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The Alaska Air-Virgin America Merger Is (Almost) Cleared for Takeoff

By Adam Levine-Weinberg - Dec 7, 2016 at 8:20AM

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Federal regulators finally gave Alaska Air approval to complete its acquisition of Virgin America -- as long as it makes two small concessions.

After a delay of several months, U.S. antitrust regulators finally approved Alaska Air's (ALK -2.39%) planned acquisition of smaller rival Virgin America (VA) on Tuesday. This removes one of the last major obstacles to closing this deal by the end of 2016.

The Alaska Air-Virgin America merger took a big step forward on Tuesday. Image source: Alaska Airlines.

As expected, the DOJ did extract some concessions from Alaska Air. Most notably, the company agreed to scale back its codeshare arrangement with top U.S. carrier American Airlines (AAL -3.56%). However, the merger still has lots of upside potential for Alaska Air.

Modest concessions seal the deal

As the DOJ's antitrust review dragged on this fall, some observers began to wonder whether the government would demand big concessions from Alaska Air. One possibility was that the DOJ would force the company to give up some slots or gates at key congested airports.

However, the agreement finalized this week doesn't include any divestitures. Instead, there are two key conditions.

First, Alaska Air will need DOJ approval if it wants to sell or lease out any of the gates and slots that American Airlines divested to Virgin America as part of its merger with US Airways. The DOJ insisted on this condition to ensure that Alaska doesn't sell any of those gates or slots back to a legacy carrier.

Second, Alaska will have to stop codesharing with American Airlines on 45 routes. For the most part, these are routes where either Alaska Air or Virgin America competes with American Airlines today. Alaska and American will also have to stop codesharing on a handful of routes to each other's hubs.

The idea behind this restriction is that the DOJ believes that Alaska treats American Airlines as more of a partner than a competitor in some markets. Scaling back the codeshare agreement is meant to force Alaska Air to compete more vigorously with American where feasible.

Alaska Air will stop codesharing with American Airlines on some routes. Image source: American Airlines.

Alaska Air's management reassured investors on Tuesday that the codesharing restrictions won't hurt much. Alaska generated $190 million of revenue from codesharing with American over the past year. The impacted routes only represent $60 million of that total, and Alaska expects to recapture $40 million-$45 million of revenue by tapping into other sources of travel demand. Thus, the net revenue impact will be a modest $15 million-$20 million.

No divestitures is a good thing -- for customers and investors

The DOJ's merger conditions are very reasonable and won't impact the economics of the merger agreement. Indeed, Alaska reiterated its target to achieve $175 million of annual revenue synergies and $50 million of annual cost synergies by 2020.

By contrast, major divestitures could have been harmful to consumers as well as investors. Alaska and Virgin America utilize their gate space fairly intensely in key markets like Seattle, San Francisco, and Los Angeles. If they had been forced to give up gate space at any of those airports, they may have had to cut some flights and certainly wouldn't have been able to grow any further.

Obviously, flight cutbacks would crimp profits. And even if the gates went to other low-fare carriers, consumers might be worse off -- especially in San Francisco, where post-merger Alaska Airlines will be the only airline with enough scale to compete effectively with market leader United Continental.

The merger should close soon

With the DOJ approval in hand, Alaska Air should be able to close its acquisition of Virgin America by year-end. That's good news for investors, as Alaska Air is already paying interest on more than $1.5 billion of debt that it raised a few months ago to cover most of the purchase price.

The only major barrier still standing in Alaska's way is a consumer lawsuit in federal court that aims to block the merger on the grounds that it would harm competition. Last month, the judge overseeing that case ruled that Alaska Air and Virgin America must give the court at least seven days' notice following the antitrust review before closing the merger.

Now that federal antitrust regulators are satisfied that the merger will be pro-competitive, it's much less likely that anything will come of the consumer lawsuit. Barring a stunning turn of events, Virgin America's history as an independent company will soon be at an end.

Adam Levine-Weinberg owns shares of Alaska Air Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Alaska Air Group, Inc. Stock Quote
Alaska Air Group, Inc.
ALK
$45.68 (-2.39%) $-1.12
Virgin America Inc. Stock Quote
Virgin America Inc.
VA
American Airlines Group Inc. Stock Quote
American Airlines Group Inc.
AAL
$14.48 (-3.56%) $0.54

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