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  • ANALYSIS: Alaska insists Virgin was smart buy as cutover looms

ANALYSIS: Alaska insists Virgin was smart buy as cutover looms

A top Alaska Air Group executive has made clear the company has no misgivings about its 2016 acquisition of Virgin America – a pricey deal that catapulted the buyer into major-player status while driving up costs amid intense competition.

Speaking just weeks before the adoption of a single reservations system – a closely-watched step that, for practical purposes, unites the airlines – chief operating officer Ben Minicucci says Alaska needed to get big to survive.

"People ask: 'Would you do it again?' The answer is absolutely yes," said Minicucci during the MRO Americas trade show in Orlando on 11 April.

"Four airlines dominate the domestic market share. At some point, we sat back and said: 'We need to get bigger,'" he adds. "Not that bigger is always better, but we needed to be bigger to stay relevant."

His comments follow a 16-month period during which Alaska Airlines' parent significantly expanded its West Coast presence, particularly in California, as it merged itself with Virgin America's disparate operation, network, culture and fleet.

Alaska could have expanded alone, avoiding the merger route by using cash on hand to buy 50 or 60 aircraft, Minicucci notes.

But more jets wouldn't get Alaska the space it needed at prime airports.

"You just simply can't go into the San Francisco and Los Angeles and New York airports, because the space is not available. Acquisition just simply made a lot of sense to us," Minicucci says.

Founded by Richard Branson, Virgin America launched operations in 2007 with a brand that proved particularly attractive to tech-savvy travellers and to workers in Silicon Valley. The Burlingame, California-based company grew steadily on the wings of Airbus A320s, and went public in 2014 under leadership of then-chief executive David Cush.

Virgin America had a strong presence in San Francisco – it accounted for 12% of available seats at the airport in late 2016 – and a presence at other major congested airports like Los Angeles International and New York's JFK and Newark. Transcontinental routes between California and New York were Virgin America's bread and butter.

At that time, eight large US airlines had recently consolidated into four – American Airlines, Delta Air Lines, Southwest Airlines and United Airlines. The moves left smaller carriers – Alaska, Allegiant Air, Frontier Airlines, JetBlue Airways, Spirit Airlines and Virgin America – pondering how to respond.

Soon JetBlue and Alaska began bidding for Virgin America, which they viewed as a means to grab valuable transcontinental routes and airport space.

JetBlue dropped out when Alaska agreed to purchase Virgin America for $57 per share, or about $2.6 billion. The deal closed in December 2016, and Alaska's executives estimated that the combination would generate annual economic benefits of $225 million.

Financial analysts generally approved of the deal despite grumblings that Alaska overpaid.

No doubt the merger accomplished Alaska's goal of getting bigger.

The day the deal closed, Alaska's share of domestic seats at California airports jumped from 7% to 12%, while seat share at the important hub of San Francisco surged from 4% to 16%, according to FlightGlobal schedules data.

That was just the start.

Alaska continued its California expansion after acquiring Virgin America, growing available seat-miles by another 17% and launching 36 new routes from the state, according to FlightGlobal schedules data and to the airline.

Alaska's route map in April 2018

Asset Image

FlightGlobal schedules data

Virgin America's roughly 60 Airbus A320-family aircraft were brought into Alaska's single-type fleet of about 150 737s, leading to speculation on whether Alaska would divest the Airbus narrowbodies and revert back to an all-737 fleet.

The company has still not publicly settled that question, though it has started repainting the A320s in Alaska's colours and is modifying the Airbus cabins with a configuration similar to Alaska's 737 cabins, says Alaska's managing director of cabin systems and airframe MRO, Jason Lai.

Flight Fleets Analyzer indicates that the company now operates about 80 Airbus narrowbodies and 155 737s.

In the last five years, Alaska's daily departures increased from 800 to 1,300, revenue increased from $3 billion to a projected $8 billion in 2018 and available seat-miles doubled to six billion, Minicucci says.

BRINGING IT ALL TOGETHER

Alaska has progressed steadily through the merger, ticking off various accomplishments as it works toward completing the process this year.

The company has merged Virgin America's and Alaska's loyalty programmes, implemented a single payroll and benefits system and, in January 2018, received a single operating certification from the Federal Aviation Administration.

In addition, pilots and flight attendants now work under the same collective bargaining agreements. Alaska has also transferred most of Virgin America's operations-related work to Seattle, leaving only about 100 staff behind in Burlingame, including mechanics, engineers and sales and marketing staff, Minicucci says.

Alaska also started to repaint A320s with Alaska's colour scheme and logo, an effort that will continue into next year, the company has said.

"The integration is going very well," Minicucci says.

But the effort has not been without its hiccups.

In mid-2017 the company reported that its unit costs had started to creep higher for the first time in seven years. Chief financial officer Brandon Pedersen attributed the increase partly to congestion in Seattle and at California airports and partly to merger "friction". At one point in 2017, two-thirds of Virgin America's flights arrived late, according to government reports.

In late 2017 an arbitrator settled the terms of the new single pilot contract. That deal was costlier than Alaska anticipated, and will push up 2018 costs by $150 million, the airline disclosed. A new single contract for flight attendants cost Alaska extra $9 million in the first quarter of 2018.

Meanwhile, the company's Horizon Air unit suffered significant operational disruptions last year amid a shortage of pilots.

As costs inched up, Alaska's in late 2017 reported that fares on some prime California routes had declined significantly as a result of unexpected competition.

The company has since tweaked its network, exiting 12 routes from California, including those to Cancun, Reno, Orlando, Denver, Mexico City and Minneapolis.

After 40% year-over-year available seat-mile growth in 2017, the company will increase capacity 7.5% in 2018 and only 4% per annum in 2019 and 2020, executives said in January,

As fares fell and costs climbed last year, Alaska's chief executive Brad Tilden insisted the company would recover once it put the Virgin America merger in the past.

"The sooner we get this thing behind us, and get back to what we do well, the better," Tilden said in October 2017. "By the middle of next year, our most critical integration milestones will be behind us."

CRITICAL MOMENT

Alaska is now one week away from perhaps the most-watched milestone in any airline merger: the transition to a single passenger service system, which is the technology that processes sales, reservations, flight check-in and flight scheduling.

It is a step known to mar otherwise smooth consolidations – one that tends to generate unflattering news headlines when it goes awry.

Alaska is set to flip the switch on 25 April, at which point all Virgin America-branded flights will become Alaska Airlines flights. The night before, the company will eliminate nearly all Virgin America's branding except the red paint on its former aircraft, says Minicucci.

"In the eyes of the customer we… become one airline. One reservations system. One check-in. One mobile app. One call centre. It all comes together," he says.

And Alaska is ready, Minicucci adds, noting the company conducted numerous tests and "many dry runs".

After the reservations system cutover, 75% of the merger will be complete, says Minicucci. Only the integration of several back-off computer systems will remain outstanding, and Alaska expects to complete those by the end of 2018, he adds.

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