To The Moon

The stock market’s gains stalled this week, but the major indexes still closed in the green. The best-performing industries are cruise concept, ev charger, food delivery and airlines concept.

Considering the different perceptions of the stock, this time TigerPicks chose $Hawaiian(HA)$ to have a fundamental highlight to help users understand it better.

$Hawaiian(HA)$

$Alaska Air(ALK)$ and Hawaiian Holdings are set to combine in an all-cash transaction, with Hawaiian Holdings shareholders receiving a significant premium. The combined company will have a dominant market share in Hawaii and a large presence on the West Coast.

However, there are concerns about the profitability and cost structures of both companies, as well as potential regulatory pushback. This makes it a risky prospect for Alaska Air Group but one that could pay off nicely.

December 5 was a monumental day for shareholders of both $Alaska Air(ALK)$ and $Hawaiian(HA)$. Shares of the former plunged 14.2% while shares of the latter skyrocketed 192.6% after news broke that the two companies are going to combine. This all-cash transaction removes a significant amount of risk for shareholders of Hawaiian Holdings, but in return, it creates some problems for Alaska Air Group.

This might seem peculiar when looking at the investor presentation released by the management team at Alaska Air Group. When you dig deeper into the historical performance of Hawaiian Holdings, you start to see how this is a rather risky takeover of the small airline. If things go well, tremendous value can be achieved for investors in Alaska Air Group as well. However, this is not something that will be determined overnight. Rather, it will take a couple of years to play out and the initial sentiment of the market is that the purchase is anything but great.

An interesting transaction

When looking at the picture at face value, the decision of Alaska Air Group to acquire Hawaiian Holdings looks like a win-win for both companies and their respective shareholders. Let's start with the easy side of the picture. And that would involve Hawaiian Holdings. In exchange for each share of stock that a shareholder of Hawaiian Holdings owns, they will receive, upon closing of this transaction, $18 per share in cash. To put this in perspective, that translates to a massive premium over the $4.86 per share that the stock was trading at immediately prior to the announcement on December 3. Even now, there seems to be a nice chunk of upside that's on the table. I say this because, on December 5, Hawaiian Holdings saw its share price close at $14.22. That still leaves a spread for shareholders of 26.6%. When you consider that the deal is expected to close in the next 12 to 18 months, that's a very nice return if things go according to plan.

Clearly, if the transaction does not come to fruition and is instead scuttled or shut down by regulators, Hawaiian Holdings will almost certainly see its share price slashed. But if the deal does go through, the party taking all the risk is Alaska Air Group. The purchase price agreed upon translates to an equity value for Hawaiian Holdings of approximately $1 billion, with net debt of $0.9 billion taking the entire transaction up to $1.9 billion.

Operationally speaking, there are multiple ways in which this transaction makes sense. For instance, the combined company will have a greater than 50% market share in Hawaii. I don't need to tell anybody that Hawaii is a massive hub for those seeking vacations and those flying to and from there should be considered premium customers in a sense. After all, it is Hawaii that has the highest average home price at around $730,000. That places it even ahead of the $683,000 in California.

Presentation

Alaska Air Group

The combined enterprise will serve 87 unique destinations that are outbound from Hawaii, granting travelers a higher number of unique destinations that are outbound than any other player in that market. And for the West Coast, the combined firm will have 433 unique routes departing, making it a massive player there. Over the trailing 12-month window ending at the end of August, the combined company will have 1,340 average daily departures that collectively carry 54.7 million passengers each year. 10.9 million of those passengers alone utilize Hawaiian Airlines. The transaction brings with it 62 aircraft, the vast majority of which are owned, with a remaining leased, to create a behemoth with 365 aircraft.

There are other benefits to this as well. One thing that many investors might be worried about would be regulators stepping in to stop the deal. This could certainly happen. After all, there has been significant regulatory pushback regarding the merger between $JetBlue Airways(JBLU)$ and $Spirit Airlines(SAVE)$. That transaction originally valued Spirit Airlines at about $3.8 billion and would result in the smaller JetBlue absorbing its larger competitor. It's still unclear whether that transaction will be agreed upon or not, but there are worries about monopolistic outcomes. This situation is so intense that, in September of this year, JetBlue agreed to transfer two gates in Boston, two gates in Newark, and 43 takeoff and landing authorizations in Newark to rival $Allegiant Travel(ALGT)$, while also agreeing to turn over up to five gates at Fort Lauderdale-Hollywood International Airport to the Broward County Aviation Department in order to ease regulatory concerns about a monopoly. The good news for investors in both Alaska Air Group and Hawaiian Holdings is that there is only about a 3% overlap between the two companies from a physical footprint perspective. So those concerns should be minimal at best.

Presentation

Alaska Air Group

At first glance, the transaction between these two companies makes a great deal of sense. For starters, Alaska Air Group is forecasting $235 million in annual run rate synergies. $110 million of this will come from additional revenue opportunities involving domestic pathways, international connection growth opportunities, and other initiatives. $85 million will be on the loyalty side since the companies can co-brand their cards and receive more favorable economics on that front. Another $20 million can involve cargo opportunities. And on the cost side, there exists about $20 million worth of opportunities associated with volume purchase benefits and reducing duplicative functions. Of course, this won't come cheap. Management is forecasting one-time integration costs of between $400 million and $500 million associated with these initiatives.

Presentation

Alaska Air Group

But let's ignore all of that since synergies are not guaranteed to come to fruition. In its investor presentation, Alaska Air Group points out that the combined firm should have around $2.5 billion in annual EBITDAR, none of which factors in the proposed synergies. Around $600 million of that is slated to come from Hawaiian Holdings. But when you look at the fine print, these profitability figures are from 2019. In some respects, I think this is logical because it was the last year that the airline industry operated under normal conditions before being severely impacted by the COVID-19 pandemic. It wouldn't make sense to look at data from 2020, 2021, or even 2022. In fact, only just this year have we finally seen air traffic almost fully recover to pre-pandemic levels. The current forecast is for global air traffic to involve 8.6 billion passengers for this year. That's down marginally from the 9.2 billion seen back in 2019. But in 2024, the industry is expected to recover further, with 9.4 billion passengers taking to the skies.

Though not as significant, I also take issue with the measure of profitability that the two companies have agreed upon. They don't actually look at EBITDA. Rather, they strip out rental costs associated with aircraft as well. Given that those aircraft do generate revenue and revenue would fall without them, I don't believe this is an appropriate measure of profitability. Adding back the rent to the equation, Alaska Air Group would be responsible for about $1.34 billion of EBITDA compared to the $484.8 million involving Hawaiian Holdings. That increases the EV to EBITDA of the purchase to 3.92 compared to the 3.15 it otherwise would have been.

Financials

Author - SEC EDGAR Data

Even if we accept that, we also need to contend with the fact that cost structures in the airline industry have changed dramatically over the past few years. In the chart above, for instance, you can see, for the first nine months of each year, the percentage of revenue from Hawaiian Holdings that went to aircraft fuel, as well as, in the chart below, both the average cost of fuel per gallon and the total number of gallons that the airline used. As the industry showed signs of recovery, it only makes sense that the total number of gallons would improve. But because of rising oil prices, jet fuel costs have gone through the roof. In the first nine months of this year, they came in at $2.82 per gallon. That's up from the $2.01 per gallon seen back in 2019. There's nothing, besides perhaps marginal improvements that could be had from flexing its combined buying power, that these firms can do to bring those costs down. The chart shown below shows that even Alaska Air Group has had to allocate a significant amount of its revenue so far this year to aircraft fuel.

Financials

Author - SEC EDGAR Data

Investors who are fond of this transaction might say that this is fine because it puts everybody on more or less equal footing. I can accept that. But then you also have the fact that wages and benefits have gone up tremendously as well. Back in 2019, Hawaiian Holdings had to allocate 25.3% of its revenue toward covering wages and benefits. By the third quarter of this year, that number has shot up to 35.6%. Management has attributed some of this increase to the cargo transportation partnership that Hawaiian Holdings has been working on with Amazon (AMZN). But it is clear that elevated wages are an issue as well when it comes to Alaska Air Group.

The chart below shows that these numbers have been improving for both companies since peaking back in 2021. But with the industry so close to recovery, it's unclear whether costs will get back to what they were prior to the pandemic, especially when you consider all of the inflationary pressures, including on wages, seen in recent years.

Margins

Author - SEC EDGAR Data

Takeaway

The presentation regarding the transaction shows a company generating $484.8 million worth of EBITDA. But when you look at data for the first nine months of this year, EBITDA was negative to the tune of $70.9 million. It is true that we are still in peculiar times. But it's unclear the extent to which the industry will stage a recovery from a cost perspective. You also have other concerns like the high costs of achieving synergies, what I perceive to be minimal regulatory pushback, and a market that reacted severely negatively to the transaction by pushing shares of Alaska Air Group down materially in response to the news.

Add on top of this the spread that currently exists between what Hawaiian Holdings is currently trading for and the implied buyout price, and it's clear that the market is uncertain about this move as well. As for me, I see this as a highly speculative transaction. It will either result in a tremendous upside for those who bet in favor of it, or a significant downside. And because of that, only investors who have a more speculative mindset should consider stepping into the arena at this time.

Stock Price Forecast:

Here are the target price forecasts for the next 12 months from analysts.

The 4 analysts offering 12-month price forecasts for Hawaiian Holdings Inc have a median target of 4.75, with a high estimate of 16.00 and a low estimate of 4.00. The median estimate represents a -64.34% decrease from the last price of 13.32.

Resource:

https://seekingalpha.com/article/4656138-hawaiian-holdings-surges-on-alaska-air-group-risky-purchase

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