Alaska Air Group Inc., Market cap $10.23bn as of 15-04-16
Virgin America Inc., Market cap $2.45bn as of 15-04-16

About Alaska Air Group Inc.

Alaska Air Group, Inc. is an airline holding company founded in 1985 and based in SeaTac, Washington that mainly serves the Pacific Northwest and Alaska. It currently owns two American carriers, Alaska Airlines and Horizon Air, which combined reach over 112 destinations with more than 1000 daily departures.

Through its two main subsidiaries, Alaska Air Group holds a fleet of 219 aircrafts: Alaska Airlines counts over 150 American Boeings with up to 181 seats, while Horizon’s fleet is for now made up of 52 Canadian built Bombardier Q400 with up to 76 seats. Alaska’s fleet is not only more than 3 times larger than Virgin’s, but also 4 years older on average.

On April 12, 2016 Horizon Air has announced the acquisition of 30 new Embraer E175 jets: the order, which also includes options for 33 additional E175s, is valued at 2.8$bn and has the aim of supporting the opening of new routes.

From an operational point of view, Alaska Air Group recently reported a 9.2% increase compared to March 2015 in both RPM (revenue passenger miles) which is now at 3.2bn and ASM (available seat miles), now at 3.7bn, as well as a 0.1 percentage points increase in passenger load factor now at 86.2%. From a financial point of view the Group has a current EV of $9.58bn, representing a multiple of 6.27x its FY2015 EBITDA.

About Virgin America Inc.

Virgin America Inc. is a California-based low-cost airline company which was launched in August 2007 as a subsidiary of Richard Branson’s Virgin Group. By law, no more than 25% of a US airline can be owned by “foreign interests” and therefore at the moment of the foundation VAI Partners LLC, a pool of institutional investors created to group Virgin America’s stockholders, owned 75% of the company while the remaining 25% was controlled by Virgin Group.

On November 14th 2014, the company was listed on the NASDAQ stock exchange, raising c. $307mln in the initial public offering.

As of March 2016, Virgin Group Holdings Ltd owns a 15.5% stake in Virgin America, while the hedge fund Cyrus Aviation Holdings is the largest direct shareholder with 23.6%.

Ninth-largest US carrier by passenger traffic, Virgin America is based in San Francisco. Its fleet is made of 60 Airbus A320 aircrafts and currently serves 18 US cities and three Mexican ones. The company generated $1.53bn revenues in FY2015, growing 2.7% compared to FY2014, carrying more than 7 billion passengers with an increase in RPM (revenue passenger miles) of 3.6% with respect to 2014.

Furthermore, CASM excluding fuel cost (cost per available seat mile, an important indicator of airline efficiency) is forecast to decline between 1% and 2% in 2016, mainly thanks to high labour productivity and a young single-fleet type which is expected to drive costs down substantially in the long term.

Deal announcement and early reactions

On the 4th of April, Alaska Air Inc. announced to have reached an agreement to acquire Virgin America Inc. for a total equity value of $2.6bn. The transaction will complete in January 2017 and is still subject to regulatory and stockholders’ approval.

However, the most prominent shareholder of Virgin America – Mr. Richard Branson, the exuberant entrepreneur who founded Virgin Group – has expressed its disappointment on the day of the announcement. He said there was nothing he could do to stop the acquisition mainly because of the restrictions on ownership imposed by the US, and that he hopes that Alaska Air would continue to pursue its mission: providing the best customer experience. The entrepreneur owns indeed a 22% stake in Virgin America, but not a majority voting stake due to his foreign nationality.

Bid war, offer and financing

Before Virgin America agreed the terms of the deal on April 4th 2016, Alaska Air had had to face a fierce competition against the low cost airline JetBlue Airways, which had engaged in a frenzied bidding war. Virgin America CEO David Cush admitted, however, that JetBlue’s final bid was “fairly close to Alaska’s, not significantly below it”. The main reason behind Virgin America’s choice seemed to be due to Alaska Air’s strong balance sheet: at the end of 4Q 2015, Alaska Air Group was indeed reporting a solid net cash, while JetBlue is a levered player. However, this bid war could extend further and in the case that Virgin America receives a higher offer from another acquirer, the company would be required to provide Alaska Air with four business days to revise its bid.

The acquisition is structured so that the target will be merged with an entity, Alpine Acquisition Corporation, fully owned by Alaska Air and it values Virgin America $57.0 per share, for a total equity value consideration of $2.6bn which will be paid in cash. The price paid represents a 46.5% premium over Virgin America’s closing share price ($39.8) on April 1st 2016, one day before the transaction announcement, and an 89.6% premium based on the closing share price as of one month prior the announcement ($30.1).

As of 2015 FYE, Alaska Air owned only $73.0m in cash, with the rest of the liquidity consisting of $1.25bn in marketable securities: hence the company will use $600m in balance sheet cash, probably selling some of its more liquid securities, and will raise $2.0bn in new debt. The impact on the debt profile of the merged entity could negatively impact the current credit rating of the acquirer (Moody’s B1 – stable). At the moment Alaska Air has a net cash of $642m and will assume further $1.4bn of leases on Virgin America’s balance sheet. This figures, together with the $2.0bn issuance to finance the transaction, will reverse the net cash into a net debt. However the debt to equity will remain one of the lowest in the industry, close to 58%, way lower American Airlines’ 84%, but also higher than Delta Airlines’ 48% and JetBlue’s 46%.

Post-acquisition takeaways

The deal is expected to be accretive to adjusted EPS from year one after the merger and is supposed to create the premier West Coast airline, with $7.0bn of annual revenues and more than 39m passengers. However, despite the elimination of overheads, the amount of net cost synergies is estimated at $50m with revenue synergies at $175m, bringing annual net income close to $1.3bn.

The main revenue synergies will derive from Virgin America’s footprint in California, since the acquirer sees the acquisition as a significant step into the West Coast and as an opportunity to overtake JetBlue as the fifth major airline in North America.

Currently California has a total population of 39.1m Americans and 185,700 passengers per day: this will contribute to consolidating the group’s position, boasting the largest seat share on the West Coast (22%) and becoming the second largest carrier in San Francisco Airport. Moreover, the company will become the most important player in the low fare premium product carriers, which include Alaska Air, Virgin America, Hawaiian Airlines and JetBlue, in an industry that – with lower fuel prices – was able to achieve a remarkable 24% pre-tax margin in 2015.

Furthermore, in the long term the renovation of the fleet will not be an issue and will give the group an edge over competition: since Virgin and Alaska operate two of the youngest fleets in the landscape. Virgin America’s average fleet age is around 6 years, while Alaska reports 10 years on average, way lower than the 17 years of age showed by Delta but close to the 8 years reported by the low fare premium carrier JetBlue.

Financial Advisors

Evercore Group acted as financial advisor to Virgin America, while Bank of America/Merrill Lynch and UBS investment bank acted as lead financial advisors to Alaska Air.

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