EADSF - Airline Merger: Alaska Airlines To Buy Hawaiian Airlines At Mega Premium

2023-12-03 21:07:05 ET

Summary

• Alaska Air Group announced an agreement to acquire Hawaiian Holdings for $1.9 billion, with $235 million in expected synergies.
• Alaska Air Group is expected to finance the merger with a combination of cash, marketable securities, and debt.
• The merger is set to close in 12-18 months pending regulatory approval and shareholder approval from Hawaiian Holdings.

While the spotlight in the airline industry is on the combination of JetBlue ( JBLU ) and Spirit Airlines ( SAVE ), Alaska Air Group ( ALK ) is stealing some of the thunder as it announced an agreement with Hawaiian Holdings ( HA ) to combine. In this report, I will be discussing the details of the transaction and I will be focusing on in what way these airlines are compatible or not.

Cost Pressure Fuel Merger and Acquisition Momentum In The Airline Industry

Following some lean years in the airline industry, it should not come as a surprise that airlines are increasingly looking at mergers and acquisitions to bolster their business. In some sense, the momentum in the M&A space has been somewhat delayed because governments have kept airlines afloat during the pandemic, and as lockdowns eased demand for air travel surged, but as we're seeing a very challenging backdrop that I previously discussed M&A becomes more and more straightforward despite the complex setting to gain regulatory approval. We're currently seeing softening in unit revenues while labor costs are rising and fuel prices have also headed higher.

In its most recent earnings report, Alaska Airlines saw yield drop 10% and revenue per available seat mile drop 12% while capacity increased 14%. Wages increased 17% on a 4% growth rate in FTEs reflecting higher pay in the industry. Fuel costs in the third quarter were 11% lower but are not providing a realistic projection base.

It's quite evident that since May 2023, fuel prices have started to head higher and that means that whereas Q3 provided higher labor costs but a lower fuel bill, Q4 likely will include higher labor costs and a lower positive impact from oil price fluctuations. If we combine that with weakening unit revenues, it's quite evident that there's a margin pressure that cannot be offset by increasing fares which is what airlines have been able to do for some time since Q2 2022. When I discussed the [[JETS]] ETF, I pointed out that some cost rationalization and management are required and one way to do that is to trim capacity expansion to stabilize unit revenues with the cost balance. Mergers and acquisitions are one way to achieve that as well as a bigger airline allows for cost to be amortized more efficiently.

Alaska Airlines Buys Hawaiian Airlines

Alaska Airlines is aiming to acquire Hawaiian Airlines for $18.00 per share in an all-cash deal, putting the equity value of the deal at $1.0 billion with assumption of $0.9 billion in debt, which would put the enterprise value at $1.9 billion with $235 million in run-rate synergies within two years after closing of the deal.

How Will Alaska Airlines Finance The Merger With Hawaiian Airlines?

During the conference call discussing the merger details scheduled for Dec. 3, 2023, at 3:00 p.m. Hawaii Standard Time, we will likely hear how the deal will be financed. Alaska Airlines currently has cash and cash equivalents of $647 million and marketable securities of $1.8 billion putting the total cash and marketable securities at $2.45 billion. So, the company could be financing the deal from its own pocket. But given that Alaska Airlines keeps around $2.5 billion in cash and marketable securities which covers their debt I would expect that the deal will be financed with a combination of both, and this was later also confirmed by a slide deck that was uploaded by Alaska Airlines.

When Is The Alaska Airlines and Hawaiian Airlines Merger Set To Close?

Alaska Airlines expects that the deal could be closed in 12-18 months pending regulatory approval and approval of Hawaiian Holdings shareholders which the company expects to be sought by the first quarter of 2024.

Are Hawaiian Airlines Shareholders Getting A Good Deal?

The short answer is "yes." The current share price is $4.86 and shareholders will be getting $18 per share which provides a 2.7x premium. Generally, it's quite difficult to establish a justified premium.

I looked up the premium paid for the acquisition of several passenger airlines in the US and found the following:

Note: The combination of American Airlines ( AAL ) and US Airways has not been listed as contrary to the other mergers and acquisitions it was an all-stock deal.

Valuing Hawaiian Holdings is certainly not an easy task with negative EBITDA expected for the year rendering an EV/EBITDA valuation for 2023 useless. The cash and marketable securities are valued at $22 per share, so the company being valued at 0.8x cash available, which I think is not a bad thing given that there's also debt outstanding. In fact, I don’t believe that we should be looking at current year figures and should be looking at 2025 figures instead when Hawaiian Holdings should be further ahead in the recovery trajectory which is quite unique to its feeder function for Hawaii. With 2025 earnings in mind and a 90% premium, we would get to a $18.24 price per share which is 1.3% lower than what Alaska Airlines has offered. So, I would say the bidding price of $18 per share is fair and I think the 90% premium against 2025 earnings also can be justified given the unique positioning of Hawaiian Airlines.

Acquisition Price Reflects Struggles Hawaiian Airlines Faces

Generally, I view the transaction value as a fair price for Hawaiian but that is not so much driven by EV/revenue or EV/EBITDAR figures as Alaska is getting the better deal here with an EV/revenue transaction value of 0.7x compared to 1.7x on average and an average of 7.4x EV/EBITDAR compared to 3.1x offered. Why do I think the price is still a fair one? The reason is the operational challenges Hawaiian faced this year. The fires in Maui resulted in $25 million lost revenue and weakness in unit revenues as demand will gradually rebuild. Apart from that the company has had some challenges reviving its business as travel from Japan took longer to revive and there are problems with the Pratt & Whitney PW1100G turbofans keeping two to four out of 18 A321neo airplanes grounded and the introduction of the Boeing 787-9 has also been delayed into next year.

A ll of t hat provides a pretty solid base to negotiate a below-average acquisition price for Hawaiian Airlines and I still think that's a good deal as it reflects a premium to 2025 EV/EBITDA valuation. On a 12-18 month approval trajectory, this means that shareholders have to wait and see but are paid an 87.5% premium for that.

Assessing Fleet Compatibility: A Very Odd Fleet Combination

From a fleet perspective, I can say nothing else other than this being a highly interesting combination that does not directly make sense to me. Alaska Airlines is an all-Boeing operator on its mainline fleet and it spent the past years becoming an all-Boeing operator again as it absorbed Airbus A320 family airplanes from the acquisition of Virgin America.

In fact, the company did not retire the last A321neo until recently as noted during the Q3 2023 earnings call:

As Ben mentioned, we crossed a significant milestone to end the third quarter as we retired our last Airbus from service. And in wrapping up our Airbus era, we announced this morning that we reached an agreement to sell the 10 A321s to our partner, American Airlines, and expect deliveries to occur over the next two quarters.

That effort is now in some way suffering a setback and one can wonder whether Alaska Airlines is interested in maintaining a relatively small fleet of Airbus airplanes. In the single-aisle fleet, Airbus would have a 7% share, and in the wide-body passenger fleet, the current fleet would be all-Airbus though Boeing 787 deliveries are expected in the years to come. So it will be highly interesting to see what the company will do with the Airbus fleet. I would not be surprised if Alaska Airlines would be looking to get rid of the Airbus fleet, which I believe should not be a major issue given market demand for next-generation single-aisle airplanes. The Airbus A330s might pose a bigger problem as they're not high in demand and one can wonder what the combination of Hawaiian and Alaska Airlines means for the contract Amazon ( AMZN ) has with Hawaiian.

Network: Unique Access Strength And International Exposure

If we look at the Hawaiian Airlines network, we see it has most of its exposure to the US West Coast but with some US East Coast destinations as well as international destinations in Japan, Australia, South Korea, and New Zealand.

As a combined entity, Alaska Airlines and Hawaiian Airlines will have a firmer grip on the US West Coast although it remains to be seen what the regulatory requirements will be for West Coast connections to Hawaii. The Alaska-Hawaiian combination has more US East and West Coast destinations which could be helpful to feed passengers into Hawaii. The Hawaiian network will add Asia-Pacific, New Zealand, and Australia to the network which could potentially be helpful in feeding travelers to mainland US.

What Are The Risks For The Alaska Airlines and Hawaiian Airlines Merger?

For the merger, I'm seeing two main risks. The first one is quite obvious and that is the anti-consolidation stance at the Department of Transportation and Department of Justice as well as opposition from lawmakers. Although, I think the current cost and demand environment does push airlines in the direction of M&A. The second - costs related to integration and synergies. Hawaiian and Alaska will both continue operations as separate brands providing services to different audiences with different products but through an upsized network, so perhaps there won’t be a lot of costs on the integration side, but it remains to be seen whether the synergies of $235 million can be achieved. When mergers and acquisitions are announced, we often see synergies touted as great value drivers. And while I would not want to say those synergies have a tendency to not materialize, realizing the synergies is a major challenge.

Conclusion: Alaska Airlines Has A Great Deal, But So Do Hawaiian Holdings Shareholders

I think that overall the low stock price for Hawaiian driven by the challenges the airline faces has opened a very strong position for Alaska Airlines to scoop up Hawaiian Airlines and its unique business as a feeder for Hawaii and neighboring islands at a price that's significantly below industry averages. So, Alaska Airlines is getting a great deal that should also help the company going forward with a broader network and opportunities for beneficial cost amortization while shareholders are paid a premium on implied 2025 EV/EBITDA valuation. The Alaska-Hawaiian route network does add strength to both carriers, but in terms of fleet compatibility, the combination is somewhat odd.

For further details see: