Two years ago, Alaska Air (NYSE:ALK) offered a big premium to acquire Virgin America in order to gain a platform for growth in California. Within three months of the acquisition closing, the carrier had announced a massive expansion in California -- including more than a dozen new routes in San Francisco -- Virgin America's hometown.
However, Alaska Air's 2017 financial performance was disappointing, and the company is still struggling with a combination of rising costs and weak unit revenue in 2018. Much of the unit revenue weakness has been concentrated in California. As a result, Alaska Air has quickly gone from expansion mode to retrenchment, making cutbacks on several routes in California.
Making a bid for relevance
Alaska Air bought Virgin America primarily because of its position as the No. 2 airline in San Francisco. That said, it trails market leader United Continental (NASDAQ:UAL) by a wide margin. At the time of the merger, Virgin America served fewer than two dozen destinations from San Francisco, compared to more than 100 for United.
United Continental operates numerous long-haul international flights from San Francisco. It also flies to many small cities in the western U.S., where Alaska Airlines and Virgin America, for the most part, don't participate.
Instead, in its bid to steal customers from United, Alaska Air has prioritized adding flights to midsize markets with significant business traffic. This increases Alaska's "relevance" for travelers based on the West Coast (and especially in the Bay Area).
Thus, between December 2016 and March 2017, Alaska announced 13 new routes from San Francisco. These flights serve Orange County, Minneapolis, Orlando, Mexico City, Albuquerque, Baltimore, Indianapolis, Kansas City, Kona, Nashville, New Orleans, Philadelphia, and Raleigh-Durham.
Going into reverse
On Alaska Air's two most recent earnings calls, management has made it clear that the former Virgin America route network's revenue performance isn't up to par and that underperforming routes were likely to be cut in the near future. That process has now begun in earnest.
In San Francisco, Alaska Airlines recently decided to discontinue two of the routes it added last year. It will stop flying nonstop to Minneapolis and Mexico City in May. The cutbacks have extended to routes Alaska inherited from Virgin America as well. Earlier this month, it stopped flying from San Francisco to Cancun. It has also reduced its San Francisco-Chicago service to just one flight per day. Finally, Alaska will cancel its routes from San Francisco to Denver and Fort Lauderdale during the second quarter.
Elsewhere in California, Alaska Air canceled routes from Los Angeles to Cancun and Havana earlier this year. It will stop flying from San Diego to Mexico City in May and end its Los Angeles-Orlando route in early July.
Most of the routes that Alaska Airlines is dropping primarily serve leisure traffic. San Francisco-Denver and San Francisco-Minneapolis are the only business-focused routes being eliminated. Alaska faced three competitors on each of those routes, and that appears to have been too much to overcome.
This isn't the end
Alaska Airlines plans to focus most of its growth in the Pacific Northwest this year, and it has already reduced its growth plans for 2019 and 2020. However, that doesn't mean it is giving up on California (and San Francisco in particular).
Even after its pending cutbacks, Alaska Airlines will serve more of the top 50 destinations from San Francisco than Virgin America ever did. Furthermore, it already has higher brand recognition in the Bay Area than Virgin America.
For the next year or two, Alaska Air will focus on completing the merger integration process, expanding its frequent flier base in California, and signing up more customers for its co-branded credit card. This will provide a more stable foundation for the company to resume its growth in San Francisco and other California markets a couple of years down the road.