Please ensure Javascript is enabled for purposes of website accessibility

Alaska Airlines Is Buying Virgin America -- but Is the Price Right?

By Rich Smith - Apr 7, 2016 at 6:13PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

With Virgin getting a 90% or so premium over its recent stock value, investors have reason to question the numbers for this deal.


The post-merger Alaska Airlines-Virgin America will have routes covering a good chunk of the continent. But the deal will also cost Alaska Airlines a big chunk of change. Image source: flyingbettertogether.com.

By now you've no doubt heard the newsAlaska Airlines (ALK 0.90%) is acquiring Virgin America (VA) in a deal valued at $4 billion. For regular flyers of both airlines, this sounds like a pretty good deal, merging airlines that -- according to travel website Airfarewatchdog -- are ranked No. 1 and No. 2 nationally for overall performance, into a single larger airline that will be able to deliver that great performance to more customers at more locations.

But what does the deal mean to investors?

Big money
The answer probably depends a lot on which investors you're talking about. As explained by the companies in their merger announcement, larger Alaska Air is the buyer in this transaction, and will pay $57 per share in cash to acquire each share of Virgin America outstanding. That's roughly a 90% premium to where Virgin shares were trading before news of the possible merger began filtering out last month.

VA Chart
Image source: YCHARTS.

The logical conclusion? Alaska Air is vastly overpaying for Virgin America -- but that logical conclusion might not be the correct one.

Price is what you pay, value is what you get
Consider: At its current valuation of roughly $80 per share, Alaska Air stock sells for about 1.8 times trailing sales, and roughly 12.2 times earnings. Virgin America, by contrast, costs only 1.6 times sales at its current market price, and 7.4 times earnings. (Do note, though, that about half of the income that Virgin America "earned" last year came from a one-time tax benefit. The company is likely to be much less profitable in the future than it appears today.)

Even accounting for that caveat, the amount that Alaska Air will ante up for Virgin America is not necessarily too much. On a price-to-sales basis, at least, Alaska Air is clearly picking up its rival at a discount. And even if Virgin America's 2015 profit number was inflated by the tax benefit, operating profits are still flowing strongly at the company. Indeed, S&P Global Market Intelligence data show Virgin earning operating profits of $177 million last year -- a respectable 11.5% profit margin on $1.5 billion in revenue.

What next?
Of course, Alaska Air's own operating profit margin is more than twice that number -- 23.8%. And that's where things get really interesting with this merger.

According to its press release, Alaska Air sees the potential to save $225 million annually from "synergies" by merging the two companies. That would be enough money to raise Virgin America's profitability up to par with Alaska's own -- or better. While success in this is by no means assured, it does seem at least mathematically possible that a combined Alaska Air-Virgin America could be much more profitable than the two airlines operating on their own. What's more, given that Airfarewatchdog ranks Alaska Air (No. 1 in its 2015 survey) higher than Virgin America (No. 2) for overall performance, it's possible that this increase in profitability could be achieved with no loss of quality for either airline.

All things considered, this truly could be a merger made in heaven -- or at least in the heavens.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Alaska Air Group, Inc. Stock Quote
Alaska Air Group, Inc.
ALK
$41.54 (0.90%) $0.37
Virgin America Inc. Stock Quote
Virgin America Inc.
VA

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/06/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.