By; Vinay Bhaskara / Published: April 29, 2016
JetBlue Airways recorded a net profit of $199 million for the first quarter (Q1) of 2016, an increase of 45.6% year-over-year (YOY). The New York-based airline bucked overall industry trends and recorded a healthy 6.1% YOY increase in operating revenues to $1.62 billion, though unit revenues (passenger revenue per available seat mile or PRASM) predictably fell 8.0% YOY in what was a rough quarter all around for US airlines on that metric.
The drop in unit revenues was more than offset by flat operating expenses (down 0.2% YOY to be precise) despite a 14.1% YOY increase in capacity (available seat miles or ASMs), which was of course led by a 35.8% decline in fuel expenses to $215 million. Overall, JetBlue’s financial results generated an excellent operating margin of 21.6%.
JetBlue came close to winning Virgin America
When news first broke of the finalized merger between Alaska and Virgin America, and the steep $2.6 billion price tag, our initial view was that JetBlue dodged a bullet. JetBlue only has +/- $1.3 billion in cash and cash equivalents, and buying Virgin America would mean sacrificing the excellent balance sheet that JetBlue has built over the last few years (with $403 million of the $1.7 billion its outstanding debt to be paid off through the remainder of calendar 2016).
Virgin America certainly had some strategic value for JetBlue as it would allow the airline to get closer to being a national airline (still lacking a hub in the central 90% of the country to be fair). The fit between the Los Angeles and Long Beach hubs would have been awkward, but the fleet and the product match up very well, and JetBlue would be well positioned to win the same customers in San Francisco that Virgin America does (“techie millennial” is the stereotype). So at the right price, Virgin America would have made a lot of sense for JetBlue.
It would appear, however, that JetBlue’s management team had a different idea of the right price than we did. In fact, thanks to a recent Securities and Exchange Commission Filing by Virgin America related to its merger, we have a ton of details on what JetBlue did to try and close a deal with Virgin. JetBlue was actually the first airline to approach Virgin about a potential merger, opening talks with Virgin back in November of 2014 as Virgin America was racing towards an initial public offering (IPO). Those talks ultimately did not develop and Virgin completed its IPO on November 19, 2014.
The talks then picked back up last fall as another three US airlines (including Delta, Alaska, and we believe one of the ultra low cost carriers [ULCCs] Spirit or Frontier) jumped into the discussion process for a merger. Throughout the first couple months of 2016, Virgin negotiated with each of the other airlines and provided assessments of the synergies on offer. Delta ultimately dropped out because it did not believe that the merger would win regulatory approval from the US government, and the third carrier dropped out because the synergies from the merger reportedly weren’t large enough.
This left Alaska and JetBlue, which was actually the first to place a bid of $43.00 per share on February 12, 2016. Over the next month and a half, both carriers found themselves in a bidding war for America’s least viable airline, with Alaska offering bids of $44.75, $48.00, $53.50 per share, and JetBlue offering bids of $46.00, $50.00, and $55.00 per share.
On the afternoon of April 1, 2016, Alaska increased its bid to $57.00 per share and JetBlue stood by its $55.00/share best and final offer. Alaska had won the bidding war for Virgin America, but in our view, JetBlue was better off without it. As JetBlue CEO Robin Hayes put it on the airline’s quarterly earnings call:
“As widely reported, we did consider acquiring Virgin America as a way to more quickly build a larger West Coast presence. However, as we explore this possibility, the price reached a level where it became clear our strategic plan for organic growth offered a better path to value creation.”
And Marty St. George, JetBlue’s EVP-Commercial & Planning noted on the call that JetBlue has plans for organic growth on the West Coast:
“We have a challenge in the West Coast with facilities. It’s certainly one of the things we find attractive about Virgin America. We’ve been working with the airport authorities in both airports trying to get additional gate access, and we’re still optimistic that we will get there at some point… Not for nothing, this is one of the reasons why we have been focused on trying to grow in Long Beach for quite a while, because we think it’s a great airport for Southern California. With respect to Northern California, we’re somewhat constrained now. We actually don’t have our own gates in San Francisco today, and we’re always looking for opportunities to grow more.”
Hayes added that, “both of those markets remain priority markets for us [JetBlue] to serve. I mean, we’ve seen a lot of success with our Mint expansion, and we do believe that there needs to be access for airlines like JetBlue to come in and offer more choice and lower fares. And we’re going to be working extremely hard to make sure those – that happens both in LAX and San Francisco.”
Ultimately Virgin America’s value to JetBlue was in the value of its assets – those assets ended up costing too much to be worth it.
Growth focus turns to Fort Lauderdale
Instead, it appears that JetBlue will focus on growing its existing focus cities, particularly Fort Lauderdale. On the earnings call, Robin Hayes stated, “In Fort Lauderdale-Hollywood, we continue to be pleased with our results, as evidenced by a continued strong customer response to our double-digit capacity growth. It is clear, our service, our brand and our network are an excellent fit with the South Florida market. Over the next few years, we plan to grow this focus city to 140 daily flights, or about 75% above our current levels.”
140 daily flights is a massive figure, even larger than what we projected when we analyzed the Fort Lauderdale market last October. The justification for that capacity is probably there with the current fuel environment and economic growth in South Florida, though the tenor of that growth will probably shift to encompass more domestic growth given Latin America’s woes – the recent addition of Mint to the market is a signal of this.
Speaking of Latin America, analysts fretted on the call about Fort Lauderdale growth increasing exposure to Latin America, but Marty St. George largely squashed those concerns: “We have a pretty strong Latin portfolio out of Fort Lauderdale now. And I’d say the last few routes we’ve had at Fort Lauderdale have included domestic routes, routes like Nashville which starts beginning of May, San Diego which starts in June, and we announced New Orleans for this fall. So, we see growth both domestically and internationally, and we’ve got a great international presence there right now. So, I don’t think we’ll look at this as a marked change in our overall Latin exposure.”
JetBlue considering the Airbus A321LR
With the success that JetBlue has found with its Mint product on domestic routes, it has been our view that JetBlue would absolutely expand the product to fly longer range routes to South America (from Fort Lauderdale) and Europe (from Boston and New York JFK). With Latin America’s economy in the doldrums, the focus has probably shifted some to Europe, but in our eyes the A321LR is a no brainer for the next phase of JetBlue’s evolution.
Robin Hayes said as much on the call: “The [A]321LR is something we are looking very seriously at because we think that the incremental amount of complexity that that provides is very manageable. I think a step-up to wide-body is a much bigger deal. I think, it’s something that, whilst one could never say never, it’s something potentially further out.”
Overall, it was another excellent quarter for JetBlue and our view is that over time, they dodged a bullet in not acquiring Virgin America at that price.
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