How Will The Virgin America Deal Alter Alaska Air’s Capital Structure?

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Alaska Air (NYSE:ALK) has recently announced its plans to acquire Virgin America (NASDAQ:VA) for $57 per share in cash. The Seattle-based airline will also assume Virgin America’s long-term debt and capitalized aircraft operating leases worth $1.4 billion, making the aggregate transaction value $4 billion. The primary objective of the deal is to expand Alaska Air’s footprint in California and to strengthen its competitiveness against the top four US airlines. The combined entity is expected to generate annual revenue of more than $7 billion. Alaska Air anticipates revenue and cost synergies of roughly $225 million, to be realized at the time of full integration. Also, the airline forecasts one-time merger related costs in the range of $300-$350 million.

However, the deal entails Alaska Air to assume the long-term debt and lease obligations of Virgin America, which will significantly increase the leverage on its balance sheet. To make matters worse, the airline plans to finance the deal by issuing additional debt of almost $2 billion. This will cause Alaska Air’s capital structure to be highly skewed. Below, we try to examine the impact of the deal on Alaska Air’s capital structure.

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In 2015, the airline’s long-term obligations (debt + post retirement obligations) were close to $850 million. As a result, its debt-to-capital ratio was around 26%, which was among the lowest in the US airline industry. However, with the Virgin America deal, the airline’s debt obligations are expected to jump to $4.2 billion at the closure of the deal (assuming the deal closes at the end of 2016). Consequently, Alaska Air’s debt-to-capital ratio is likely to increase sharply to 59% at the end of 2016. While the ratio is still lower compared to the legacy carriers – American Airlines, United Continental and Delta Air Lines – Alaska Air acknowledges the sudden rise in its leverage and aims to de-lever its balance sheet post the merger. The airline plans to bring down the ratio to close to 45% by 2020.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Alaska Air Group

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