This may sound crazy, but hear me out. There were two separate pieces of news last week concerning Virgin America and Frontier that got me thinking about a combination between the two. Both are low on cash and need to raise more. This is one way to do it. It may not be a good idea, but that’s never stopped airlines before.
The first piece of news was that Virgin America posted yet another awful loss in the first quarter of the year. How bad? The airline posted a negative 14.7 percent operating margin and a negative 22.2 percent net margin. There’s only $25 million in cash in the bank. Not good, but not surprising either.
On the other side, we saw Frontier parent Republic strike a deal with the pilots union. If the union members vote for the deal this week, they will agree to postpone a pay raise, cut back benefits, and extend the existing contract for an additional two years. In return, Republic will start a profit-sharing plan, put growth requirements out there for aircraft, begin the restructuring program by the end 2011, and raise cash.
How will the airline raise cash? Republic will raise “at least $70 million . . . through one or more debt issuances or other financings,” and the company will make a “good faith effort . . . to attract equity investment(s) in Frontier that would reduce the Company’s ownership of Frontier to a minority interest by December 31, 2014.” That’s right, Republic will do its best to become a minority shareholder in Frontier, effectively letting Frontier go it alone once again.
With this scenario set, I started thinking about a combination between the two. Frontier isn’t going to be able to get that $70m+ loan for cheap . . . unless Sir Richard Branson provides the loan at a low interest rate.
Meanwhile, if Virgin America buys a majority stake in Frontier, Branson will have his share in the combined airline diluted, so he can pump more money in to get back to the 25 percent foreign ownership cap. That seems crazy to pour more money into two airlines that are losing money, but a lot of the airline business is driven by ego and dreams and not business sense. (Reason #518 why the airline business has always sucked.) Then he would just need to find some other money people (American citizens, of course) to put more money in to help pad the cash cushion and provide the rest of the equity. That’s probably the hardest part.
For Republic, this makes some sense. It would undoubtedly keep flying Embraer 190 aircraft for Frontier but on a more traditional express capacity purchase arrangement. I imagine a deal like this could include deploying more of those airplanes into the current Virgin America system. So Republic gets out of Frontier (mostly) but keeps its airplanes flying with the new airline. The only thing it has to lose is its remaining investment in the combined airline, if it thinks that the airline’s fate could be worse than its current predicament (something that’s not entirely clear). Besides, who else is going to pony up the cash for Republic?
The rationale for Virgin America is less convincing. If Virgin America does this and takes over Frontier, it will undoubtedly end up standardizing around the Virgin America name and product. It can use that as part of the pitch to the money men. Can’t you see it? “Frontier is too similar to Southwest right now, so we’re going to leapfrog Southwest and create a killer product that will take people away from Southwest in droves.”
Does the Virgin America product work in Denver going up against heavy competition from United and a growing Southwest, regardless of product? I doubt it. People might like it, but they aren’t going to pay a lot more for it. And Virgin America’s superior product doesn’t come cheap. Besides, a lot of the flights from Denver are in the 2 hour range, when the onboard offering doesn’t matter nearly as much as on longer flights.
I know, this sounds crazy. Combining two airlines in trouble usually doesn’t make sense . . . or does it? America West and US Airways successfully did just that, but that was a different story. America West management went into US Airways in bankruptcy and cut costs, ditched airplanes, and basically cleaned the place up. The money flowed and that was a successful merger. (You can talk about the pilots not being merged if you want, but neither airline would exist at this point without that merger. It was successful.)
The problem here is that Virgin America and Frontier don’t have nearly as compelling of a story. What changes? Virgin America brings its brand to Denver and makes a better (pricier) product offering available. There are no great “synergies” between the two that will help wring out costs. But it does create a larger airline . . . with more cash. That doesn’t solve its problems but it buys more time to try to solve them.
Ultimately, something needs to happen with each of these airlines. They’re both short on cash and Republic has made it clear that it is in the market to raise money as part of this pilot deal. I just don’t see Branson backing down from Virgin America, so would he dig a deeper hole? This is the kind of scenario that, while not really making much sense to me, wouldn’t shock me at all if two things happen.
- Branson would have to decide he’s willing to pour more money in the airline.
- Branson would have to find more people willing to put money in as well.
What do you think?