Why Alaska Air Group Bought Virgin America Inc.

Merger Monday lived up to its name yet again! Last week, Alaska Air (ALK 0.72%) bought Virgin America (VA) in a deal valued at $4 billion, and shares of Virgin America soared almost 70% on the news.

In this segment from the MarketFoolery podcast, Chris Hill, Jason Moser, and Taylor Muckerman explain how the deal makes sense for both companies. Then, how this deal in particular highlights the pros and cons of investing in the airline industry, and what investors should think about before buying into any company in the air travel space. Last, how this merger sets up Alaska Air a little better to compete with the big guys.

A transcript follows the video.

This podcast was recorded on April 4, 2016.

Chris Hill: Let's start with the merger of the day, which is Alaska Air buying Virgin America in a deal worth $4 billion. And apparently, JetBlue (JBLU 0.07%) was in the bidding for this, and unless, Jason, we're going to see a repeat in the airline industry of what we're seeing in the hotel industry, and there's more back-and-forth and then we have to come back next week and talk about, "Oh, JetBlue had a higher offer!" But this does appear to be a done deal. And certainly, if you're a shareholder of Virgin America, you are having a really good day.

Moser: Sure thing. And I think if you're Richard Branson, you're probably feeling pretty good about this, too. We had talked about, with the whole Marriott/Starwood/Anbang back-and-forth. It was really nice to be in Starwood's position because they obviously had the asset that people wanted. And, I think in this case, Virgin was very much the same thing. This was a property that was in demand, and Alaska Air and JetBlue were going back and forth for it. And I think this makes sense. Alaska Air is the bigger operator, and financially speaking, its balance sheet is in better shape. So, I think that, on the whole, this makes sense. I think if JetBlue kept on going back to the well here, it would promptly become a little more than they could handle.

But I guess my biggest problem, when I look at this from an investor's perspective, my biggest problem with airlines as an investment is that it seems like, as we go forward, there's no real discernible competitive advantage when it comes to airlines. Possibly customer service or rewards for your miles, but even that, really, even the lines are becoming a blur there. I think the number of travelers who care primarily about getting the best deal, I think that number far outweighs the number of travelers who would consider themselves loyal to a particular airline. I'm not denying the fact that there are loyalists out there. But I just think the people who care about getting a better deal outweigh that number.

And I think that trend is continuing. I think more and more people really just care about getting a good deal with an airline they know will get them there in one piece. I don't think any of us gets on a plane anymore and expects much. We just want to get on the plane and get there, right?

Hill: Not much.

Moser: I hearken back to this tweet that (laughs) I saw you send maybe a month or so ago. I think it was for the trip to Austin. You were tweeting the airline, and it was something to the extent of, "Hey, thanks a lot for being four hours late, now I'm sitting next to this guy," and you post a picture of a guy who just took his shoes off --

Hill: Yes. (laughs) 

Moser: So, that to me, that epitomizes air travel these days. You're just not ever going to win, really, at the end of the day. Just get me there safely at a reasonable price.

Hill: Let me go off-topic for one second. So, one of the podcasts that I listen to from time to time is Bill Burr, who's a comedian, The Monday Morning Podcast, and that's where I picked it up. Bill Burr, it's just him on his podcast. It's him talking for an hour, and he'll go down little tangents, that sort of thing. But he'll hit different topics and he'll go on some of these rants and he went on this stretch where he just -- and I'm not going to use the language that he used --

Moser: Why not?

Muckerman: Use your imagination, listeners.

Hill: Because Bill's podcast is designated with the little red E that says explicit, and we try and keep it family-friendly here on Market Foolery. But he just went off on -- because, he's a comedian, he flies around a lot, and he went off on people who get on a plane and the first thing they do is they take off their shoes, and their bare feet -- he just kept calling them animals. "Animals! These animals!" So, that was the thing where I was just like, (sighs). (laughs) On top of the delay, this is who I'm sitting next to.

Muckerman: I was actually going to bring that up, too, except from one of his stand-up specials I saw on Netflix like a month ago, just like, it instantly clicked when you were talking about taking your shoes off.

Moser: Yeah, I mean, I personally have a pretty good feeling when it comes to Alaska Air. I've not ever taken a flight intentionally with them, but we were heading out to Hawaii last year, we had a little bit of a snafu here getting out of D.C. and reshuffled a few things, and we got out to Seattle, we even took from Seattle to Hawaii on an Alaska Air flight -- it was not initially supposed to be an Alaska Air flight, but they were extremely friendly, we got there, our bags were left back somewhere of course because... traveling. And, Alaska Air's customer service was extremely helpful, extremely friendly, I pinged them on Twitter a couple times, very responsive. I mean, the one experience I had with them was really outstanding.

Muckerman: Some of the things I read about it though, the concerns were that, a lot of overlap on flights between these two, both West Coast, mainly, whereas JetBlue has more East Coast flights, so maybe you expand your regions that you're treating. And then, Alaska, mainly with Boeing (BA 0.16%), and they said that Virgin is mainly Airbus, so maybe some issues there in terms of, like, saving money on maintenance with the same airplanes, you're not necessarily going to see that with this deal.

Hill: Well, and that's going to be, I think, one of the interesting things to watch if you're an investor and you're looking broadly at this space, and you touched on it perfectly, Taylor. It is Boeing and Airbus, because Alaska Air is based in Seattle. That's where this now-joint company will continue to be headquartered. Boeing, right there as well. So, it'll be interesting to see if the next shipment of planes ordered comes from Boeing. 

One other thing I wanted to touch on before we move on, first of all, well done if you're a Virgin America shareholder, because this company went public in November of 2014 $23 a share, and the buyout price is $57. So, that's more than doubling in about 18 months.

Moser: I mean, for an airline stock, that's really phenomenal. 

Hill: But here's a quote I saw from the CEO of Virgin America that got me thinking about, not necessarily, "Hey, I want to run out and buy a basket of airline stocks," but, to me, it points to one of the potential opportunities for investors in airlines, and that was, he said -- and this is a quote from, I think, one of the interviews he did, maybe on CNBC, where he said: "It's going to be a long time before you see a new national start-up airline because it's impossible to get gates." And that's the thing, I think it's natural for us as investors who travel to think first and foremost about our own experience. And you're right, Jason, for the most part, unless you are a business traveler doing a lot of traveling, you're looking for the best deal. That said, when you think further about the business that these airlines are in, and how a big part of their business is getting more gates at more airports, expanding their footprint, it makes me think that, "Well, you know what? When we talk about businesses with moats... " There are a lot of reasons not to invest in airlines, but not having a moat isn't on the list.

Moser: No, and I think that's probably one of the most attractive parts of this industry. I mean, there are a lot of question marks there, but the barriers to entry here are just tremendous. I mean, from a regulatory perspective, from an economic perspective, you can't just go out and start up an airline. Just like you said, the gates alone... I guess, maybe that's sort of comparable to a taxi medallion or something. Taxis are obviously being disrupted to a pretty good extent with Uber, I don't think --

Muckerman: We're not going to have digital airports, though. (laughs) 

Moser: But I mean, I think the point still remains that it's not like you can just go buy a few planes and start flying. You have to be able to have a presence at major airports and, obviously, be able to manage your costs wisely as well. Alaska Air has a good reputation for being able to manage the cost side of the business. If I read correctly, they never actually had to declare bankruptcy, which I think is pretty special, considering--

Hill: That's -- (laughs) 

Moser: -- with the majors, it more or less happens like clockwork. So, yeah, from a barrier-to-entry perspective, I do think that is just a tremendously attractive part of that market. The costs involved are always so difficult to manage. And remember, we are in a period of time now where energy prices are extremely low. I can't help but wonder how this would have looked -- if this even would have happened in the face of record-high energy prices, or even somewhat-higher interest rates. But, it is what it is, as they say, and we're here in the present right now. So, I think, with all that said, this was a smart deal, and it brings together two airlines that, while they still won't be as big as the majors, they will be big enough to compete, and they seem to me to have a bigger focus on the customer service side, which to me, in many cases, can be a big differentiator, if they can consistently do that.