In the past couple of months, the airline industry has been reshaped as a result of the coronavirus grounding air fleets all around the world. This has put extreme financial pressure on airlines that typically run very tight time schedules for their many planes. Typically, in the airline industry planes are leased at tight margins in regards to cash flow. It is estimated that leasing an Airbus A380 can cost more than USD $1.5 million per month. For this reason, the commercial airline industry cannot afford to have their fleets sitting on the ground for a prolonged time as it creates drastic cash flow issues. As a result, the coronavirus enforced shutdown of domestic and international air travel continues to have a significant impact on airlines around the world. There is a lot of uncertainty around the future of air travel and this creates problems for airlines with underlying financial issues. Notably, Warren Buffet’s holdings company Berkshire Hathaway has sold all of their stakes in the four largest US airlines fearing that airlines will no longer be a wise investment going forward.
Heading into the Coronavirus, Virgin Australia was already in serious financial trouble with looming debt of over AUD 6.8 billion and losses made for the last seven years consecutively. This has meant that Virgin Australia was never in a good position to handle a huge hit to its cash flow via being essentially suspended indefinitely from flying commercial flights. In March reports began to swirl that Virgin would ask for a bailout package from the federal government which was swiftly rejected by the coalition government. There were calls from the opposition leader, Anthony Alabanese, to provide a bailout for Virgin of $1.5 billion and for the government to take a stake in Virgin as a shareholder but this was rejected. The coalition opted in April to allow the airline group to go into voluntary administration however this did come after Nationals leader and minister for Infrastructure, Transport and Regional Development announced a $1.2 billion package to effectively pay for routes to remain running by Virgin within Australia.
Opting for voluntary administration by the government in April has seen Deloitte effectively take control of the Virgin Australia group and all of the assets owned by the group are now able to be sold as Deloitte sees fit such as old planes, etc. The government has appointed former CEO of Macquarie Nicholas Moore to lead engagement among the administrator, the federal government, and the Virgin Australia group. The owners of Virgin Australia effectively tried to leverage the government into bailing them out from years of poor financial performance. Their cries for help have fallen on deaf ears with numerous reasons for the rejection of financial assistance cited by the government. The reasons cited include the potential for creating a dangerous precedent for other companies that operate within Australia and employ large numbers of Australian workers because if the government were to offer financial assistance this creates a safety net that may not be able to be recreated in the uncertain future. Other members of the coalition have cited the foreign owners of Virgin Australia as being inadequate for acting in the interests of the Australian people. Notably, the government has claimed that because Virgin is predominantly foreign-owned (up to 90%) that the federal government should not be subsidising foreign interests. Another key reason why the government rejected the bid for financial assistance is the complications created by Alan Joyce the CEO of Qantas who has stated publicly that if Virgin Australia were to receive a bailout then Qantas would need a similar bailout to the tune of at least three times the size. These reasons may be perfectly adequate for rejecting financial assistance but that by no means provides security to the thousands of Australian and foreign workers employed by the Virgin group who are at serious risk of losing their jobs.
Virgin founder Richard Branson (Source: CNBC)
The future of Virgin remains uncertain at the present time but there are plenty of investors interested in investing in a stake in Virgin with reports that up to twenty suitors are preparing bids. A successful investor would need to have seriously deep pockets to make this purchase viable as they would need to be able to clear the vast amounts of debt owed. This debt includes up to $16 million just to Perth airport who has taken the extraordinary step of impounding Virgin planes stationed at the airport. It also includes a large number of bonds issued in previous years that have been rated as junk by various agencies including Moody’s.
Going back to the key takeaway from the bidders, who is it going to be that is actually going to make a bid? The three front runners are believed to be Brookfield, BGH Capital, and Bain Capital with various potential bids from other entities including the Queensland government, Twiggy Forrest’s mining company Fortescue Metals and Lindsay Fox.
Virgin Planes are at a standstill (Source: Traveller)
There have been further arguments by the federal government and others that the current shareholders should dig deep into their own pockets to come up with the money required to bail out the fledgling airline, however, it is not that simple. Analysing the makeup of shareholders for Virgin, the majority shareholders are five companies including HNA with 20%, the Nanshan Group with 20%, Richard Branson’s Virgin international airline with 10%, Singapore Airlines with 20%, and Etihad Airways with 21%. None of these companies currently have a high enough ownership stake to leverage decisions to be made which effectively negates the potential for multi-company fundraising for Virgin Australia. These companies have their own interests and are all being tied down by the collective shutdown of the airline industry around the world. Singapore Airlines has been negatively affected by the ownership of Virgin Australia with its financials down in recent years. It is difficult to look at the position of the other airlines because their accounts are not made public however, Richard Branson has investments across the airline industry which means he will likely be looking to mitigate his losses rather than double down. Similarly, HNA and the Nanshan Group are probably more focussed on domestic matters within China as airline travel begins to open up there. Etihad appears to be the most well equipped to help out Virgin Australia but has appeared unwilling thus far.
(Source: Forbes)
The future for Virgin Australia while uncertain does look like it will exist at this stage with a leaner business model. The Australian airline market is difficult to break into and accrue market share due to the market power exercised by Qantas both internationally and their subsidiary Jetstar domestically. Furthermore, Tiger Airways also remains a competitor, but Virgin Australia under a new business model would perhaps give it the breath of fresh air it needed. Ideas have been floated for a Virgin Mark II to avoid the disaster that was the collapse of Ansett in 2001.
A new business model for Virgin Mark II would involve cutting staff, restructuring debts, and changing routes to minimise the travel on routes that are not competitive. Many regional routes such as flights to local airports like the Sunshine Coast airport may need to be cut out in order to remain competitive. Brookfield Capital remains the choice of the unions with their proven global track record. Brookfield Capital is a Canadian company with experience in owning and operating Australian ports and coal mining investments and very deep pockets with ownership of almost $500 billion in assets around the world. Bain Capital also remains in the frontrunners as they have experience in the United States turning around poorly performing airlines such as Delta. A local option based out of Melbourne BGH Capital may also be in the running due to the Treasurer Josh Frydenberg’s flagged recent change to foreign ownership approvals.
Whoever is successful in taking over Virgin Australia will likely have great challenges set out for them with Qantas CEO Alan Joyce flagging flights as cheap as $19 one way between Melbourne and Sydney. This has raised concerns with the ACCC of the potential for predatory pricing within the Australian market. Despite this, it’s clear that Virgin Australia is not going to go anywhere anytime soon, but it may look a little different.
References
https://www.livewiremarkets.com/wires/virgin-is-another-disaster-for-hybrid-buyers
https://www.abc.net.au/radio/programs/am/opposition-calls-for-virgin-australia-support/12167794
https://thenewdaily.com.au/finance/finance-news/2020/05/13/who-will-buy-virgin-australia/
https://www.abc.net.au/news/2020-04-02/coronavirus-airline-bailout-virgin-qantas-failure/12110064
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