Acquired Episode 10 Virgin America

In episode ten of Acquired, hosts Ben Gilbert and David Rosenthal discuss the non-technology acquisition of Virgin America by Alaska Airlines, highlighting their fascination with the airline industry. Despite the deviation from their usual tech focus, they delve into the strategic implications of the $2.6 billion deal, emphasizing the significant premium paid by Alaska Airlines and the challenges of integrating Virgin America's Airbus fleet with Alaska's Boeing-dominated lineup. They also touch upon the industry's consolidation trend, the role of brand affinity in the acquisition, and the potential impact on Alaska's financial structure. The episode features discussions on the broader airline market dynamics, including the influence of fuel prices on profitability and the competitive pressures airlines face. Additionally, they mention their sponsor, Pilot, a startup-focused accounting firm that provides comprehensive financial services.

• The episode is number ten of the "Acquired" podcast, hosted by Ben Gilbert and David Rosenthal.
• The episode's focus is on the acquisition of Virgin America by Alaska Airlines.
• The hosts express their personal interest in aviation, despite the acquisition not being technology-focused.
• The hosts remind listeners to sign up for email delivery of episodes and to rate the podcast on iTunes.

"Welcome to episode ten of acquired, the podcast where we talk about technology acquisitions that actually went well. I am Ben Gilbert. I'm David Rosenthal, and we are your hosts."

This quote introduces the podcast episode and the hosts, setting the stage for the discussion on Alaska Airlines' acquisition of Virgin America.

• Pilot is a company providing accounting, tax, and bookkeeping services for startups and growth companies.
• Pilot is recognized as the largest startup-focused accounting firm in the U.S.
• The services offered by Pilot are designed to allow startups to focus on their core business by outsourcing non-core functions like accounting.

"Our next sponsor for this episode is one of our favorite companies and longtime acquired partner pilot for startups and growth companies of all kinds."

This quote introduces Pilot as the sponsor, highlighting its relevance to the startup community and its role in supporting the podcast.

• Virgin America was founded by Richard Branson in 2004 and launched in 2007 after overcoming regulatory challenges.
• U.S. laws limit foreign ownership of domestic airlines to 25%, leading Branson to sell 75% of Virgin America.
• Virgin America was noted for its inflight innovations, including Wi-Fi and interactive touch screens.
• Alaska Airlines acquired Virgin America for $2.6 billion, a significant premium over its stock price.

"So Virgin America was actually founded in 2004 by Richard Branson and then had to go through a whole series of machinations to end up finally launching their airline service in the U.S. Not until 2007."

This quote summarizes the founding and early challenges faced by Virgin America, setting the context for its eventual acquisition by Alaska Airlines.

• The acquisition deal includes taking on Virgin America's debt and aircraft leases, totaling an enterprise value of about $4 billion.
• The deal is cash-based and reflects the capital-intensive nature of the airline industry.
• Regulatory review is expected, and the deal may face challenges similar to the American Airlines and US Airways merger.

"So when the dust clears and all is said and done, basically the total enterprise value of the deal ends up being about $4 billion if you include the debt and the aircraft leases that Virgin had."

This quote outlines the financial magnitude of the acquisition, indicating the combined value of cash, debt, and leases involved in the transaction.

• The acquisition is seen as a move to increase capacity and presence, especially on the West Coast.
• Alaska Airlines aims to become the dominant West Coast airline, with the acquisition significantly enhancing its California presence.
• The acquisition's strategic value lies in gaining a brand with customer affinity and expanding route capacity.

"Ultimately, though, what I think they're acquiring here is capacity. They identified the opportunity that they wanted to be the West coast airline, and right now they don't have a meaningful presence in California."

This quote captures the strategic intent behind Alaska Airlines' acquisition of Virgin America, emphasizing the importance of expanding capacity and presence in the competitive airline industry.

• The airline industry is experiencing a phase of consolidation, where airlines merge to achieve greater scale to compete.
• Consolidation is common in mature industries like airlines, differing from the dynamic tech industry.
• The conversation suggests that Alaska Airlines' acquisition of Virgin America is part of this industry consolidation trend.

"This would fit closest to a business line... But I actually think the best categorization is this is industry consolidation."

This quote highlights that while the acquisition could be seen as a business line extension, it is more accurately described as a strategic move within a period of industry consolidation.

• The airline industry has a history of economic value destruction, with significant losses from 1977 to 2009.
• However, recent years (2010-2015) have seen a turnaround, with the industry generating substantial profits.
• The conversation points out the inherent challenges and risks of investing in the airline industry.

"From 77 to 2009, the industry lost $52 billion... Yet from 2010 to 2015... $45 billion of value."

This quote illustrates the stark contrast in the economic performance of the airline industry over different periods, with recent years showing a positive trend.

• Alaska Airlines cites a fundamentally changed industry structure due to consolidation as a reason for bullishness.
• Other factors include constrained airport real estate, growth in leisure travel, and new revenue sources like charging for bags and in-flight services.
• The conversation critiques some of these points, suggesting that not all of them may be sustainable or indicative of intrinsic industry health.

"A fundamentally changed industry structure...constrained airport real estate...new revenue sources."

The quote summarizes the reasons Alaska Airlines provided to investors for optimism about the industry's future, despite its troubled past.

• Major airline mergers have led to a concentrated market, with the top four airlines controlling 80% of US domestic traffic.
• Alaska Airlines' market cap comparison with other airlines and tech giants like Apple shows the relative value capture in the industry.
• The supply chain dynamics, with Boeing and Airbus holding significant power as duopoly suppliers, also affect the industry's competitive landscape.

"Between the top four airlines, 80% of all US domestic airline traffic."

This quote underscores the extent of market consolidation and the dominance of a few major players in the airline industry.

• Virgin America is recognized for its strong brand and customer loyalty, which was a factor in its valuation.
• Alaska Airlines plans to rebrand as Alaska by 2018, raising questions about the preservation of Virgin's brand equity.
• The discussion reflects on the strategic implications of brand integration following an acquisition.

"People who love Virgin love Virgin."

This quote captures the essence of brand loyalty and its significance in the valuation of Virgin America during its acquisition by Alaska Airlines.

• Alaska Airlines anticipates $225 million in net synergies post-integration, indicating cost savings and potential for additional revenue.
• The payback period based on these synergies alone is estimated at 17 years, highlighting the long-term nature of the investment.
• Fuel prices play a critical role in airline profitability, with recent low prices contributing to improved margins, but the future remains uncertain.

"They cite Alaska sites that they'll have $225,000,000 of total net synergies at full integration."

This quote provides insight into the expected financial benefits of the merger between Alaska Airlines and Virgin America, which are used to justify the acquisition to investors.

• Delta has been expanding its presence in Seattle, pressuring Alaska Airlines.
• The conversation suggests that Delta's strategy involves both competing with Alaska domestically and leveraging Seattle as a gateway for international flights to Asia.
• The discussion highlights the differing strategic priorities and market focus between Delta and Alaska.

"Delta coming into Seattle was part about competing with Alaska domestically... But also an even bigger part, probably for Delta, is using Seattle as a gateway for international flights to Asia."

This quote explains Delta's multifaceted strategy in Seattle, which has implications for its competition with Alaska Airlines and the broader industry dynamics.

• High market valuations can indicate buying at a peak, which is risky.
• Synergies often involve cost savings and economies of scale.
• Alaska Airlines and Virgin America have incompatible fleets; Alaska uses Boeing, Virgin uses Airbus.
• Mixed fleets are common among airlines, except for Southwest which uses only Boeing 737s for efficiency.
• The acquisition disrupts Alaska's previously uniform fleet, complicating operations.

"Gosh, it seems like you're buying at the top of the market here, where profits are artificially inflated."

This quote expresses concern about purchasing a company during a market peak when profits may not be sustainable.

"Alaska flies Boeing planes and virgin flies Airbus planes, exclusively Airbus, their entire plane, only flies Boeing and virgin only flies Airbus."

This quote highlights the incompatibility of the two airlines' fleets, a significant operational challenge post-acquisition.

• Virgin America's recent profitability and dual brand strategy as both low-cost and premium is difficult to maintain.
• The Edsel car by Ford is cited as an example of a product that failed due to trying to appeal to everyone.
• Alaska Airlines faced market pressure and needed to expand, leading to the Virgin acquisition.
• The acquisition's success depends on the ability to integrate and leverage Virgin's smaller operations effectively.

"Virgin is sort of only recently profitable."

This quote indicates Virgin America's financial vulnerability and recent entry into profitability, making the acquisition timing critical.

"Ford wanted the Edsel to be everything to everyone."

The Edsel's failure is used as a cautionary tale of a brand's unclear market position, drawing a parallel to Virgin America's strategy.

• Alaska Airlines is significantly larger than Virgin America in terms of passengers, departures, destinations, and profits.
• The acquisition cost is high relative to Virgin America's size and profitability.
• Virgin America's operational growth is limited, especially in the San Francisco Bay Area due to airport constraints.

"Alaska has 32 million total passengers a year. Virgin has seven."

This quote provides a stark comparison of the scale between Alaska Airlines and Virgin America, questioning the acquisition's value.

• Statsig is a feature management and experimentation platform for product teams.
• The platform provides real-time product observability and helps in making data-driven decisions.
• Statsig's customers include notable tech companies, and it facilitates AI feature testing.

"Statsig is a feature management and experimentation platform that helps product teams ship faster, automate a b testing and see the impact every feature is having on the core business metrics."

The quote describes Statsig's primary functions and its value proposition for product teams.

• Both Alaska Airlines and Virgin America succeeded by serving niche markets effectively.
• The principle of starting with a passionate niche audience and expanding applies to technology startups.
• Technology companies can grow significantly by sequentially targeting and capturing niche markets.
• Brand loyalty is crucial for growth and can be a competitive advantage.

"The way you're going to beat Google down the road is you start with a small audience, a small niche of people who love you passionately, and then you grow from there."

This quote suggests a growth strategy for startups to compete with established giants by initially focusing on a niche market.

• Loyalty programs' influence on customer behavior is significant, with airlines historically setting the precedent.
• Consolidation in the airline industry may be necessary to maintain loyalty in a changing market landscape.
• The advent of online travel aggregators has commoditized airline travel, impacting airline profits and loyalty.
• The paradox of loyalty programs is that while they lock in customers, they also make it difficult to maintain multiple memberships, leading to consolidation.
• Southwest Airlines is an example of resisting aggregation, maintaining a strong brand and customer loyalty.

Yeah, I mean, totally. I think that everybody that has done well at loyalty in the last 50 years has taken it from airlines. The question is like do you need.

The quote emphasizes the historical importance of airlines in developing successful loyalty programs and questions the current need for such programs.

Open table. Yeah, add it to the list. Yeah, I'm trying to think about is it necessary, has something changed in the world where it's necessary to consolidate to keep loyalty? Because does something exist now that didn't exist before, where people only ever want to use one airline?

This quote reflects on whether market conditions have evolved to the point where airline consolidation is required to preserve customer loyalty.

And with Slack I think that the network effect was because people were starting inter company slacks. So you would end up with like, oh, I'm in this slack, that's like a social thing or an industry thing. And then it was like, I'm not going to keep using two separate applications.

The quote draws a parallel with Slack's network effect, suggesting that the inconvenience of using multiple platforms may drive consolidation in loyalty programs.

So therefore margins are driven down because airlines get more commoditized. And when they're more commoditized, then there's less profit to be had even though they weren't making a lot of profit before, they need to consolidate to create a cheaper back office to take advantage of economies of scale.

The speaker explains how online travel aggregators have commoditized airlines, leading to reduced margins and the need for consolidation to achieve economies of scale.

• Aggregation theory posits that value in the digital age lies in owning the customer relationship and experience.
• The airline industry, while not fully digitized, shows signs of this theory through the commoditization of backend operations.
• Southwest Airlines' strategy to avoid aggregation and focus on brand loyalty is highlighted as a counterexample to industry trends.

It's interesting, it feels a little bit, it's different because it hasn't fully become a digitized industry, but it's reminiscent of Ben Thompson's aggregation theory, right, where aggregating the consumer endpoint and experience, he argues in the digital 21st century post Internet world, is where all the value is.

The speaker compares the airline industry to Ben Thompson's aggregation theory, suggesting similarities despite the airline industry not being fully digitized.

Southwest has refused to participate in the aggregators to let themselves be aggregated and probably has some of the most loyal customers.

This quote highlights Southwest Airlines' strategy of not participating in aggregators as a way to maintain a loyal customer base, contrasting with broader industry trends.

• The speakers analyze a recent acquisition in the airline industry, considering the financial and strategic aspects.
• They discuss the inflated value of the acquisition due to a bidding war and question the leveraging of the acquired brand.
• The speakers grade the acquisition decision, with varying opinions on the quality of decision-making and the price paid.

For me, I think the value is inflated both by the biding war and by the fact that they bought something that had brand built into the market cap when they're not necessarily going to leverage and in fact have announced they're not going to leverage that brand.

The speaker critiques the acquisition, suggesting that the value was inflated due to a bidding war and doubts about the effective use of the acquired brand.

I'm going to go c minus because what you said is right. But they paid so much money. They paid so much money.

This quote reflects the speaker's lower grade for the acquisition decision, primarily due to the high cost of the acquisition.

• The speakers discuss the balance of luck and skill in success, referencing a talk and book by Michael Mauboussin.
• The paradox of skill is introduced, which states that as the level of skill increases among participants, luck becomes a more significant factor in outcomes.
• This concept is applied to various fields, including sports, investing, and the tech industry.

It is so fascinating. He gives so many great examples that will make you both follow it logically and nod your head and sort of scared about how much of your own success has been out of your control or how much the world is out of our control.

The quote praises Michael Mauboussin's work for its compelling presentation of the role of luck in success and its implications for personal achievement and control.

The paradox of skill is that even in things that are highly skill based, as the level of play gets higher. So imagine the example Malveson uses is basketball, as basketball, which is very skill based, as the level of play gets higher and higher, and the parity of skill amongst the players gets more and more uniform, then luck plays an increasing amount role in the outcome, even though it's a skill based game.

The speaker describes the paradox of skill, explaining how luck can become a significant factor in outcomes as the overall skill level of participants becomes more uniform.

• Crusoe Energy Systems is a clean compute cloud provider specializing in AI workloads, partnering with Nvidia.
• Crusoe's data centers are powered by stranded, wasted, or clean energy, offering environmental benefits and cost savings.
• The company's unique approach allows them to operate in remote locations, differentiating them from traditional cloud providers.

Nvidia is one of their major partners, and literally Crusoe's data centers are nothing but racks and racks of a because Crusoe's cloud is purpose built for AI and run on wasted, stranded or clean energy, they can provide significantly better performance per dollar than traditional cloud providers.

The quote outlines Crusoe Energy Systems' partnership with Nvidia and their focus on AI workloads, leveraging non-traditional energy sources for better performance and cost-effectiveness.

Crusoe, of course, locates their data centers at stranded energy sites. So think oil flares, wind farms that can't use all the energy they generate, et cetera, and uses that power that would otherwise be wasted to run your AI workloads instead.

This quote explains Crusoe's strategy of situating data centers at sites with excess energy, using what would otherwise be wasted to power AI computations.