Friday, April 1, 2016

Smaller Airlines Looking to Expand With Virgin America Acquisition: JetBlue and Alaska Air making bids to acquire their rival

The Wall Street Journal
By Susan Carey and Robert Wall
April 1, 2016 5:28 p.m. ET

Smaller U.S. airlines are finding it harder to grow as fast now that the four largest carriers have amassed control of more than 80% of the domestic market.

So when an airline like Virgin America Inc. —which just concluded the most profitable year in its short history—explores selling itself, rivals are going to jump at the rare chance to gain more routes and more passengers overnight.

Both JetBlue Airways Corp. and Alaska Air Group Inc. are bidding to purchase Virgin America. Other U.S. airlines kicked the tires, people familiar with the matter said, but the contest is down to just the two low-cost carriers.

Final bids were due late this week and the Virgin America board was expected to make a decision over the weekend, according to a person familiar with the matter. A deal is expected to be valued at more than $2 billion, well above Virgin America’s current market capitalization of $1.4 billion.

The acquirer would gain greater presence in important California markets including Los Angeles and San Francisco where Virgin America is based, access to Hawaii, some transcontinental routes and a fleet of 57 narrow-body planes. “Obviously, this is beach-front property,” said another person of the prospect.

It is possible Virgin America, which is 54% owned by Richard Branson’s Virgin Group Ltd., and New York-based Cyrus Capital Partners LP, could extend the deliberations or ultimately decide not to sell. But talks have been under way for “a few months,” one of the people familiar with the matter said.

Virgin America has won kudos—and a dedicated following in Silicon Valley—for the mood lighting and sophisticated inflight-entertainment systems on its planes, its stylish service and its frequent-flier plan. But the ninth-largest airline by traffic, launched in 2007, only achieved profitability in 2013, after it slowed its breakneck growth and started filling its seats at higher fares. Now it is poised to grow again and has new planes set to arrive in its fleet over the next few years.

The U.S. airline industry is on track in 2016 to exceed record operating profits, according to Deutsche Bank. But on Friday, its analysts raised the possibility that the sector’s earnings have peaked because the economy is in the latter stage of an upcycle that has lasted nearly seven years.

Between 2008 and 2013, eight large carriers merged into four behemoths. During that turmoil and in a period marked by high fuel prices, the big carriers pulled out of smaller markets and kept a tight rein on their capacity, giving small and medium airlines room to thrive, said consultant Jonathan Kletzel, U.S. transportation and airlines leader for PricewaterhouseCoopers LLP.

Today, with fuel prices low for a sustained period, the big airlines can afford to add back routes and compete on price with low-fare rivals.

“For small and medium airlines, their ability to grow organically is harder,” said Mr. Kletzel, who isn’t involved in the Virgin America sale. “It’s faster to grow by acquisition.” He sees much uncertainty about the future of those smaller carriers, not only the low-fare flock but also regional airlines that fly for the majors and the ultradiscounters that prospered by offering rock-bottom fares.

There is some disagreement among industry observers about whether antitrust regulators would approve a Virgin America transaction. The Justice Department has been sharply critical of the large airline mergers the department itself has approved in recent years. Last July, the agency said it was investigating whether the four largest airlines were colluding on their capacity plans to keep airfares high.

Jamie Baker, an analyst with J.P. Morgan, said last week that he thought the “regulatory environment remains hostile toward further U.S. industry consolidation.” But Mr. Kletzel said “anything that is going to improve the ability of the remaining airlines to be competitive should be viewed favorably by the government.”

One thing that could allay regulatory concerns is the fact that the cost structures of JetBlue, Alaska Airlines and Virgin America are quite similar, and much lower than the big carriers, suggesting that ticket prices wouldn’t necessarily rise after a transaction.

Last year, JetBlue’s unit cost—the cost to fly a seat a mile—excluding fuel and profit-sharing was 7.51 cents. Virgin America’s unit cost was 7.47 cents and Alaska’s unit cost in its jet division, excluding its commuter planes, was 7.39 cents.

Moreover, the route overlaps of both JetBlue and Alaska with Virgin America are modest.

A person familiar with the matter said those involved in the talks believe any actions to appease regulators would be limited to concessions on a narrow number of routes at most. Sweeping remedies that could undermine the value of the takeover aren’t expected, one of the people familiar with the matter said.

Some analysts have suggested that JetBlue, the nation’s No. 5 airline by traffic, has an advantage because it operates Airbus A320 aircraft, the same model used by Virgin America.

But JetBlue, which launched service in 2000 and is based in New York, also operates smaller Embraer E190 jetliners and has a dedicated fleet of 13 larger Airbuses that are outfitted with its first-class Mint cabins. So a deal wouldn’t result in it operating just one aircraft type, which can save on training, maintenance and spare-part costs.

No. 6 Alaska Airlines, which is based in Seattle, operates 151 Boeing Co. 737 planes, having migrated to a single aircraft type in the past decade. But the company also owns a commuter affiliate that flies Bombardier turboprops and plans to purchase some small jets soon. A person familiar with the matter said the opportunities afforded by Virgin America’s fleet of 57 planes were large enough to overcome losing the cost benefits of a single-fleet type.

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