Acquired - Acquired Episode 10: Virgin America

Episode Date: April 27, 2016

Ben and David deviate entirely from the stated purpose of the show, tackling this non-technology acquisition that is so recent, we have no idea if it went well yet. But, the April 2016 acquisition of Virgin America by Alaska Airlines was so fascinating, we had to do it!Sponsors:ServiceNow: https://bit.ly/acqsnaiagentsHuntress: https://bit.ly/acqhuntressVanta: https://bit.ly/acquiredvantaMore Acquired!:Get email updates with hints on next episode and follow-ups from recent episodesJoin the SlackSubscribe to ACQ2Merch Store!Items mentioned in the show: Louis C.K. - Everything is Amazing and Nobody is HappyAlaska Acquires Virgin America Investor Deck“Measuring The Moat” Paper - Michael J. MauboussinBusiness Adventures - Twelve Classic Tales from the World of Wall StreetCarve Out:Michael Mauboussin: "The Success Equation:Untangling Skill and Luck" | Talks at Google

I should see what episode this is going to be. 10. 10. Easy. Who got the truth? Is it you? Is it you? Is it you?

Who got the truth now? Is it you? Is it you? Is it you? Sit me down. Say it straight. Another story on the way. Who got the truth?

Welcome to episode 10 of Acqu 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 today we come to you with an acquisition that is actually not a technology acquisition but something that david and i were um inclined to about anyway, because we both sort of have a little romantic fascination with anything involving airplanes. And this is particularly interesting. Today, we're going to be talking about Alaska Airlines acquiring Virgin America right here in our own backyard in Seattle. Before we get into the acquisition history and facts, I wanted to remind you that you can sign up now at Acquired FM to get our episodes delivered via email. We also would really, really, really appreciate it if you could rate us on iTunes. It'll help us grow the show

and expand what we can do with it from productions to new topics and guests. Okay, listeners, now is a great time to tell you about longtime friend of the show, ServiceNow. Yes, as you know, ServiceNow is the AI platform for business transformation, and they have some new news to share. ServiceNow is introducing AI agents. So only the ServiceNow platform puts AI agents to work across every corner of your business. Yep. And as you know from listening to us all year, ServiceNow is pretty remarkable about embracing the latest AI developments and building them into products for their customers. AI agents are the next phase of this. So what are AI agents? AI agents can think, learn, solve problems, and make decisions

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by clicking the link in the show notes or going to servicenow.com slash AI dash agents. Now, with that out of the way, David, you want to dive into acquisition history and facts? Indeed. Yeah, this will be a fun one. Listeners, let us know what you think. Don't worry, we're not changing the topic of the show, but we thought we'd have some fun and analyze a very different industry than technology. Yeah, and not to mention the fact that it's not a tech acquisition.

There is technology involved, but the way we're kind of breaking the mold on this one, too, is this just happened last month. It's not like this month, actually. Yeah, a couple weeks ago. Yeah. So this is something where it's going to be highly speculative, but I think it's going to be a fun ride. All right.

With that. 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. And over those three years, a whole bunch of things happened.

So one, it turns out that due to some crazy laws, U.S. domestic airlines cannot be owned, cannot have foreign ownership greater than 25% of the company. Crazy. Crazy. So Branson and Virgin had to basically sell off 75% of the company before they could even have a hope of operating. It's wild. And I think at that point when they were first starting, it was Virgin USA even. And then they rebranded a little bit.

It was later that they rebranded to Virgin America. So Branson sells 75% of the company to a couple hedge funds. And licenses the Virgin brand to Virgin America. So that Virgin America doesn't even own virgin that's painted on their own airplanes yep uh and there was talk at various points in time about uh ditching virgin uh the name would that help get regulatory approval earlier uh faster craziness anyway they finally clear all the regulatory hurdles. They buy some aircraft. They start operations in San Francisco with SFO as their hub. They launch in 2007.

Things go fairly well. They don't die, at least, like a lot of startup airlines. And they actually have some major kind of technology-related innovations. So in 2009 2009 virgin actually becomes the first airline to offer go-go in-flight wireless in-flight wi-fi um which is uh that's hard to imagine now you know taking it as as louis ck says is magic and is the newest thing i know that exists uh i still i hate it when i now the random you know rare times when you end up on a plane without wi-fi sorry uh they also are the first airline um uh to i believe to install in flight uh seat back

uh interactive touch screens for uh everybody uh all throughout the whole plane not to mention purple afterglow lighting not to mention nightclub inspired mood lighting um for our listeners who haven't flown virgin america they're probably gonna have no idea what we're talking about but yeah i guess it's a pretty west coast i think anybody listening in the bay area has definitely flown it since they're helped out of sfo um so the virgin actually ends up going public uh having an ipo in november 2014 um and then not that long later we're about uh we're about 18 months uh since then um a bidding war erupts for the company uh between alaska uh which ended up buying them uh and and had been interested and rumored to be interested in the company in Virgin for a long time, and JetBlue.

And then Monday morning, April 4th, Alaska announces that they have agreed to acquire Virgin for $2.6 billion, which was a 47% premium to the stock's closing, the Virgin stock's closing price the previous Friday, and about an 80% premium to where the stock was before rumors came out that a bidding war was happening. Yeah. And this is the first red flag for me. I mean, I think that... Basically, a massive premium. Yeah. Yeah. Anytime you see a spike like that, you start to dig into why and i think we'll talk a little bit more about kind of the way the industry has shifted but with all the consolidation the only way that um you know an airline can really compete with the

big guys is to be big themselves and the big guys being united delta um american and southwest and so you know which itself started as a little guy very true i think that's that's like the typical low-end disruption case study and they're they're really that's that's a great business and a really interesting story on its own yeah but i mean that clearly alaska in in trying to compete there's there's a limited number of airlines that it could buy. And JetBlue clearly identified the same opportunity, and the result is this very, very inflated purchase. Yep. 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. Which is fascinating because normally when we talk about these acquisitions, we would say a $2.6 billion purchase in cash and stock or maybe an all stock deal. This was an all cash $2.6 billion purchase plus taking on that $1.4 billion of leases on airplanes and debt. And what a ridiculous capital intensive high fixed cost industry air travel is that's four instagrams ben wild uh and then perhaps the craziest part about this deal is uh again relative to the technology sector um so it was announced a couple weeks ago uh on april 4 2016. Not expected to close until early 2017 at the latest.

Huge amount of regulatory review that still has to happen here. And we've actually seen precedent, I think, in the American Airlines-USA merger where there was regulatory troubles and it almost didn't go through. And the government extracted huge concessions from um from those two airlines when they merged so we may be doing a follow-up at some point in the future if uh if by 2017 we don't see a joined airline here and our listeners don't revolt against us we're talking about airlines it's true well the other the other really interesting thing here is in just talking about the the deal price, Alaska Airlines does not have $2.6 billion in cash to make this purchase. If I have my numbers right, as of November of 2015, according to their earnings, they had $88 million in cash and $1.1 billion in marketable securities. Yep. billion in marketable securities yep so i believe what happened here is in the bidding war with jet

blue um alaska has has incredibly clean books they have um they're one of the few airlines that actually is very low debt load uh and actually have investment grade debt which uh for listeners who aren't in the come from the investment banking world basically means that um the amount of debt that alaska has is small enough relative to its earnings power that people think it's very very unlikely they'll go bankrupt especially for an airline no other airline has is rated as highly basically which means that people who lend to them think there's a good chance they'll go bankrupt yeah so is there a chance then that um that the way i sort of understand it is is uh jet blue sort of had to cry uncle because they didn't have the amount of debt didn't have the borrowing power to be able to make the purchase

yep reach these this price um but now this is going to totally transform alaska like they're going to take out another billion and a half perhaps plus of debt to to make that well yeah i mean to make the purchase and then to to take on the debt and leases that that uh and virgin was also a fairly low debt load airline as far as airlines go um but still it's changing the capital structure of the company combined company pretty significantly yeah um great should we move on to acquisition category yeah that sounds good to me um why don't i start with that uh moving on to the acquisition category this to me doesn't fit our mold necessarily of people technology product business line, or other.

I mean, I guess if everything fits in other. In some ways, it's a business line. They picked up a brand that people have tremendous affinity for and access different customers with- That's assuming they keep the brand. Well, yeah. And that's something we should talk about. Ultimately, though, what I think they're requiring 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. They're hubbed out of Seattle.

They have very little San Francisco and even less LAX presence, and this gives them major, major capacity to kind of be the West Coast airline. Yeah, basically, you know, if you look at it, if you think about kind of airline route maps that, you know, you see on the back of the cards and the back of your seats. Makes your head spin, but it's super cool. Makes your head spin, but it's usually, you know, it's like the spider web that emanates

from a few major cities. You know, the Alaska hub is Seattle, and there's a huge spider web coming out of Seattle to every country in America, or to every country in america and every city in america and um uh and and several international uh destinations um and then and then very few route pairs from other cities uh and and virgin is the same thing but just from sfo so in your opinion then well before we get that, how would you categorize the application?

So yeah, I was actually, we hadn't discussed this beforehand, but I was going to go down the same path you are and say in our framework, this would fit closest to a business line, kind of like buying the best categorization is this is industry consolidation, which is in a super mature old school industry like the airline industry, very different from technology. You get these periods of consolidation where players merge with each other because they feel like they need greater scale to compete. And I think that's what we're seeing happen here. Yeah. And this is an interesting time to go into how Alaska makes the case to their investors for this. There's this great investor deck that they have on their website where they talk about why their investors should feel comfortable with this purchase. And they say that we're bullish on the industry.

From 77 to 2009, the industry lost $52 billion. I mean, the airline industry is notorious for... Oh, yeah. I mean, we should talk about... There's a great, great... I almost included this as my carve-out for the week, but I'm going to do something else because I knew we'd talk about it on the episode. There's a great paper that was written by Michael Malbison and his team, who's a great investor.

He was head of Legg Mason, which is a large mutual fund at Credit Suisse for a long time. And I believe he's now back at Credit Suisse. He's written a number of great books. He's also a professor at Columbia Business School, I believe. And he wrote this great paper called Measuring the Moat. And it's all about the concept of the moat, you know, as an investor is sort of the most important thing. You know, Warren Buffett emphasized and Berkshire Hathaway and Charlie Munger, you know, emphasize the moat as sort of the most important thing they look for. And he uses the airline industry as an example of a terrible industry that has destroyed so much economic value and has no boat yeah and this this is um i'm not sure if this i think this is still true it's at least true a couple years ago if you look at the airline industry since its inception and you look at

basically a profit and loss statement for an aggregate of of every single airline it's it's lost value like it's it's actually been it's lost value. It's actually not been profitable if you look at every single- The entire industry. And not just lost value, but lost a huge amount of value. A huge amount of capital has been destroyed in this industry. So when they say that 77 in 2009, they've lost $52 billion as an industry. It is interesting that people continue to invest in it. Yet, from 2010 to 2015, over the last six years, it's generated –

It's been good times in the airline industry. Yes, $45 billion of value. And so some of the things they cite are – Alaska cites to their investors are a fundamentally changed industry structure. And that, I think, is largely – I mean mean when you look at the consolidation that's going on they're basically saying okay the the fragmentation's gone and right now the the industry structure is that there's four relatively perfect substitutes and these these big ones that are all you know you're going to get treated sort of like cattle when you're in coach. And you've seen in the past few years, I believe the first was United and Continental merged.

You've seen all the major legacy domestic airlines consolidate and merge. And then US Air and American merged. And so you've got this consolidating power structure of the industry that actually represents, you know, between the top four airlines, 80% of all U.S. domestic airline traffic. Yeah. So it's interesting. I went and grabbed all their market caps today. Highest right now, Southwest is a $30 billion company. Delta's, I'm sorry, Delta's higher at $36 billion. Southwest at 30, American at 25, United at 21. And then if you look at Alaska's is $10 billion without Virgin. Virgin's $2.5 billion and JetBlue at $7 billion.

So if you just look at those players, $132 billion, effectively market cap for the industry. And when you think about Apple as a $590 billion market cap company, you start to understand like, wow, the whole industry here is, you know, if we were looking at this, any given airline and comparing it against one of these mega technology companies that we usually talk about on the show, like airline companies just don't create that much value. Or maybe more accurately, they don't capture that much value. Yeah. And it's super interesting. I'm sure we'll get into throughout the show, the supply chain of the airline industry is fascinating. You know, you've got basically a duopoly that are direct suppliers to the airlines in Boeing and Airbus that make the

big passenger jets. And they have a huge amount of power over uh over the airlines because you know while there is two of them you could go from one to the other it's not like you can say it's not like the airlines can be like a you know like a google and be like you know oh we're gonna like you know become a you know full stack company and we're just gonna obsolete you and we're gonna make our own cloud or whatever like the airlines can't make their own airplanes yeah getting good at servers is different than getting good at airplanes yeah yeah so getting back to the alaska reasons they're bullish on the industry the industry structure is consolidated this is sort of a bs bullet point i think but returns focused

leadership teams that's sort of like tooting your own horn and claiming competency um constrained airport real estate this this one's sort of interesting. I guess they're sort of saying, like, we've reached a saturation point right now where we're not building more airports. The airports aren't getting bigger. And over the last, you know, since 1960, that's been the case. And now it's all about sort of vying for space at the existing airports that we have. And then the capacity acquisition starts to make a lot of sense.

Yeah, there are only so many gates. Right, right, right. Growth in leisure travel, which is interesting to sort of pick apart and think about why that might be. And then new revenue sources. And I think we can all gripe about how we are well aware of all the revenue sources that airlines can... Charging for bags.

Food and entertainment. Some of these are new services they've added and virgin and alaska have both been kind of the bleeding edge here of doing flight wi-fi and entertainment and movies um and snacks that are actually edible and co-branded with tom douglas so yeah it's always so funny to see, to get on those planes and see how far, um, for, for those of you not from Seattle, he's sort of like the big restaurateur in town, um, to see how far he's leveraged that brand. Now that I opened the little snack pamphlet on an American airlines and there's Tom smiling at me and on the front of it, love it. So artisanal.

So, um, yeah, I, uh, from a category perspective, you know, I think, uh, absolutely. I would chalk it up to capacity. Yep. And the other, the other point I want to, uh, I want to explore here a little bit is, um, there's a really interesting context for this deal that, uh, people in Seattle might be aware of, but I doubt anyone not here is. And that's that Delta actually has been putting a huge amount of pressure on on Alaska here in Seattle in their in their hub. Delta has been growing over the last few years, their presence in seattle a lot um and uh and and for a long time i think alaska was probably um concerned either concerned or expecting that delta was going to make an offer to buy them um and uh they haven't um instead they've just organically grown and taken more and more gates

uh here here in, in Seattle. And it's really interesting. I was talking to somebody who is far more of an airline industry expert, uh, than, than we are. Um, and, and he was making the point that, um, the frame of reference is really different for these two companies, Delta and Alaska. You know, Alaska is a domestic carrier and it's a West Coast focused carrier.

Delta is an international carrier. And Delta coming into Seattle was part about competing with Alaska domestically because Alaska has built a really nice business here. But also an even bigger part probably for Delta is using Seattle as a gateway for international flights to asia um because gate real estate as as you were saying ben is is so scarce and and at the other

big cities on the west coast at sfo and at lax uh is so competitive and impossible to get um to get more real estate there um i think delta really viewed seattle as as kind of their gateway so that they could send people from all over the u.s on flights to seattle and then hop over to japan to korea to china um to what have you makes sense whereas for alaska you know that's not even an accessible market to them right now right right right in looking at this acquisition category and the kind of the way we've we've both defined it in a 2.6 billion dollar sale that it seems inflated for two reasons one kind of the bidding war because it was because there was scarcity of good airlines to buy that would complement JetBlue or Alaska well.

But two, a lot of the value, the kind of intrinsic value that was given to Virgin even before rumors of a sale was brand value. I mean, they have tremendous customer affinity. They do things a little bit differently you people who love virgin love virgin i always have a better experience love alaska too it's true but actually and actually those are two of my favorite airlines to fly but but virgin is like notoriously different and better and feels premium and

that had to be factored into their market cap. And when you think about what they are going to be used for, I mean, Alaska announced that by 2018, they hope to be fully rebranded as Alaska. Hopefully, they can learn some things from Virgin and they've been watching them very carefully. But if they obliterate that brand, what was the point of paying a markup on a markup

for capacity yeah it's it's a great point um you know the alaska brand uh again it was very good especially in the airline industry on its own i think you know really uh was kind of like very professional they had either the best in the industry or the best on the West Coast on time percentage. Lots of great, you know, very, very business commuter friendly. And Virgin was like, you know, like we joked earlier,

like a nightclub on a plane. Lots of, it was the favored airline of me and all my classmates when we were in business school. We can leave it at that. So then one other thing that I want to bring up in that realm is payback period. So Alaska cites that they'll have $225 million of total net synergies at full integration. So what we can pull from that is that there will be $225 million of cost savings after they're fully integrated.

So let's call that 2018-ish. And that means that there's probably other value that they can create on top of that, like ability to create more revenue because they have these economies of scale, new things just on top of that. But that means that they have on this, if we look at the $4 billion as the figure, that's a 17-year payback period on this acquisition just on the synergies. And do we think that now virgin had earnings as well that would contribute to that but two points i want to make but go ahead yeah uh no no go for it i've pretty much made the point that like it it seems like it's going to take a while to yeah to any way you slice it it's going to take a while and i think there are two really head-scratching things

about this merger um that uh that are really important that some certainly industry experts are questioning um but you know alaska didn't hasn't talked a lot about one um the primary reason for the sort of economic renaissance of airlines in the last couple years has been falling fuel prices yeah which are only nominally passed on to consumers and everyone's getting right right and so airlines as a whole across the whole industry have gone from you know call it spending x on, which was a huge amount of their operating budget and kept their margins low to negative to spending like X divided by two on fuel. And thus they are enjoying, as an industry, much greater profits than they used to. Now, the question is, is that a new normal?

Or are oil prices going to go back up at some point and you know we could do another show on the oil and gas industry and this is a major existential question for that whole industry but if you were to take the viewpoint that like this is a temporary thing and prices will go back up which historically they have you know fluctuated throughout history um you know gosh it seems like you're buying at the top of the market here where where profits are artificially inflated um so that's one two you know synergies uh as as you rightly mentioned ben are um you know often about the combined revenue potential and real you know and and being able to extract more money from consumers and

routes and whatnot but they're they're also really about cost savings. Yeah. Consolidating the back office. And economies of scale and all that front. But there's kind of a problem here with this acquisition, and that's that Alaska flies Boeing planes and Virgin flies Airbus planes. Exclusively Airbus. Their entire fleet.

Alaska only flies Boeing and Virgin only flies Airbus planes. Exclusively Airbus. Their entire fleet. Alaska only flies Boeing and Virgin only flies Airbus. And you might say as a naive consumer, as I did before I started looking into this, like, no we don't. I mean, like, they look like it's a plane. A plane is a plane, right? Like, I get on it, it looks the same. Well, it turns out that actually they have completely different control systems. And pilots who fly Boeing planes can't fly Airbus planes. And pilots who fly Airbus planes can't fly Boeing planes.

So it's not like they're going to be able to share pilots at all between these fleets. Not going to be able to share pilots. And, of course, all the maintenance and all the parts are completely different. Um, no, there are the other major airlines do use a mixed fleet of both. Um, except for Southwest, except for Southwest. Yes. Um, uh, but, um, so Southwest is entirely Boeing 737s because, um, they realized that in a part of their business model was going to be staying as lean as possible and keeping everything totally interchangeable and swappable. And that's actually been a big part of their story to Wall Street and investors about why they're a great company.

That's been kind of a pillar of it. And Alaska had the same playbook. And now all of a sudden, they're like a 50- shop of you know airbus and boeing yeah and and you know from a heartstrings perspective too how dare a seattle company buy a company that's entirely airbus planes that's just not patriotic much much uh sordid and painful history on seattle and boeing and um perhaps for another show. Yeah, yeah. So, yeah, and I think that kind of actually segues into what usually is a short segment for us, and I think we'll also probably be short here,

of what would have happened otherwise. And here, clearly, the other one, I mean, Virgin was going to be acquired, and the otherwise was JetBlue had acquired them. Now, JetBlue is also an airbus uh company so um would have been a lot easier for them to realize cost synergies yeah and there's two two points i want to make here one virgin is sort of only recently profitable i think that so they launched in 2007 took them three years to have their first profitable quarter. They're struggling as pitching themselves as both a low-cost airline and an airline that has a really premium service. And I think that they were better at adhering to the premium service than they were to the low cost.

But that's a tough story to sell to consumers. And I think they were struggling with how to be both because you can't both be a Volvo and a Cadillac and have that story be sustainable and enduring. And so I think that Virgin didn't necessarily need to sell. They were definitely in the right place, right time, where they had exactly what- They got an 80% premium to their pre-acquisition share price. That's pretty good. Yeah, yeah. Good on them for their M&A positioning. But that seems like a little

bit of a precarious position. And at Pioneer Square Labs, a lot when we're thinking about starting these companies, I think I would get a lot of crazy looks if I was like, well, we're going to be a low-cost premium company. It reminds me of, I've been reading another, could have potentially been my carve-out, but won't be. I've been listening on audiobook to a great book called Business Adventures. It's a classic. It's from, I believe it was written in either this in the seventies, perhaps I was recommended to me by a good friend and, um, I've been listening to it and it's just, it's 10 vignettes of like more, more aptly titled business misadventures. Uh, the first one is about a stock market crash in the sixties, but the second one that

I'm listening to now is about the Edsel, the car that Ford launched that's widely considered the worst product launch in history. And one of the key lessons from it is that Ford wanted the Edsel to be everything to everyone. They say, daringly adventurous with a dash of conservatism. And it's like, what? Are you kidding me like you know i you're uh or um you know for the uh it's elegant you know luxury for the aspiring you know young executive you know and affordable for like the middle market and it's like what and it failed spectacularly yeah yeah i you know i'm not over here preaching preaching that that was going to be Virgin's path,

but that was always sort of a head-scratcher to me about that company. Now, the question that I want to pose to you is, what would have happened to Alaska with all the consolidation in the market going on and kind of moving to four major players, the pressure from Delta and the home front? You know, what if they don't expand yeah and i think this you know to give some credit to to alaska um i feel like we've been sort of taking pot shots at this deal um they were in a tough position i think um you know doing well in the moment, but facing this pressure from Delta, this consolidation across the whole industry. And they had developed a really, really nice niche here in Seattle as the, you know, by far the best routes and customer service for people who live in Seattle and fly in and out of SeaTac. But great business routes.

But they kind of had nowhere to go. They were getting pressure from delta here super hard for them what are they going to do expand internationally are they gonna um go to other cities and that's what they did with this they said we we kind of need to we need to grow it's going to be super hard to do organically here's an opportunity we have a great balance sheet um and and for an airline a lot of cash we know we're relative to the industry pretty well run here's an opportunity to buy virgin and basically double our size and run the same playbook again um or they could have just stayed in sort of

steady state where they are well it's funny you you you would hope that they double their market size because the the acquisition is so expensive but when you look at the numbers of um what alaska is doing and what what virgin's doing um alaska has 32 million total passengers a year virgin has seven alaska has a thousand departures a day the virgin is 200 there's 112 destinations served by alaska virgin is 24 pre-tax profit from alaska 1.3 billion dollars virgin 200 million dollars so like that is an expensive purchase for a much much smaller operation yep and a much smaller operation with um no room to grow in san francisco yeah i mean mean, all, you know, not just SFO, but the other airports in the Bay Area too,

Oakland and San Jose, which are different. They're really commuter airports, although pro tip for Seattle to Bay Area commuters, never fly to SFO. You always got to do Oakland or San Jose. Because if you do SFO, there's so much fog and fog delays and they always delay the seattle flights because they want the cross-country flights to land on time got to do oakland or san jose pro tip pro tip anyway but there's no room to expand

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both Virgin and Alaska before the merger really succeeded at this. In a crowded marketplace with lots of big platform players in the big national carriers they found a niche alaska here in seattle and with business travelers and virgin in san francisco with you know sort of um quality of service and uh and um sort of style-minded customers. And they served it really, really well. And they grew very big businesses out of that. I mean, you know, combined,

obviously the price for Virgin at $2.6 billion. And I can't remember, what was Alaska's market cap before? Oh, it's... Their stock actually went down on announcing the acquisition. It's about $10 billion now. About $10 billion. You know, these are great businesses.

And I think that same principle totally applies in technology. And people, especially startups, often overlook it. They try and go after, you know, the Delta or the United or the Southwest on day one. They try and go after Google on day one. You're not going to beat Google on day one. 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. And then you can knock down, in crossing the chasm speak, the next bowling pin and the next bowling pin and the next bowling pin and that's much easier to do in technology than it is in airlines but the great thing about it is that you know you're probably not going to become the next facebook or google but if you knock down a couple bowling pins along the way you're still going to become a really great and valuable company and then maybe you get a chance to knock them all down and you will become the next you know you will be snapchat and become the next facebook calling it here there you go yeah that's a good point does that analogy also kind of apply to the the brand loyalty aspect of

airlines which they've you know huge um innovation yeah invented loyalty in the inventing you know the the loyalty and the airline miles um and status hmm yeah so you're postulating that they're in order to are there are there technology companies that have probably not enough there should be more but that have taken that sort of loyalty aspect where like the more i use a platform the deeper i get locked in because the more you know airline miles i have on it for lack of a better word yeah i mean totally i think that everybody that has has like done well at loyalty in the last 50 years has taken it from airlines the question is like do you need to open table definitely did yeah uh quite successfully yeah i guess well i guess i'm wondering do you need to

that would be a great uh acquisition to cover at some point open table yeah yeah i'll add it to the list we um yeah i'm trying to think about like is it necessary it has something changed in the world where it's necessary to consolidate to keep loyalty because like does something exist now that didn't exist before where people only ever want to use one airline? I mean, that's definitely the case in technology. I think about the power law and the power of network effects, like HipChat, right? Two years ago, a bunch of our portfolio companies used HipChat, and some of them used Slack, and some of them used HipChat.

And I'd talk to people using HipChat, and I'd be like, you should really check out Slack. And they used hip chat and they would you know i'd talk to people using hip chat and be like you should really check out slack and they'd be like ah you know we use hip chat it's good enough but then like as their friends at other companies got on slack and then slack channel started popping up for you know industry groups and whatnot and then it was like well we should really think about moving to slack and like then you know this power law takes over and being on even if you know i think slack has done a lot of great product innovations but even if they hadn't you would be pushed to move towards it even if you're on hip chat because the rest of the world

is on it yeah and with slack i think that the like network effect was because people were starting inter-company slacks so 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. So like, does that apply here? Where, oh, I'm not going to maintain points

at two separate loyalty programs. Because that was always super annoying. I mean, there was a few startups that I was trying out that were trying to aggregate my loyalty programs for me, or at least help me keep track. And that was a kind of total pain. Oh, but to segue off of aggregator onto another technology trend, let me think through this and see if this logic kind of follows.

So sites like Kayak and Hipmunk and all these, you know, travel agregators pop up. Yep. And that's 15, 20 years ago. And that effectively commoditizes airlines and compresses their margins because people's loyalty to those airlines is shaken because they have an easy way to find cheaper prices. It's a price comparison. to those airlines is shaken because they have an easy way to find cheaper prices. So therefore, margins are driven down because airlines get more commoditized. And when they're more commoditized and 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. And now if you're a smaller airline, the inefficiencies from you having a smaller operation could kill you. And so if you follow it all the way back to the online travel aggregators, does that sort of create the environment in which you need to have a bidding war for this acquisition

so that you can be a more major player in a consolidated market. 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, where aggregating the consumer endpoint and experience, he argues, in the digital 21st century post-internet world is where all the value is. And then you can aggregate all the difficult content creation behind that,

content creation uses, but in this case, airlines, like point-to-point travel, and own that relationship with the customer at the front end. And then you commoditize everything on the back end, and that's completely happened. And interesting, know has refused to uh participate in the aggregators and to let themselves be aggregated and and probably has some of the most you know loyal customers um you know i mean their ticker symbol is love luv right

and they always talk about how much you know everybody loves each other at southwest um yeah they've fought that actively and and they've probably had the most success on the branding front yeah yeah yeah why don't we move on to rendering our conclusions i think that's i think it's that time yeah and i think we've you know we've kind of expressed our our opinions laced in a bunch of comments throughout this for me you know i think the value is inflated both by the bidding 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 um but i think they needed to and i don't think they had a lot of options and i think they both picked the time right when this was an available purchase, and they put themselves in a really good position to make that purchase by, you know, I'm probably the wrong person to talk about this, but by putting their books in a great position over the last five years and being really intentional about having or being an investment grade or having investment grade credit. And I think that JetBlue didn't prioritize that as much and neither did any of the other smaller airlines. And in a world where they need to consolidate, they put themselves in a position where they're able to do so. So I'll give it a B minus. Yep. I mean, it's hard to, it's hard to separate out, uh, just at least for me, the sort of coming from the tech industry, this sort of, uh, shock at looking at the terrible economics of the airline industry as a whole in dynamics um versus the actual um quality of decision making in this acquisition um so i think a lot of what you said i agree with um but i'm gonna go lower i'm going to go C- because what you said is right, but they paid so much money.

They paid so much money. I mean, I don't think it's public, and I don't know that anybody except the executives involved know what Alaska's initial bid for Virgin was but like it got bid up so many times and like oh that's a large price for something that your pilots can't fly can an airline make a good purchase yeah good point good point yeah all right should we move on to the carve out yeah so this is wild like i i was like stopping myself from laughing and my jaw dropped. And I think it almost ruined David's train of thought earlier when he started talking about how it wasn't going to be his carve out. But it was a paper that Michael Malbison wrote about this. I picked my carve out as a Michael Malbison talk that he gave at google oh this is so good everybody

everybody should watch this talk it's really good like and this david this is so weird i haven't watched this in probably two years and it was something that i've recommended to friends very often and so i was sitting here before the episode thinking you know i didn't see anything particularly interesting this week that i wanted to recommend but how about an oldie but goodie and it is absolutely wild that this talk is great and it's it's based on a book uh that i've read the book too which is worth reading too um called untangling luck and skill yep yep untangling skill and luck the success equation and it is so so fascinating he gives so many great examples that will make you both like follow it logically and nod your head and sort of scared

that about how much of your own success has been out of your control or how much the world is out of our control. So how much of your own success cannot be attributed to you and how much of your own failure cannot be attributed to you and trying to figure out what are things that you have attributed to your own skill yes yes and and what are things that you know you actually should be focusing on and what are things that you should know that there's going to be randomness in the world it's this the the talk if you only have an hour listen to the talk if you really want to go deep on this get the book uh it's so good i will restrain myself i could go in so many directions but one one real quick vignette i want to throw out is

one of my favorite themes from this talk and book is um the paradox of skill uh which is such a a cool thing that like in a a given activity the whole the whole premise of the talk in the book is that any activity the results of which are are going to be based somewhat on the skill of the participants in the activity and somewhat on luck. And there's a spectrum and some things go more towards the luck end and some towards the skill end. 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 Malbison 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, particularly due to globalization, because the only people who are even considered for this are the best in the world. So then it's like, well, among the people that are all the best that look very similar to each other in skill level.

The variation in skill gets so minute. That luck is magnified. That luck is magnified. Yeah. And the exact same dynamic holds true in investing, in startups, in lots of things. When the world is the pool, you always have the cream of the crop. And then it's all about all the crazy dynamics that play out from there. So can't recommend it enough.

It's on YouTube. We'll link it in the show notes. Definitely check out the success equation, untangling skill and luck. I've taken enough time. I'm going to save mine for another time. It wasn't super interesting anyway. I'm going to doubly recommend this.

It's so good. All right. Well, there you have it. We want to thank our longtime friend of the show, Vanta, the leading trust management platform. Vanta, of course, automates your security reviews and compliance efforts. So frameworks like SOC 2, ISO 27001, GDPR, and HIPAA compliance and monitoring, Vanta takes care of these otherwise incredibly time and resource draining efforts for your organization taste better, i.e. spend your time and resources only on what's actually going to move the needle for your product and your customers and outsource everything else that doesn't.

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