Virgin America's IPO was opportune. Selling now would continue that streak of good timing.
The $1.5 billion U.S. airline backed by billionaire Richard Branson is working with an adviser to evaluate a full or partial sale after receiving takeover interest, Bloomberg News reported Wednesday, citing people familiar with the matter. It would be a quick turnaround for a company that went public less than 18 months ago.
Virgin soared more than 30 percent in its stock market debut in 2014, propelled by investors' love for airline stocks amid falling jet fuel prices and buoyed profits, and the stock has remained above its IPO price since. (It surged 13 percent on Wednesday's news). But there are signs that the good times may be ending and a sale at a decent price may be just the exit Virgin shareholders need as they face a less certain future.
The expansion of low-cost carriers, price wars at competitive hubs such as Dallas and the pressure to pass along fuel savings have kept airline fares low and reduced the amount of money carriers collect for each seat flown per mile. For now, the drop in fuel expenses is making up for the lower revenue and protecting airlines' profitability, but for how long? It's a tricky balance and the current dynamic can't last forever.
Virgin's relative youth as an airline gave it an advantage over legacy peers burdened by years of union wage negotiations and put its cost structure more in line with that of no-frills ultra-discounters. That's starting to change: Virgin's pilots and flight attendants have both moved to unionize. Maintenance expenses may creep up as well as the fleet ages. Excluding fuel, the company's cost to fly one seat mile, a measure of efficiency, was 8.7 cents at the end of last year -- up from 6.9 cents at the end of 2013, according to Bloomberg Intelligence.
Virgin's attempt to be hip and offer premium amenities means operating margins don't reach the level of the discount carriers. Meanwhile, the company's reliance on a just a few key markets for almost a third of its revenue puts it at a disadvantage relative to the bigger operators, JPMorgan analyst Jamie Baker noted when initiating coverage in January. This quote from his report rings particularly true:
``These are good days to be a US airline. But not all operating models are created equal.''
Analysts still saw Virgin's stock rising on its own over the next year before news of the deal talks, but their average target price has dropped to about $38 as of Tuesday from about $49 in January 2015. Only five out of 13 recommended buying it. It's not hard to understand the appeal of a big juicy premium. And there should be plenty of interest, from other carriers and private-equity firms alike.
Delta is one possibility among the largest operators. Virgin America would give Delta more access to slot-controlled airports such as Newark and LaGuardia and help the carrier build out its business hub needs on the West Coast -- particularly in San Francisco, which doubles as a jumping off point for Asian travel, said Bloomberg Intelligence analyst George Ferguson. Seattle-based Alaska Air also could be interested, though it operates a fleet of Boeing jets while Virgin uses Airbus planes. Because Virgin isn't that big, the antitrust scrutiny may be surmountable, Ferguson said. The merger of American Airlines and US Airways was initially challenged by the Justice Department in 2013, though it was eventually approved.
The most logical buyer may in fact be a buyout firm. Discount carrier Frontier Airlines was acquired by private-equity investor Indigo Partners in 2013. Others could see an opportunity here. Now boarding….
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