The Real Reason behind Alaska’s Merger Bid for Virgin America – Part 1
The US airline industry has been one of the most dynamic, with several mergers taking place over the years, completely changing the status quo in the country and leaving little room for more takeovers. And yet, just when nobody expected it, the news broke in April 2016 that Alaska Airlines had made a US$2.6 billion bid to merge with Virgin America, provided regulatory approval is granted, of course. If the consolidation goes ahead, the newly formed company could become the sixth largest player in the US. Speculation is highlighting, however, that the real strategic interest of Alaska Airlines lies in its goal to outmanoeuvre rivals such as JetBlue and Delta, which have been increasing their competitive pressure on the player over the years. Alaska Airlines aims to cement its dominance on the West coast, while trying to gain more access to the East coast through Virgin America’s slots there.
The market demands
Both of the airlines in focus have little overlap in terms of route network, service proposition, financial health and, last but not least, brand awareness. Despite that fact, both players have built a unique niche in the market, which certainly differentiates them from the crowd.
Category Comparison between Alaska Airlines and Virgin America
|Category||Alaska Airlines||Virgin America|
|Fleet Type||Boeing 737||Airbus A320|
|Fleet Ownership||80% owned||Leased|
|Brand Awareness||Weak brand awareness||Strong brand awareness|
|Management Approach||Conservative||Innovative, customer focused|
|Airline Products||Utilitarian product offer with minimum travel perks||Customised seats and modern in-flight entertainment system; mood-lit cabins; electronic ordering scheme|
|Consumer Segment||Mid to budget; traditional travellers||Premium; corporate travellers|
|Regional Coverage||North America; Latin America||North America; Latin America|
|Hubs||Anchorage, Seattle, Los Angeles, Portland||Los Angeles, San Francisco|
|Frequent Flyer Programme||Alaska Airlines Mileage Plan Program||Elevate Frequent Flyer Program|
Source: Alaska Airlines and Virgin America websites, company presentations, trade press
Note: as of May 2016
The move, however, is very bold on the part of Alaska Airlines, which, of the two carriers, is considered to be the strongest operator in terms of financial stability. All major US airlines benefitted from the very low fuel prices in 2015, and Alaska Airlines (excluding the figures for its regional operations and the Horizon brand) was no exception, recording total operating revenues of US$4.6 billion for the fiscal year ended 31 December 2015, compared to US$4.5 billion for the same period in 2014. Virgin America, on the other hand, showed a more modest performance of US$1.5 billion in 2015, which represented a mere 3% increase over the same period in 2014. With increased market consolidation in the US, smaller players such as Alaska are forced to venture into a merger in order to be able to achieve greater visibility at key airports, while gaining access to profitable routes and buying market share.
And this is exactly what Alaska aims to achieve – secure more access to the profitable Californian market, which, according to corporate sources, represents its second biggest state, where it currently operates 22,747 daily seats, compared to its leading market of Washington, where it registers a strong 39,654 daily seats. California is of interest to Alaska Airlines as it is home to the largest consumer market in the US, as this is the most populous state, with an economy more the size of a major country than an administrative division. If approval is granted for the merger, the newly formed airline will have a value share of 3.4% country-wise, right behind its rival JetBlue, while, on the West Coast, the carrier’s share will reach 22%, ahead of Southwest, which will have a 21% share in this part of the country.
US Airlines Company Shares: % Value 2013-2015
|American Airlines Group Inc||22.3||21.9||20.9|
|Delta Air Lines, Inc||18.4||18.9||19.0|
|United Continental Holdings Inc||18.1||17.8||16.9|
|Southwest Airlines Co||10.7||10.7||11.2|
|JetBlue Airways Corp||3.3||3.3||3.6|
|Alaska Airlines Inc||2.5||2.5||2.6|
|International Airlines Group||1.7||1.7||1.8|
|Deutsche Lufthansa AG||1.5||1.4||1.5|
|Virgin America Inc||0.9||0.9||0.8|
|Air France-KLM Group SA||0.9||0.9||0.8|
|Air Canada Inc||0.7||0.7||0.8|
|Emirates Group Plc||0.5||0.7||0.8|
Source: Euromonitor International 2015 provisional data
The price is right?
The total amount to be paid by Alaska Airlines for Virgin America, including the latter’s debt and aircraft leases, is near the US$4 billion mark. After an intense bidding war with JetBlue (the other main contender for Virgin America), Alaska Airlines, the veteran on the market, is in a strong position to pay such a high price tag for the hipster poster child Virgin. Its strong balance sheet, lack of any debts and cash-rich position allowed the carrier to go on such an expensive shopping spree.
The dynamics of the US market have not only led to a plethora of big mergers and acquisitions since 2005, but also transformed the nature of airline players. Alaska Airlines and Virgin America have self-proclaimed themselves hybrid carriers, which have relatively low costs, while providing “premium services”. Although more relevant for Virgin than Alaska in regards to premium product offering, in the same “hybrid” group are also included such companies as JetBlue and Hawaii Airlines. By securing Virgin America, Alaska Airlines hopes to outplay its rival JetBlue, gain national coverage and, ultimately, access a new premium consumer segment vis-à-vis its more traditional consumer base.
Buying Virgin America will also help Alaska Airlines increase average price levels in its markets, while absorbing a competitor in itself.
Alaska’s secret to success
Alaska Airlines has always been a tactical player. Back in the day, it signed a code-sharing agreement with Delta, but also American Airlines, on all Alaska routes out of its hub in Seattle. A move that allowed it to reap the ticket price benefits of a monopolist on the market for a long time.
This dramatically changed, however, when Delta reviewed its partnership and then grew its operations from the same hub to directly rival Alaska Airlines. The move was ultimately the beginning of the end of this partnership. For Delta, Pacific Northwest is the door to two very strong regions in terms of tourism demand – Europe and Asia Pacific – which explains its unwillingness to easily give up on this lucrative hub.
Despite this fact, for over 30 years Alaska Airlines has been showing strong financial results on the back of consistent cost reduction, aided by one of the best on-time performances in the country, extensive capacity growth, and its leading role as a transportation player in its home state of Alaska.
Source: Company reports
The player has also been very good at diversifying and building a very profitable route network (eg Hawaii, Cancun, Baltimore, New Orleans), which, in turn, boosts its profit margins. The merger with Virgin America will, in turn, add another dimension in its efforts to expand, especially in San Francisco and Los Angeles, and thus more extensively rival Delta.
In the second part of this article we will analyse the potential hurdles that could impact this merger as well as areas where Alaska Airlines should improve to remain competitive on the market.