Alaska Airlines’ purchase of Virgin America could start a new wave of consolidation – The Economist

7 months ago Comments Off on Alaska Airlines’ purchase of Virgin America could start a new wave of consolidation – The Economist

SIR RICHARD Branson says he is sorry to bid farewell to Virgin America, an airline that he helped found in 2004. But as a shareholder with a 18% voting stake in the firm, he will not really be maudlin. Alaska Airlines is paying $2.6 billion to buy 100% of the equity of the airline, after a high-altitude bidding war with JetBlue, a rival. It is also taking on the airline’s debt and leases, bringing the total pricetag to $4 billion. The new carrier will become America’s fifth-largest.

Alaska is betting that Virgin America, with bases in Los Angeles and San Francisco, will complement its strongholds in Seattle, Portland and Anchorage, solidifying its presence on the west coast. It will also gain Virgin America’s east coast slots, in New York and Washington, DC, where Alaska has struggled to gain access. Still, the price is steep, says Loizos Heracleous of Warwick Business School in Britain. Alaska will pay $57 for each of Virgin’s shares. They have been trading between $26 and $38 over the past year. Brad Tilden, Alaska’s boss, says that the tie-up could result in $225m of annual cost savings and revenue benefits. Acquisitions are often accompanied by bold claims about synergies, says Mr Heracleous. So far the market seems sceptical: Alaska’s shares tumbled as investors got wind of the deal.

Alaska might be willing to pay a big premium to avoid missing a rare opportunity. Size matters in American aviation and the chances to grow through acquisition are rare. The industry has seen turbulence in recent years. The effect of terrorist attacks in 2001, overcapacity, followed later by a high oil price and the global financial crisis, all helped to push many big American carriers into financial difficulty. A period of consolidation followed, leaving just four big airlines: American, Delta, United and Southwest. That cosy quartet now controls 80% of the domestic market and today, after previous heavy losses, the sector is taking in piles of money. America’s airlines made $24 billion of profits last year, as firms cornered most of the gains from a low oil price.

Previously small- and medium- sized airlines had sensed an opportunity when the big ones pulled out of loss-making routes. But now the lower oil price means that bigger airlines are thinking of returning to some of those routes again, says Jonathan Kletzel of PwC, a consultancy. As a result, North American airlines are likely to increase capacity by 4.8% in 2016, says the International Air Travel Association, IATA. If the return of the big boys does put second-tier airlines under pressure, their best defence might be to merge.

JetBlue evidently decided that the price for Virgin America was too high. Some analysts suggest it has Hawaiian Airlines in its sights instead, so more consolidation could be in the air. Consolidation among smaller carriers could be a boon for passengers, if it means they can make enough money to invest in better services, rather than focus solely on controlling costs. Whether there is sufficient competition among the big ones, to make sure lower costs are passed along to consumers, is another matter.

Alaska Airlines’ purchase of Virgin America could start a new wave of consolidation – The Economist

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