A Sept. 30 deadline is approaching for the Department of Justice to act on Alaska's planned $4 billion purchase of Virgin America, and as the date draws closer investors are getting nervous about the transaction. Shares of Virgin America are now trading about 6% below Alaska's offer price, a spread that has widened significantly in the last two weeks.
While a DOJ lawsuit to block the deal as of now is unlikely, a source close to the deal predicted the companies will likely agree to extend the deadline to allow for more talks with the regulator. Representatives from the airlines have reportedly held a series of face to face meetings with DOJ antitrust officials in recent weeks seeking a compromise to address potential concerns and allow the merger to proceed.
In theory, approval for Alaska and Virgin America should come easy, especially considering that since 2008 the DOJ has given its blessings to a series of transactions involving Delta Air Lines and Northwest Airlines, United Airlines and Continental, Southwest Airlines and AirTran and most recently American Airlines and US Airways that have led to a "Big Four" controlling nearly 80% of domestic capacity.
This deal involves two minnows and would arguably create an entity better-able to compete with the giants, a scenario that should help consumers. But the DOJ has shown remorse over allowing those deals to proceed, launching multiple investigations into airline pricing in recent years and pushing back on smaller deals between airlines to swap assets at certain airports, and is seemingly currently suspicious about any and all airline deal-making.
Despite the concern, most in the industry still believe the deal will get done. Raymond James analyst Savanthi Syth, in a note, called the merger skepticism "largely unwarranted," saying she expects a concession agreement to be reached and the deal to close as early as late this year.
"While any airline consolidation would likely be scrutinized heavily following the legacy consolidation phase, we believe that due to limited overlap and relatively small market share that does not significantly alter control of the industry, the merger should still close accordingly," Syth wrote. Virgin America overlaps on just six of Alaska's 220 routes, she noted, and even combined the two airlines' would rank fifth in market share at crowded Los Angeles International Airport.
Alaska/Virgin would control about 22% of seats on domestic West Coast flights, in line with Southwest's 26% share and 17% share held by United Continental. Alaska's current pre-merger share is 18%.
There appears room for compromise. At airports including San Francisco, Los Angeles and Seattle, Alaska might be asked to give up gates or agree to at least temporarily trim service. The combination could also be forced to either commit to or sell Virgin America's slots at Dallas' Love Field, a capacity-restrained airport. Southwest and Delta are currently in court fighting over access to that in-town airport, and other airlines have been turned away.
Virgin America acquired the Love Field presence thanks to divestitures required as part of another deal, the 2014 merger between American Airlines and US Airways.
Morgan Stanley's Rajeev Lalwani also believes the deal will get done, and said Alaska is well-positioned even if it does not. The airline pre-merger traded at a premium to its peers and some investors at the time of the deal announcement criticized the merger as expensive and adding significant integration risk.
Virgin, however, could see its shares fall more than 40% in the event of a deal collapse should the market restore its stand-alone valuation to the low-end of its peers.