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Analysis: Alaska Airlines Clears Major DOJ Hurdle for Virgin America Acquisition

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Analysis: Alaska Airlines Clears Major DOJ Hurdle for Virgin America Acquisition

Analysis: Alaska Airlines Clears Major DOJ Hurdle for Virgin America Acquisition
December 07
09:30 2016

MIAMI — Alaska Airlines cleared the primary hurdle to closing its acquisition of Virgin America, as it agreed to a settlement with the US Department of Justice (DOJ), which had sued to block the merger on antitrust grounds.

Under the agreement, Alaska will be required to significantly pare back its code share agreement with friendly rival American Airlines, which we estimate could have an adverse revenue impact of more than $100 million in the initial years after the deal. The concessions required of Alaska are relatively light, as previous mergers such as that between American Airlines and US Airways have required aggressive divestitures of hard assets such as gates or slots at airports with capacity restrictions.

So, the settlement represents a relatively tame end to an eight month process that has seen the Virgin – Alaska merger held back significantly.

The American code share is more or less gutted

While Alaska and American will not be prohibited from operating under a code share after the settlement, much of the functionality has been stripped from what remains. American and Alaska will be prevented from codesharing on any route currently served by both airlines, on any route currently served by both American and Virgin America, or on any route that is later started by American or Alaska to any of the hubs of the other carrier (for example if Alaska started Fresno – Dallas Fort Worth, American could not code share on that route).

By virtue of American, Virgin America, and Alaska having hubs at many of the busiest airports in the United States, this effectively blocks American and Alaska from code sharing on many of the highest volume routes that make sense for the two airlines to share traffic on.

Alaska basically stated publicly that it expected the adverse revenue impact of this settlement to be $60 million, out of which Alaska claims it will eventually re-capture $45 million by winning those customers directly. We are less optimistic. Because these are the highest volume routes, there are second order effects that will make connections onto secondary flights (like Seattle/Portland – Boise or Chicago O’Hare – Des Moines) much less attractive (because each airline’s flights are much more optimized for connectivity at their hubs). Accordingly, we expect an adverse revenue impact in the range of $80-100 million, with a lower re-capture rate for Alaska than it predicts (closer to 50% than 75%).

Note: We have a full list of markets and routes affected at the bottom of this story.

Alaska got off relatively scot-free


Relative to previous mergers, the divestitures the DOT has asked of Alaska and Virgin are relatively light, though they are more or less similarly sized in terms of revenue impact as a percentage of top line revenue as previous deals involving American and US Airways or United and Continental. But Alaska probably counts itself lucky that it was able to escape this process without having to hand over gates at San Francisco, Los Angeles, or even Seattle to a competitor like JetBlue.

Forcing Alaska to divest slots at Washington Reagan or New York LaGuardia, where it serves as a small, lower cost competitor to the legacy behemoths, never really made much sense, and Alaska probably would have been fine with getting the problematic (for Virgin America economically) Dallas Love gates off its books.

The one piece that was surprising to see left in tact was the code share with Delta Air Lines, as Delta is arguably even more competitive with Alaska in terms of overlap routes due to sharing a hub at Los Angeles (like American) and a hub at Seattle with the Eskimo airline. This codeshare agreement has been a dead man walking since Delta really built up Seattle as an important hub in its network, and it didn’t feel like Alaska would have been devastated if the Delta agreement went away.

The DOJ has set a bad precedent 


By going after the American code share, the DOJ broke many of the rules of legal precedence that it had set over the past 20 years in assessing airline mergers, and in doing so set a counterproductive precedent for future rulings. The DOJ’s historical considerations of Hirschman – Hiefendahl Index (HHI) measures of market concentration and of assets such as slots and gates at the very least made some sense as metrics by which to judge the anti-competitive effects of a business combination.

But code share agreements don’t fit into that bucket. At the top level, they sort of look like unfair coordination, but because they are arms length, passengers don’t really pay higher prices versus what they would pay with the two airlines competing independently.

Frankly in the modern world, code share tickets are not all that different than the interline tickets sold through online travel agencies like Expedia or Kayak. In fact, it’s possible to argue that they’re almost entirely pro-consumer due to expanded choice, and so by turning these into a deal point for future mergers, the DOJ has set a bad precedent.

American will expand more on the West Coast


From American’s point of view, $100 million is more or less a drop in the bucket, so this settlement isn’t all that painful. The one piece it does bring into question is whether on the margins American will open more routes to tier II and tier III cities in the western United States like Fresno, Mammoth Lakes, and Sun Valley. Without an easy way to sell conveniently timed connecting access to these cities via an Alaska hub, perhaps American will add more routes to these kinds of cities from Los Angeles and Phoenix.

Alaska isn’t quite over the finish line but its close


The DOJ lawsuit was probably the biggest hurdle for Alaska to cross, and that settlement should help get Alaska and Virgin across the finish line by early in the New Year. There is still a California lawsuit floating out there that aims to block the merger, and unlike the nation at large, the merger has more of a market concentration impact in California proper, which could prompt more scrutiny. But at a high level, you expect the lower courts to fall in line with the DOJ ruling, so it would appear that Alaska and Virgin have navigate the trickiest roadblock.

List of Routes Banned Under the Code Share

  • Anchorage to
    • Phoenix
  • Dallas Fort Worth or Dallas Love to
    • Washington Reagan
    • New York La Guardia
    • Las Vegas
  • Los Angeles to
    • Portland
    • Anchorage
    • Salt lake City
    • Seattle
    • Washington Reagan
    • Baltimore
    • Washington Dulles
    • Boston
    • Chicago O’Hare
    • Dallas Love Field
    • Dallas Fort Worth
    • Fort Lauderdale
    • Miami
    • Honolulu
    • Las Vegas
    • New York JFK
    • Newark
    • Orlando
    • Seattle
    • Kahului/Maui
  • New York JFK to
    • Fort Lauderdale
    • Miami
    • Las Vegas
  • Portland to
    • Phoenix
    • Dallas Fort Worth
    • Chicago O’Hare
  • Seattle to
    • Newark
    • Miami
    • Fort Lauderdale
    • Phoenix
    • Philadelphia
    • New York JFK
    • Dallas Fort Worth
    • Chicago O’Hare
  • San Diego to
    • Newark
    • New York JFK
  • San Francisco to
    • Dallas Love
    • Dallas Fort Worth
    • Fort Lauderdale
    • Miami
    • New York JFK
    • Los Angeles
    • Chicago O’Hare

American hubs/key airports under the deal where Alaska cannot add a code share route

  • Charlotte
  • Chicago Midway
  • Chicago O’Hare
  • Dallas Fort Worth
  • Dallas Love Field
  • Fort Lauderdale
  • Miami
  • New York JFK
  • New York La Guardia
  • Philadelphia
  • Phoenix
  • Washington Reagan

Alaska/Virgin hubs/key airports under the deal where American cannot add a code share route

  • Seattle
  • Portland
  • Los Angeles
  • Anchorage
  • San Francisco
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About Author

Vinay Bhaskara

Vinay Bhaskara

Senior Business Analyst, Big Airline Enthusiast, Avid Airport Connoisseur, Frequent Flyer, Globetrotter. I Miss Northwest Airlines Every Day. vinay@airwaysmag.com @TheABVinay

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