MIAMI — Alaska Air is to acquire Virgin America for $57 per share, leading to a price of $2.6bn, rising to a cost of $4bn once Virgin America’s debt and other obligations are taken into account. Is this a good strategic move for Alaska?
This acquisition continues a trend of consolidation in the U.S. aviation industry that has done its part to help profitability over the last three years, together with lower fuel prices and less intense price wars. Both are healthy airlines with ambition and with the right approach to the customer, which on the face of it is a good basis for a merger. It also makes strategic sense for Alaska Air to acquire Virgin America in terms of network coverage, since the transaction will strengthen Alaska’s position at San Francisco and Los Angeles airports and aid its market development.
Why did Alaska Air proceed with this transaction? There are three reasons. First, as an asset-heavy business, scale matters in airlines in terms of enhancing operating efficiency. This is one reason for the recent wave of consolidation in the industry. Given slim margins, it is imperative that airlines are as efficient as possible. This transaction will enhance Alaska Air’s scale and negotiating power.
Second, Alaska Air has had a strategic goal of expansion over the last few years, opening new routes and putting a substantial number of new aircraft on order, and this transaction fits within the growth goal. Third, it is a matter of grabbing opportunity when it arises, for both airlines. From the perspective of Virgin America’s investors, this would be the right time to sell. The company has started being profitable in 2013, with record profits in 2015. Given the unpredictability of industry conditions, and the acquisition premiums that can be achieved when the industry is on an upturn, this would be a good time for investors to capitalize on their investment.
However, 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. If oil prices remain low, the upward trends in the aviation industry performance continue and Alaska successfully gains synergies from the acquisition (reportedly $225 million per year once the integration is carried out), then this will have been a good strategic move. However, the aviation industry performance is cyclical, oil prices are unpredictable, and synergies are notoriously hard to achieve – so this is one to watch with interest.
Did Alaska Air overpay? 57$ per share seems like a steep price to pay, when Virgin America had been trading at between $26 and $37 over the last year. It will be very challenging for Alaska to gain value from this transaction to cover the price paid over and above what the market thought Virgin America was worth. Perhaps that’s why Alaska Air’s share price is down from $82 on 1st April to $77 on 4th April. The market is pricing in the cost and strategic risk emanating from this transaction, into Alaska Air’s value.