Seat 2B By Joe Brancatelli
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Virgin No More: Alaska Airlines' Big Purchase
April 7, 2016 -- Want the happy happy joy joy explanation of Alaska Airlines' decision to buy Virgin America for $2.6 billion? Listen to the relentlessly upbeat investor's call conducted by Alaska Air management on Monday and view its attendant deck of blue-sky projections. Don't have an hour to spare? Just assume everything is awesome as you zip through the two carriers' cloyingly sweet Flying Better Together website. The reality, of course, is something else again. The airlines did a deal because they had no other choice. Despite tip-top operations, solid profits, a strong balance sheet, dedicated employees and loyal passenger base, Alaska Air Group (NYSE: ALK) is out of runway in the Pacific Northwest. There was no place left to grow and it is being pressured in its hometown of Seattle by Delta Air Lines, which is intent on focusing its transpacific operations at now-overcrowded Sea-Tac Airport. Nine-year-old Virgin America (Nasdaq: VA) is finally profitable, but it is puny even in its hometown of San Francisco. It must kick back a percentage of every sale to the bombastic, past-his-prime Richard Branson and its once-inventive in-flight product is aging and uncompetitive on several key routes. Then there's this depressing reality: Small is not beautiful — and maybe not even viable — in the U.S. airline business. Thanks to serial mergers over the last 35 years, four airlines now control 84 percent of the domestic skies. If you're not United, American, Delta or Southwest airlines, your chances of prospering — or surviving — are slimmer than ever. Which explains why Number 5 JetBlue Airlines also pursued flyspeck Virgin America, driving up the purchase price for Number 6 Alaska, which is paying about 13 times earnings for Virgin's 2 percent market share. Alaska Air's $2.6 billion all-cash deal values Virgin America about 90 percent above its market capitalization of a few weeks ago. "Virgin isn't much, but it has some scarce assets," one Big Four airline executive told me over the weekend before it was clear that Alaska would best JetBlue. "Besides, it's about the only thing left on the board. If you want to bulk up and become more attractive to frequent flyers and corporate buyers, you need to grab what's available." What's it mean for us, the business flyers who'll now have even fewer competitors vying for our higher profit custom? Here's what you need to know.
Do nothing nowEven by the aggressive, everything-is-awesome timeline proposed by Alaska Air executives, it'll be several months before the carriers' respective shareholders approve the deal. It'll be near the end of the year before regulators sign off. (Since Alaska Air and Virgin America have little route overlap and their combined market share will only be about 7 percent, it's hard to see why the government would demur or demand any carve outs.) So assume nothing will change in our flying experience this year. The respective frequency plans will almost certainly remain unchanged in 2017, too. You may see some code-sharing between the two airlines sooner and, one assumes, substantive reciprocity between Alaska's Mileage Plan and Virgin Elevate.
The Virgin name will goRichard Branson, the Donald Trump of travel, peddles his Virgin brand to all comers, including the domestic carrier being acquired by Alaska Airlines. He currently receives 70 basis points of every dollar of revenue that Virgin America generates and that licensing deal has been worth more than $20 million over the last three years. Logic dictates that Alaska will dump the Virgin branding as soon as legally and logistically possible. Branson half-heartedly bemoaned the merger this week, but he'll be reaping an unexpected windfall from the disposal of his 30 percent stake in Virgin America.
Alaska Airlines will changeAlaska Airlines is updating its branding, but a smiling Eskimo and the Alaska name might not play nationally. So don't be shocked if Seattle's best-kept secret looks for a more relevant name and more urbane image. If only that cool Virgin America brand didn't cost 70 basis points, eh?
Downgrading VirginThe airline that became JetBlue launched in 2000, but only after Richard Branson bailed on a deal to call it Virgin. Branson then spent seven years and burned through tens of millions of dollars to launch the carrier that eventually became Virgin America. The problem is Virgin America hasn't changed since its 2007 premier. That makes it wildly out of steps with current airline economics. Its first class seat pitch of 55 inches is far too generous for many of the shorter-haul flights it operates. There's no true premium economy section, either. Alaska recently began remaking its first class cabin with 41 inches of legroom, more than the legacy carriers. It's also adding a premium economy service. Virgin America's mood lighting and multi-purpose video systems may stay, but expect Alaska to remake Virgin's seating in its own image.
Wither the transcons?Alaska Airlines flies coast-to-coast from its Seattle-Tacoma hub, but it has been shut out profitable and prestigious Transcon Triangle of New York, Los Angeles and San Francisco. Virgin America plays in that market and its 55-inch seat pitch in first class is once again a problem. This time, however, it's not good enough since the other competitors all offer lie-flat beds in their premium classes. Will Alaska make the investment in better premium classes on these key routes? Watch this space.
Airport assetsAs you'll surely learn if you listen to the conference call or rifle through that merger deck, Alaska says its purchase of Virgin America is all about bulking up along the West Coast in general and California in specific. That'll make the combined carrier strong in Seattle, Portland, the San Francisco Bay area and the fractious Los Angeles market. But what of those limited, yet financially valuable, Virgin America assets at slot-constrained airports such as Dallas Love Field, Washington National and New York La Guardia? Given how much Alaska Air overpaid for Virgin America, some of those chips may quickly be flipped. My guess for first to go? Two gates at Love Field, where Virgin has struggled to create a beachhead against Southwest Airlines. Southwest controls Love's 18 other gates, including two it obtained from United Airlines for the eye-popping price of $120 million. It'd surely be interested in Virgin's little corner of Love.
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