaska or Virgin America or wanting to interline with the post-merger Alaska.
Virgin America CEO David Cush noted that “seven out of our top 10 corporate customers are tech companies [with employees] that travel up and down the West Coast and across the country” and said the merger will benefit these passengers, adding, “There’s a much bigger symbiotic relationship between the three big West Coast cities [Seattle, San Francisco and Los Angeles] than there ever has been because of the tech industry.”
Alaska Airlines’ pilots, represented by the Air Line Pilots Association (ALPA), and flight attendants, represented by the Association of Flight Attendants (AFA), both issued statements in support of Alaska’s acquisition of Virgin America. The International Association of Machinists and Aerospace Workers (IAM), which represents Alaska’s mechanics and other ground workers, took a more cautious approach, saying its “sole focus in the transaction is to make sure employees are not disadvantaged.”
Alaska executives expressed confidence in executing the labor aspect of the merger. “Our union leaders are excited,” Minicucci said. “I think they’re going to work really hard to make this successful.”
Getting approval for the merger from DOJ will likely be the primary focus of Alaska executives over the next several months. “We know [DOJ] will take a close look at it,” Alaska general counsel Kyle Levine said. “We think we have a good story to tell them … [There is] very little [route] overlap.” He called the merger “pro-competition and pro-consumer.”
Asked by ATW about skepticism in Washington DC over US airline consolidation, Levine responded, “We’re planning for a slightly longer period [for the regulatory review]. We’ll follow the lead of the regulators and plan accordingly.”
An Alaska-Virgin America merger would follow the mergers of Delta Air Lines and Northwest Airlines, United Airlines and Continental Airlines, Southwest Airlines and AirTran Airways, and American Airlines and US Airways in the recent round of US airline industry consolidation.