Market Overview

Virgin America-Alaska Air Deal Accretive To Earnings By 20%

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It's been an emotionally tumultuous week for billionaire, minority owner and founder of Virgin America Inc (NASDAQ: VA) Richard Branson, as he has watched his beloved airliner engage in merger talks beyond his control.

"I would be lying if I didn't admit sadness that our wonderful airline is merging with another," Branson shared in a blog post. "Because I'm not American, the US Department of Transportation stipulated I take some of my shares in Virgin America as non-voting shares, reducing my influence over any takeover. So there was sadly nothing I could do to stop it."

"In 2007, when the airline started service, 60 per cent of the industry was consolidated. Today, the four mega airlines control more than 80 per cent of the US market. Consolidation is a trend that sadly cannot be stop."

Related Link: Dow Jones, Wall Street Journal Reporting Alaska Air To Buy Virgin America

The Merger

It was announced Monday that speculations were correct in surmising Alaska Air Group, Inc. (NYSE: ALK) has won the acquisition auction for Virgin America.

According to the New York Times, "In agreeing to buy Virgin America for $2.6 billion, Alaska Air Group is betting that the airline industry is so consolidated after years of mergers that what it needs is another takeover."

As reported by Virgin America, "Alaska Air Group, the parent company of Alaska Airlines, and Virgin America have today announced that their boards of directors have unanimously approved a definitive merger agreement, under which Alaska Air Group will acquire Virgin America for $57.00 per share in cash."

Analysts Weigh In

Following the announcement, Morgan Stanley analysts Rajeev Lalwani and David Streger issued an industry report on U.S. airlines, rhetorically asking, "VA wins, industry ties, and ALK loses?"

"Recent consolidation efforts are modestly supportive for the group, but the real winner appears to be VA (upgrading to EW) given a large premium received. On ALK, while it paid more than a full price, cheap funding and synergies limit the valuation impact, thus we remain OW as upside is evident," they elaborated.

Regarding the consolidation trend in the sector, Lalwani and Streger stated, "In our opinion, the US Airlines have already consolidated considerably and we believe there is limited scope for a material shift from this deal. This is because post deal five carriers will still control ~85 percent of domestic supply as VA represented less than 1.5 percent of the industry.

"Nonetheless, we view it as positive on the margin since relative to the 3–4 percent average, VA was one of the highest growers at 10–15 percent a year whereas the acquirer's (ALK) target remains unchanged in the 4–8 percent range. Lastly, in regard to the read-through for other airlines, larger carriers could conceivably look for potential strategic value in other small US airlines in the event this M&A trend continues."

In speaking about the merger itself and subsequent valuation expectations, Lalwani and Streger calculated a potential 20 percent earnings accretion. "ALK's proposed transaction value of ~$4.0 billion all-in represents ~6x EV/EBITDAR on 2017 stand-alone MSe with ~2.6 billion of equity value at ~13x P/E […] Altogether, we anticipate EPS accretion of ~20 percent despite what some view as an expensive valuation, a dynamic we believe is driven in part by the absence of any equity issuance, low assumed cost of financing (~4 percent), and achievable synergy targets."

Morgan Stanley reiterated its Overweight rating on Alaska Air, while upgrading Virgin America to Equal-Weight.

At time of writing, Alaska Air was up roughly 3 percent at $81.18; Virgin America was essentially flat on the day at $55.00, although it is up more than 60 percent over the past five days.

Latest Ratings for ALK

DateFirmActionFromTo
Jun 2020Raymond JamesMaintainsStrong Buy
Jun 2020B of A SecuritiesUpgradesNeutralBuy
May 2020UBSMaintainsNeutral

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