Tuesday, April 5, 2016

Alaska Airlines just massively overpaid for Virgin America, and it's a deceptively smart move

Seattle-based Alaska Airlines announced Monday that it would acquire Virgin America for $2.6 billion after a short bidding war with JetBlue.

The value of the deal, including Virgin's debt and aircraft-leasing obligations, could reach $4 billion.

Though Virgin America is regarded by consumer-ratings agencies as the best airline in North America, Alaska paid nearly twice what it last traded at.

"Fifty-seven dollars per share seems like a steep price for Virgin America, when it had been trading at between $26 and $37 over the last year," Warwick Business School professor of business strategy Loizos Heracleous told Business Insider.

"The bidding war for Virgin America has raised the price to levels that will make it challenging for Alaska Air to garner benefits that can justify this price, at least in the short term," Heracleous said.

The airline's $2.6 billion price tag is about 16 times the airline's 2015 earnings, Vinay Bhaskara, a senior business analyst at Airways News, told Business Insider.

"Even with cratering fuel prices and the airline earning cycle at its peak, Virgin America hasn't been able to be very profitable," Bhaskara said.

So what, exactly, did Alaska Airlines buy?

Although Virgin America operates a fleet of 60 Airbus A320-family jets, the airline owns only five of them, with the rest leased from various companies around the world.

As a result, Virgin America's most valuable assets are its terminal space at San Francisco International Airport and Los Angeles International Airport, along with landing rights at Love Field in Dallas, LaGuardia in New York, and Reagan National in DC, Bhaskara added.

And then there's the cachet of the Virgin brand, which brings intangible value to the airline.
At first glance, forking out $4 billion for some terminal space, landing rights, and a few jets makes little sense, but a deeper analysis shows that Alaska's move, though risky, may be a smart buy for three key reasons.

First, the acquisition of the San Francisco-based airline keeps Virgin America and its sizable West Coast presence out of JetBlue's control. New York-based JetBlue has a strong East Coast and transcontinental business, but it still lags behind Alaska, Virgin America, and Southwest in its ability to serve the western US.

Acquiring Virgin would have given JetBlue instant scale on the West Coast and bolster its already formidable transcontinental business.

Second, Alaska's acquisition of Virgin America makes it an instant powerhouse airline that's a viable competitor to juggernaut Southwest, Bhaskara told Business Insider.
Alaska, the seventh-largest airline in the US, now has additional resources to scale up operations in key markets around the country, such as Dallas and New York.

Virgin America's large presence in San Francisco and Los Angeles also allows Alaska to fortify its position in those two very competitive markets.

Third, Alaska Airlines is a major brand and big-time player in the western US. But it remains relatively unknown to a lot of travelers on the East Coast and abroad. The acquisition of an airline tied to a world-renowned brand allows Alaska to make a big splash outside its traditional market.

Time will tell if the Virgin America acquisition will pay off for Alaska, but there's no doubt the deal will greatly affect the landscape of the commercial air travel on the West Coast.

(Benjamin Zhang - Business Insider)

1 comment:

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