Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Leave it to an airline to command one of the year's most sky-high premiums.

Virgin America, the carrier backed by billionaire Richard Branson, announced on Monday that it was selling itself to Alaska Air for $57 a share, or about $4 billion including debt and aircraft leases. That's an 89 percent premium to Virgin's average price in the days before news broke last month of a possible deal -- and well above any price Virgin has ever reached in its less than two-year tenure as a public company. No investor is going to complain about selling at the top, particularly when price wars and rising costs make Virgin's stand-alone future less certain.  

Ready for Takeoff
Virgin America's highest price as a stand-alone company was about $44. Alaska Air is offering $57.
Source: Bloomberg

For Alaska Air, the deal's strategic logic is sound: Buying Virgin will allow the Seattle-based carrier to strengthen its presence on the West Coast in the face of growing competition from Delta and add valuable routes at slot-controlled airports including LaGuardia and Washington D.C.'s Reagan airport that would have been hard to obtain otherwise. But the price tag gave investors a little sticker shock: Shares of Alaska Air dropped more than 5 percent in early trading.

Yes, airlines don't come up for sale all that often, meaning some kind of scarcity premium is necessary. And yes, Alaska Air also had to pay enough to outlast JetBlue in what CEO Brad Tilden called a "hard-fought" bidding battle. But it's acquiring an airline whose net income is forecast to drop this year and which just reported two straight quarters of declining passenger revenue per each seat flown a mile. That's partly a function of Virgin becoming a more mature airline and starting to take on the cost structure that comes with that. It's also a sign that the good times of record profitability for airlines amid historically low fuel prices may be coming to an end.

High Flier
Virgin America is commanding one of the highest premiums among North American takeovers of more than $1 billion this year.
Source: Bloomberg
Premiums are calculated relative to the target's 20-day average price before the announcement of a deal. The premium for the Virgin America takeover is calculated relative to the average price before March 23, when Bloomberg News reported the company was exploring a sale.

Alaska Air's clean balance sheet means it will have no problem funding the deal and an acquisition should add to earnings even before accounting for the $225 million in eventual projected synergies, according to data compiled by Bloomberg. Just because the math works, doesn't mean Alaska Air isn't stretching, though. Looking at the deal from a valuation perspective, the bid ranks on the high end for airline transactions as a multiple of Ebitda. Alaska Air is putting itself in a position where it's banking on a lot of things going right in an industry where mergers have often gone horribly wrong. No investor likes buying at the top, either.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net