Another Virgin Lost
Absent government aid, Virgin Australia files for bankruptcy.
Virgin America, Virgin Express, Virgin Sun, Virgin Nigeria, Virgin Samoa, Little Red… all gone. Same for Virgin Connect, the would-be name for Flybe, the first airline victim of the current virus crisis. Flybe’s part owner Virgin Atlantic, the very first Virgin-branded airline, itself now stands on the precipice of bankruptcy. Virgin Australia, alas, is already there — it filed for “voluntary administration” last week.
The filing makes Australia’s second largest airline the first major airline worldwide to seek judicial protection from its creditors. To be clear, Virgin Australia continues to operate normally, which in these bleak times means running just a skeleton schedule of flights. It’s still carrying cargo, for example. It’s still offering charters for Australian natural resource companies, demand for which it says remains strong. It’s operating a few flights to Los Angeles and Hong Kong each week to help Australians return home. And it’s flying some domestic routes — with government subsidies — deemed essential by Canberra. But most of its fleet is currently idled.
Virgin was hoping it could avoid the bankruptcy court. But repeated pleas for government help went unanswered. Politicians, no doubt, were concerned about Virgin’s importance to the economy, its 10,000 employees, and its role as a counterweight to Qantas, which would otherwise monopolize much of the country’s airline market. But ultimately, it was too difficult to stomach a taxpayer rescue that would protect the equity of Virgin’s mostly foreign shareholders. Richard Branson’s U.K.-based Virgin Group owns 10% of the airline. Abu Dhabi’s Etihad owns 21%. Singapore Airlines owns 20%. China’s HNA Group owns another 20%. The parent company of China’s Qingdao Airlines owns 20% as well.
All shareholders now face the possibility of losing their entire investment, pending the outcome of Virgin’s court-supervised restructuring. The proceedings get underway this week with a meeting between Virgin’s newly appointed administrators — four turnaround specialists from the global advisory firm Deloitte — and major creditors. The creditors include banks, aircraft leasing firms, and employee unions, among others. For now, the Deloitte administrators say they’ll keep the carrier’s current management team, led by CEO Paul Scurrah. Scurrah became CEO just last year, charged with putting Virgin on more stable footing after years of poor financial performance.
It was this record of poor performance that made Virgin so vulnerable heading into the crisis. The airline actually enjoyed a prosperous beginning. Today, it’s a victim of crisis. But in 2001, it was a major beneficiary of a crisis. Shortly after its 2000 launch, Virgin Australia, then called Virgin Blue, watched with glee as rival Ansett Australia collapsed from the post-9/11 demand shock. Virgin thrived as an orthodox low-cost carrier during the early 2000s, competing against its much higher-cost rival Qantas. The low-fare leisure market in Australia is only so big though, and Virgin soon felt the need to expand its offerings in order to grow.
So it began offering premium amenities to chase business travelers. In 2009, it began flying widebodies to the U.S. Before long, the once B737-only operator was also flying B777s, A330s, E190s, and E170s. It would add Fokker jets and ATR turboprops when it acquired the Australian regional carrier Skywest in 2012. That same year, it acquired Tigerair Australia, giving it A320s as well. In the meantime, it created a virtual network abroad via partnerships and joint ventures with foreign airlines, most importantly its shareholders Singapore Airlines and Etihad. Delta would become a JV partner too. In addition, Virgin befriended Air New Zealand to share revenues in the key trans-Tasman market linking Australia with New Zealand. The two became so close that ANZ for a time became Virgin’s leading shareholder.
But ANZ grew frustrated by the losses, and by its partner’s rising costs and ever-increasing complexity. In 2018, ANZ decided enough was enough. It wanted nothing more to do with Virgin, which suddenly found itself alone across the Tasman. All the while, Qantas was turning itself into one of the world’s most profitable global airlines. It boldly undertook deep labor reforms in the wake of the global financial crisis of 2008-09, at one point even grounding its entire fleet to force union concessions. It managed to pinch Virgin from both ends, winning the upper-end of the market while harassing its rival’s low-fare flank with Jetstar. Qantas today earns its highest margins in the Australian domestic market, where Virgin barely gets by. During calendar year 2019, Virgin earned a mainline domestic operating margin of just 2%. Qantas mainline earned 12%. Virgin’s Tiger unit, meanwhile, suffered a negative 6% margin. Internationally, Virgin’s margin last year was negative 8%.
Things only got worse as Australia’s long era of economic growth began petering out with the slowdown in China’s demand for the country’s natural resources, notably iron ore and coal. That caused troublesome Aussie dollar weakness. Virgin then encountered new trouble by entering Hong Kong, and forming a partnership with the fragile Hong Kong Airlines, just as the city was becoming paralyzed by street protests. An epidemic of wildfires across Austrlaia didn’t help, suppressing tourism throughout much of the country.
It’s in this context that Scurrah, well before the current crisis, began cutting jobs, reducing capacity, renegotiating contracts with suppliers, shrinking its B737 MAX order, rightsizing Tiger’s fleet, and repurchasing full control of its Velocity loyalty program, the one part of Virgin’s business that’s always generated strong profits. On the network front, Virgin announced a retreat from Hong Kong, redeploying planes to Tokyo Haneda instead, having secured new slots at the airport. Brisbane-Tokyo flights were supposed to have launched late last month.
Virgin, you can see, was in no shape to withstand even a mild downturn, let alone the worst downturn in industry history. The question now is: Can it find new investors to provide the necessary capital to exit bankruptcy? Would anyone be interested?
In fact, many are interested. Reports abound of private equity firms and even Chinese airlines looking to participate in Virgin’s revival. Existing shareholder Etihad, too, is mentioned as a possible contributor of more capital. Most interesting among the rumored suitors is the U.S. private equity firm Indigo Partners, which was involved in the original Tiger Airways based in Singapore. More importantly and influentially, it was responsible for turning Spirit into an ultra-LCC success story. It today controls Wizz Air, Frontier, Mexico’s Volaris, and Chile’s JetSmart.
The abundant interest suggests Virgin Australia can survive its current trip through bankruptcy, which for many airlines can result in liquidation. Why is there so much interest? Would not the airline’s long ledger of red ink suggest otherwise?
Don’t underestimate the advantages of a court-supervised restructuring. Virgin will have the opportunity to wash clean many of its unfavorable contracts — with suppliers, with unions, with airports, and so on. That should leave it with a much lower cost base. It can rethink many of the strategies that got it into trouble. Does it want to continue operating Tigerair? Does it want to continue to chase premium corporate traffic? Does it want to continue flying a subscale fleet of aging B777-300ERs? Does it want to continue to operate a subscale intercontinental network dependent on multiple airline partners, each with their own agendas?
Virgin will likely have even greater wherewithal to renegotiate contracts and abandon contractual obligations than unusual, given the parlous state of industry affairs — counterparties have virtually no leverage right now to, for example, redeploy aircraft elsewhere. Suppliers need Virgin to survive. So do unions. So do Australia’s airports. So does its home city Brisbane, whose local government offered some rescue money pre-bankruptcy. So does Canberra, loath to let Qantas dominate the Aussie skies. The city of Melbourne offered money if Virgin agreed to move its headquarters there.
Virgin’s best bet might be a return to its past. Before it became a Blunder Down Under, remember, it thrived as something akin to an ultra-low-cost carrier. True, Qantas is a much tougher competitor today, armed with Jetstar and a much lower cost base. But Qantas will be its only meaningful competitor. As mentioned before, Virgin mainline did earn a profit domestically in calendar year 2019. With a significantly slimmer cost base, less complexity, and a better business model, then surely it would have done better. The Velocity loyalty plan by the way, remains a part of Virgin but separately incorporated, and not currently in bankruptcy. Its 10m members are another lure for prospective Virgin investors.
Calendar year 2019, of course, was a different time and place. Post-pancession, the world will surely look different? But the differences might favor a domestically-oriented, low-cost carrier. Longhaul international markets, after all, are expected to take much longer to recover.
And speaking of recovery, don’t look now but Australia is one of the few places, along with South Korea and Taiwan, getting praise for a successful response to the Covid pandemic. The country has had fewer than 100 Covid-19 deaths, and few new cases in recent days. New Zealand too, a market to which Virgin would likely maintain service post-crisis, is starting to open its economy amid low infection rates. Back in Australia, Virgin’s home state Queensland began relaxing some restrictions on economic activity last week. All of this suggests Australasia could be among the first airline markets to recover.
That’s hardly a sure thing, especially with winter now coming in the southern hemisphere. IATA, meanwhile, said last week it hasn’t seen any evidence of demand recovery yet. But sooner or later, Australians will be flying in great numbers again, and Virgin Australia — cleansed of its sins through bankruptcy — will likely be there to serve them.