22 April 2016

Alaska Air inches forward in Virgin America merger

Early this month, airline operator Alaska Air agreed to take over Virgin America, a California-based budget carrier backed by Richard Branson, for USD 4,000 million (inclusive of debt). The offer price is USD 57 per share, which represents an 86 per cent premium over the target’s close of USD 31 on 22nd March, the last trading day before the acquisition was first reported. Private equity investor Cyprus Capital Partners is among shareholders that are offloading their interests. According to Zephyr, the M&A database published by Bureau van Dijk, the deal is set to be the purchaser’s largest ever.

Alaska Air’s stock plunged 4 per cent to close at USD 79 following the announcement, indicating concern among investors over the high premium, which had previously helped to fend off bidding rival JetBlue.  Loizos Heracleous, a professor at Warwick Business School, posited that the offer price is steep relative to Virgin America’s stock, which has been trading at between USD 26 and USD 37 over the last year.

Similarly, Brooke Sutherland of Bloomberg is not entirely optimistic. She wrote that the target’s net income is forecast to fall this year and that days of low commodity prices (which have benefited many oil dependent industries) may soon be over. Antoine Gara, a Forbes reporter, also expressed doubt as to whether both companies, which reported huge increases in revenue last year, can withstand a rise in oil prices or possibly more market competition down the line.

To others, the premium is justifiable. The Economist noted that the takeover will allow the Seattle-based airline to grow inorganically, a rare opportunity in the US aviation industry.  Owning Virgin America will strengthen Alaska Air’s presence in the West Coast and conveniently give it access to hard-to-obtain slots at New York and Washington DC airports.

Additionally, according to Rich Smith of the Motley Fool, Alaska Air has a higher price-to-sales ratio compared to Virgin America, suggesting that the buyer is purchasing the target at a discount. Describing the deal as a “merger made in heaven”, he calculated that both firms working as a combined entity could possibly yield higher profits than if they continued to operate separately. Furthermore, the acquiror also stated in its press release that it expects to achieve USD 225 million of cost savings annually following the merger.

The transaction came after years of loss-making in the US airline industry (partly due to the 9/11 attacks and the 2008 global financial crisis, according to the Economist), which triggered a wave of consolidation. As a result, the country is currently left with only four large airlines, namely United Continental, Delta, Southwest and American Airlines, known as the Big Four.

Even with the increased size upon closing (which is expected to take place by 1st January), Alaska Air will still not be in the same league as the Big Four, according to the New York Times. The buyer will, however, replace JetBlue as the fifth largest airline in the US.

Despite the attractive exit price, UK billionaire Richard Branson may be one of the few Virgin America shareholders who are less than pleased. Due to his status as a foreigner, he is prohibited from owning sufficient voting rights to influence the takeover. In a post published on the Virgin Group’s website, he solemnly stated: “I would be lying if I didn’t admit sadness that our wonderful airline is merging with another.

© Zephyr