Why I Wouldn’t Be Surprised to See Virgin America Acquire Frontier

Frontier, Mergers/Finance, Virgin America

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.

Frontier and Virgin?

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.

Virgin and Frontier?

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.

  1. Branson would have to decide he’s willing to pour more money in the airline.
  2. Branson would have to find more people willing to put money in as well.

What do you think?

[Original Virgin America Photo via Flickr User dtweney/CC 2.0]

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49 comments on “Why I Wouldn’t Be Surprised to See Virgin America Acquire Frontier

  1. Like the analysis– a lot.

    I am sure that some posters will say things like, “well, Virgin America uses Charmin and Frontier has always been a Quilted Northern-type of airline,” but it makes sense to me.

    Besides, crazier things have happened.

    One question: do you know if Republic has ever patched things up with the former Midwest mainline pilots?


    1. I don’t believe they have. They are also facing a big seniority integration fight between Frontier pilots and existing Republic pilots. That will seemingly go away if Republic does indeed become a minority shareholder.

    1. +1

      Without some sort of bankruptcy, I don’t see why anyone would really want to acquire Virgin America given how much debt they are in. Sure, they have new A319s and a few good slots, but right now, profitability and margins are essential rather than extra capacity.

    2. They don’t start making money without a dramatic shift in course (or oil dropping to $30 a barrel again). I agree it would be like two drunks holding each other up, but those drunks are low on cash and need some more to afford more alcohol. This could get them more cash to burn on liquor.

      (And Fred, nobody is suggesting that anyone acquire Virgin America. This would be the opposite.)

  2. Cranky – Maybe you could so the same exact article for Wednesday, except substitute Virgin for US ? Your analysis is great.

    People have always talked about Republic and US. I presume that Republic and US have at least talked ? To me biggest differences are inflight with directv and stretch seating. Almost (and I say almost – there are others) everything else seems complementary and fleet type is Airbus.


    1. Republic and US or Frontier and US? The difference is that US Airways doesn’t have cash to put into this deal and an acquistion of Frontier would be a distraction that adds little value to US itself. (Though I have no doubt they looked at this during Frontier’s bankruptcy.) Why does US need another low fare hub in Denver? It doesn’t. I can’t see why US would touch this unless it got them some unbelievable deal on regional flying via Republic.

    1. Absolutely. Nobody at Virgin has more than 3.5 years, so FAPA would come out well, even if adjustments were made. It would also be easier for Frontier to dominate. They have about 700 pilots at Frontier while Republic has over 2,000. Virgin America has less than 500.

    1. I think the plan was to find a place to fly a bunch of Republic airplanes that had no home. That seemed to have worked. The whole profit thing? Maybe not so much.

  3. Two airlines who lack pricing power getting together equals a bigger airline with no pricing power and still no city or region to call their own. How long until Virgin stops storming into other airline’s hubs? Their future picks such as Houston, Newark, and the already announced Dallas and Chicago remind me of PeoplesExpress who did great flying to the Buffalo’s and Columbus’s of the world, but got into big trouble going to the Dallas’ and Chicago’s of the world.

    1. Well, Virgin likes to base its whole premise on the fact that it’s going to fly to the big business markets and provide an alternative to other airlines. So if it really wants to stick with that plan, it needs to be in Dallas and Chicago. Now, whether that’s a good plan or not . . .

  4. One major problem I see with this scenario is the hyper competitive situation in Denver, Milwaukee, Los Angeles and San Francisco where both airlines are going head to head with both United and Southwest.

    The America West / US Airways situation was very different that way. US had (and still has) a significant market share advantage in PHL and is dominant in CLT. America West was reasonably competitive (in a two way battle with Southwest that was there from HP’s inception) in Phoenix. Frontier and Virgin America have no such advantages.

    Frontier and Virgin America have no real geographical strengths, unless they want to focus on OMA and MCI. Maybe the best long term solution is to sell both to United. That would really dilute Branson’s stake.

    The 800 pound gorilla in the room for Republic is the overall health and the future of the regional airline sector. If I remember correctly, that’s what prompted Republic’s investment in Midwest and Frontier in the first place; it wanted more diversification of its flying portfolio. That challenge hasn’t changed. If anything it’s gotten worse. There’s way too much to this topic to continue here.

    1. A buy out by UAL???? They are going to take years to merge CO with UAL and the fun has yet to start with a co mingled carrier. Now add to more cultures to the already screwed up logic on board???

      1. Republic put three carriers together at once; Republic, Midwest and Frontier, so it’s not impossible. Most airline managers and employees can walk and chew gum at the same time (I’m really showing my age with the last part of this comment, a reference to the late former president Gerald R. Ford).

    2. You’re right on the rationale for the original purchase by Republic, DesertGhost. And the regional business has just gotten worse, but Republic is one of the best, lowest cost providers around. It will just keep getting its margins squeezed. But at least those are positive margins. Frontier’s have been very, very negative and have definitely dragged down Republic’s results.

      1. I completely agree with your assessment of Republic’s regional operations. It’s going to be one of the survivors of a contracting sector. Not only is it an efficient operator; it has the one of the largest operations in the 70 plus seat segment, the real future of regional flying in my humble opinion. That’s why I feel cutting bait is its best strategy at this point. And the best carrier to do that with, from a capacity perspective, is United.

  5. I have not flown Frontier in over 8 years due to crappy service and always late flights, I would welcome the Virgin brand and would fly that carrier if merged.

  6. I’d be even less surprised if AA acquired Alaska Airlines, which has an extremely well designed nationwide route network that somehow avoids practically any duplication with AA yet it touches major AA gateways — MIA-SEA, BOS-SEA and LAX-ANC for example. Also many West Coast-Hawaii routes with no competitors. The AS 737 fleet is compatible with AA’s. AA is the only remaining legacy carrier that hasn’t acquired another.

    1. Why do people think that Alaska wants to merge with someone? I would be very surprised if that happens.
      They are doing very well alone, customers like them, and they have low costs. If AA wants to merge that’s different, but it’s not going to happen anytime soon. The ‘loser’ airlines would merge so they might have a fighting chance, but if airlines are doing well they have little to gain.
      The only thing AS would gain is routes all over the country rather than to/from SEA/PDX/Alaska, but they already have partnerships with AA and DL that work fine.

  7. If Virgin America bought Frontier, it doesn’t mean they would stay in Denver at all. Why fight with UA and WN if you can use the planes elsewhere with a slogan….

    “Virgin Frontier, where no man has gone before”

  8. Sounds a lot like the circumstances that Midwest Airlines found itself in 3 years ago. Republic wasn’t the answer for Midwest and they haven’t been the answer for Frontier. The Frontier pilots are going to get a taste of the same medicine the Midwest pilots were forced to swallow. Good luck Frontier and Virgin pilots.

  9. This won’t ever happen. First, their business plans are far too different. Frontier focuses on funneling people through their hubs in Milwaukee and Denver. Virgin focuses on point to point traffic in major markets. Frontier has been angling for smaller markets/subsidized ones not served by anyone else.

    Cost wise, Frontier has great costs now except for the Chautauqua fifty seat jets although I believe those are eventually slated to leave as the E190’s fly in. Virgin’s cost structure is too high even for its current business model, let alone a hyper price competitive market such as Denver and Milwaukee, and any merger would result in the higher airline’s cost structure dominating.

    Replacing Virgin America with Frontier would doom the one major advantage Frontier has over Southwest and United, the people of Denver’s loyalty. Southwest has not been getting as much O&D from Denver due to this, relying instead upon O&D from other markets to pump up its Denver growth. Removing this well loved brand and replacing it with an English one would likely erase that advantage.

    Frontier will soon be obtaining some relief in Milwaukee as Airtran’s Skywest flying goes away (ends September 6th, retaining only Akron/Canton and Des Moines with large jets, be interesting to see how long that lasts), more A320’s and E190’s arrive, and as Southwest pulls down some unprofitable flying. At the moment, it appears Frontier will get Indianapolis, Omaha, Pittsburgh, and St Louis all to itself once more. Without the Airtran merger, they already removed a flight to Kansas City and made Tampa seasonal. Also, Milwaukee will probably lose some FL/WN service to slot markets such as New York LaGuardia and Washington National, retaining enough to be competitive in order to transfer slots to markets such as Chicago Midway.

    The only way anyone would ever want Virgin America would be if they wanted to simply take out a competitor. Sure, JetBlue could buy them out, phase out the VX product, develop the SFO/LAX bases especially with the E190, and eventually lower cost structures to match theirs. AA, UA, and DL could all do the same. However, I would imagine that all of these carriers would rather seen them spiral slowly into liquidation as it costs a lot less. I wonder what the carrier would be worth?

  10. Well, Denver may be getting ready to get real interesting. I fly UA a lot (Prem Exec 7 years in a row) and more than one UA employee has told me UA is getting ready to downsize Den to less than hub status. The downsizing is (was?) going to start in Oct. One employee even said there will be no UA regional flights, and possibly even no flights to some of the remaining hubs(Dulles). The reason for the downsizing-Den is a financial bloodbath at the moment, and the merger ain’t cheap-at least this is what the worker bees told me.

    1. That’s a lot of flights to move out of Denver. So many in fact that I doubt it happens because of the disruption it will have on all the regional locations served by Denver. The nearest big mega hubs would be Chicago and Houston and both are located on the edges of the North/South US…not a good spot to distribute regional service to places four states away, places which Denver currently serves. It could be done but it would be ugly.

      1. I think that there may be some reduction in DEN, but not in the immediate future (2-5 years). It simply is too big with a good location to just kill a lot of flights. Sure, redundant flights will disappear (so you fly through IAH instead of DEN) but most flights will stay for the time being. Not too much will change in the time it takes VX to go bankrupt (!)

        Even though the DL/NW merger was 3+ years ago now, MEM has shrunk a bit but it still has a good number of mainline and RJ flights including AMS.

  11. Please…nobody is going to buy a massive amount of our debts (except for other countries in Asia). Now that I got the bad joke out of the way let’s be serious. Virgin left the “wowing them” phase and is now in the “show me the money” phase. Yes; people love the product. At what cost? Remember Song. Virgin is in ORD now. Well guess what? There is too much competition. They should start to fix their balance sheet. So, unless they start making massive smart decisions that effect their cash flow (all at once) they won’t be around. If Branson wasn’t in this equation they would have been gone already.

    I’ll say it once and I’ll say it again. I love Virgin America. I love competition for benefiting the people. BUT if I were an investor; I would’ve yanked my money out a long time ago. Nobody (only considering airlines and investors of airlines) will buy them out. They have too much debt. And this economy is not helping them either.

  12. I think it’s crunch time at both F9 and VX. Hobbling the two together might buy some time in the short term, but long term viability is iffy at best. This version of Frontier finds itself in the same position as the first version: being crushed by two 900lb gorillas at its home market, DEN. F9 has MKE and MCI, which the old Frontier did not, but MKE is under yield assault from AirTran and MCI is limited in growth options due to WN. WN is sure to rationalize MKE flying, but can F9 hold out that long? And even if it catches a break at MKE, it wont be enough to offest the ongoing bloodbath at DEN.
    There was an article online the first of the year entitled “Brands That May Disappear in 2011” and Frontier was on the list. I posted a link on airliners.net and there was a limited discussion on it, but most people there laughed at the idea. Now with the financial situation at F9 and the seemingly drastic cost cutting, the analysis may have been more spot-on than people knew.
    I wish the best for Frontier, but I think we are gonna see “something” happen at RAH in the next 12-18 months which may spell the end of Frontier either as an entity or separate brand.

    1. They are ADDING another MKE to DEN flight? They have one because they have to… How can that possibly make any money against Frontiers 6x daily service? Not to mention the two daily flights United makes using Skywest?

    1. Because JetBlue wouldn’t get anything worthwhile out of the deal. JetBlue is a profitable airline with a good cash balance, so it’s not trying to create a story to encourage further investment. If it just bought Frontier, it would buy a money-losing operation in low fare hubs with serious pressure already. It just doesn’t need it and most likely doesn’t want it.

  13. Frontier & Vergin American merging would be not to dissimilar to the merger between Sears & K mart. You cant take two failing businesses, merge them & end up with a successful enterprise.

  14. So cranky, you don’t see any chance at all that JetBlue could come in, grab Frontier, reduce there DEN hub, and put those planes on some of the JetBlue routes? Would it really be that un-worthwhile for JetBlue?

    1. I just don’t see it. Why would JetBlue want to do that when it’s been only deferring deliveries over the last few years? If you want airplanes, those are easy to get these days. But why take all the baggage on from Frontier if you’re just going to cut Denver back and move the airplanes elsewhere?

  15. Hey Cranky,

    Do you find it odd that F9(republic) is spouting all this financial doom & gloom while there is widespread labor unrest? I guess my question is: do you believe their claim of impending bankruptcy if they don’t raise cash by the end of the year? It seems like a big coincidence that this is happening while their regional pilots are talking about a strike.

    1. Well, the numbers are ugly and they are relatively low on cash over there, so I don’t think they’re making anything up. Are they possibly embellishing on timing of doom and gloom to create more urgency? That’s always possible, but it’s definitely not a rosy situation over there.

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