--This article was written by Lou Whitman of The Deal
Alaska Air Group (ALK) has won the bidding war for Virgin America (VA) with an offer that values the target at about $4 billion including debt and aircraft leases.
Seattle-based Alaska beat off competition from JetBlue Airways (JBLU) as well as a handful of domestic and foreign investors after Virgin America began exploring options earlier this year, a source speaking before the deal was announced said.
The acquisition will allow Alaska to vault past bid rival JetBlue to become the fifth largest airline in the U.S. as it expands the buyer's revenue by 27% to more than $7 billion to create a group with hubs in Seattle, San Francisco, Los Angeles, Anchorage, Alaska, and Portland, Oregon.
Alaska Air said it would offer $57 per Virgin America share, which is almost 47% more than its Friday closing price of $38.90. That values the equity at $2.6 billion in total and compares with a Virgin America November 2014 IPO price of $23.
Alaska Air sees the purchase boosting earnings per share in the first full year and allowing for synergies of $225 million, with one-off integration costs pegged at $300 million to $350 million.
The combined company will have 1,200 daily departures and about 280 aircraft, with an average age of 8.5 years.
"With our expanded network and strong presence in California, we'll offer customers more attractive flight options for nonstop travel, said Alaska Air chairman and CEO Brad Tilden in a statement.
In terms of antitrust issues, Alaska and Burlingame, Calif.-based Virgin America have little overlap--less than 15% of their available seat miles are in competition--meaning regulators are more likely to look favorably on this combination than they would a deal involving one of the four industry titans that currently combine to control about 80% of the U.S. market.
Virgin America to date has been more of a success with customers than it has with investors, winning plaudits and loyalty for its focus on in-flight experience. But that level of service came at a cost to margins, and Virgin America is also saddled with a relatively high-cost fleet and concerns that it was overly-reliant on transcontinental service and a few airports.
Shares of Virgin America were trading near all-time lows in February before deal talk becoming public. The company is led by president and CEO David Cush.
Alaska had ample reason to want to do a deal, having historically operated as a free agent outside of the U.S. alliances, partnering with various carriers to feed traffic to its predominantly west coast route network.
But it is increasingly facing pressure from Delta Air Lines (DAL), traditionally one of its partners, which is aggressively building a hub in Seattle. Though Alaska so far has held up well against the new competition a growing threat from Delta, coupled with fears of an energy-induced slowdown in travel to its namesake state, could have made the company vulnerable without the added scale and diversification buying Virgin America should provide.
Alaska has a reputation has a strong operator that can likely bring greater cost discipline to Virgin America, but the deal is not without risks. Integration will likely mean moving Virgin America pilots and other workers to much higher wage rates, further pressuring margins, and Alaska will face difficult choices over whether to keep Virgin America's popular branding and in-flight experience.
Sources said that Alaska could attempt to monetize certain Virgin America assets, including its coveted orders for next-generation A320s and potentially landing rights in Dallas, New York and Washington, to help pay down the acquisition costs. Partner-turned-rival Delta would likely pay a premium for any Virgin America slots Alaska made available at Dallas's Love Field, where Delta has been battling with Southwest Airlines (LUV) to provide service.
Southwest in its 2011 purchase of AirTran Airways proved that adding new fleet types in a merger doesn't have to be a stumbling block, quickly reaching a deal to transfer AirTran's Boeing 717 aircraft to Delta. With most of Virgin America's fleet leased, many at rates believed to be above current market prices, Alaska could be motivated to phase out the Airbus and could even receive incentives from Boeing (BA) to remain an all-Boeing operator.
British entrepreneur Richard Branson announced his intention to form Virgin America in 2004 and the airline took flight in 2007 backed by $177.3 million in funding from Black Canyon Capital LLC and Cyrus Capital Partners LP, with Branson's Virgin Group Ltd. owning 25%.
The Alaska/Virgin America tie-up leaves little left for JetBlue to acquire, with most of the remaining independent discounters more focused on ultra-low costs and secondary markets outside of JetBlue's traditional focus.
JetBlue could try to acquire private equity-owned Frontier Airlines Inc., which is considering an initial public offering and has a strong presence in Denver, but Frontier previously struggled when trying to operate a JetBlue-like premium cabin and has only found success emulating extreme discounter Spirit Airlines (SAVE).
Many in the industry assume that Frontier and Spirit will eventually come together. The two companies share a similar business model and both were influenced by private equity firm Indigo Partners, Frontier's current owner.
--This article was originally published by The Deal, a sister publication of TheStreet that offers sophisticated insight and analysis on all types of deals, from inception to integration. Click here for a free trial.
