OPINION – Patriot games
Forget the corporate rhetoric from Borghetti and Joyce in their latest public exchanges on Virgin’s rampant capital-raising efforts this year, what is becoming clear is that the majority foreign-owned carrier Borghetti leads is staving off a financial cold, writes Julian Green.
In the last 12 months, Virgin Australia has raised more than $1 billion in cash – much of it through debt. This is not an unusual move for any airline and indeed it could be argued as prudent – depending on the outlook and Borghetti has said repeatedly the outlook is uncertain. Regardless, that amount in such a short time points to some fundamental and potentially worrying issues.
Primary among then are Borghetti’s repeated assertions of the need to improve the company’s liquidity position, a situation that has been manifestly reinforced by senior executives of VAH since the airline posted its $100 million FY2013 loss.
Tracking back through the various cash-generating transactions, in June this year Virgin Australia Holdings (VAH) leveraged its remaining fully-owned aircraft. It was the first tangible sign of a potential liquidity struggle. The move, which was telegraphed via a statement to the Australian Securities Exchange, raised US$732.6 million through the issuing of enhanced equipment notes against 24 aircraft, including 21 737-800s, two 737-700s and one 777-300ER.
In its statement to the ASX, Virgin’s chief financial officer Sankar Narayan said: “The transaction is part of our ongoing commitment to diversify our funding sources and further supplement the company’s liquidity position.”
The notes issue came within months of VAH selling its Brisbane heavy maintenance facility to Brisbane Airport Corporation (BAC) as part of a complex and slightly bizarre transaction associated with the airline lending its support to the BAC’s new parallel runway project. VAH now leases back the facility from the airport operator.
In the wake of the recent transactions, VAH is left with effectively no unencumbered assets. In a sense it is becoming a virtual airline in the same way Borghetti has steered the carrier towards a virtual global network.
Through the airline’s new rights issue that cash balance will now be supplemented by the progressive increases in equity by Etihad, Singapore Airlines and Air New Zealand – the foundation of the current public spat.
Qantas is vigorously trying to block the move by the three airlines’ play for additional equity and a seat on the VAH board for each via Virgin’s $350 million rights issue. The move would take the combined foreign airline investment in VAH from the current 62 per cent to more than 70 per cent. To maintain his 10 per cent interest, Richard Branson has had to pay an estimated $35 million. This reinforces he wishes to remain in the game and offers some proof of the faith he continues to hold in VAH.
If approved, the new VAH shareholdings would look thus: Air New Zealand 25.5 per cent (up from 22.9), Etihad 22.2 per cent (up from 19.9) and Singapore Airlines 22.1 per cent (up from 19.8). With Virgin Group retaining its 10 per cent, the dilution will have occurred in the ‘others’ group (small investors plus management and staff), which would reduce to 20.2 per cent from the current 27.4 per cent.
While the $350 million adds to VAH’s cash war chest, the increases in shares by the three foreign airlines are very clearly strong strategic plays.
Singapore Airlines and Air New Zealand historically have never hidden their historical desires for direct entry into the Australian domestic market (remember Ansett?), moves that have variously been lobbied against by an aggressive Qantas. Now these two airlines and Etihad are achieving entry via Virgin Australia and to the aggravation of Qantas, and with a direct role in the oversight of VAH through board membership.
For Etihad, VAH is just one of a growing list of such equity investments that is increasingly paying sweet dividends to its balance sheet – and to finance its recent prolific aircraft orders – in what has become a self-perpetuating cycle of global expansion.
The strategic minds of the Abu Dhabi carrier and that of VAH’s other two equally successful equity investors demonstrate an acumen by them of portfolio diversification and revenue enhancement that is enviable.
In justification of the proposed equity changes, Borghetti stated: “The capital raising announced on 14 November 2013 is designed to enhance Virgin Australia’s liquidity and gearing position to ensure we are in a stronger position moving forward, so that we can continue to bring much needed competition to the Australian aviation market and continue to grow jobs in Australia.”
That word liquidity surfaces again in justification.
In its 2013 financial results, VAH said its total cash position at the end of June this year was $580.5 million and that the airline was generating positive operating cash flows. This was the first overt repeated reference to the need “to supplement and diversify the company’s liquidity position”.
Alongside the issue of cash-raising is cost management, and expenditure controls and productivity gains take on a new emphasis given the apparent urgency of cash needs. In FY 2013, VAH achieved “efficiency gains” of more than $60 million through its Game Change program. The company has targeted $400 million in savings through to June 2015.
All of this follows a period of heavy investment for VAH. It completed its $99 million takeover of Skywest in a savvy move against Qantas in the regional and FIFO markets. VAH also invested $60 million in Tigerair. It also expended $25 million on protecting customer products while introducing its move to a new reservations system. All these commitments, together with what VAH described in its FY 2013 annual results as $105.1 million in one-off “transformational costs”, understandably have depleted cash reserves.
VAH said about last year’s financial results: “The Group has undertaken a review of its balance sheet during the financial year. As part of this process, over the year we have executed the sale and lease-back of the Virgin Australia hangar at Brisbane Airport and several other initiatives have also been identified and are underway to further improve liquidity and balance sheet efficiency.”
For Joyce, the move by VAH and its equity partners has been taken almost personally. In a memo to staff he said: “…now we face an unprecedented situation. For months Virgin has been losing money, driven by a strategy of setting un-competitively low prices to win customers off Qantas across all our flying businesses.
“The reason for this otherwise irrational behaviour became clear last week with the near-full acquisition of Virgin by airlines owned by the governments of Singapore, Abu Dhabi, and New Zealand. With the benefit of unlimited sovereign funds – including the recent injection of a further $300 million – Virgin can set prices below a competitive level simply because, unlike us, they don’t need to make a profit. And despite being owned by foreign governments, Virgin would retain all the traffic rights of an Australian carrier.
“The agenda of these foreign airlines is to terminally weaken Qantas and Jetstar in our domestic markets, force us to shrink our international business, and sacrifice jobs. If nothing is done, they will be perfectly placed to take a domestic monopoly position in the Australian market over the longer term,” Joyce said.
To whit, Joyce has rolled out the foreign ownership cap argument again, stating in a letter to the government the increase in foreign airline ownership of VAH is against the national interest. Joyce cites limitations under the Qantas Sale Act meaning any single foreign airline is limited to acquiring 25 per cent of shares, or a group of foreign airlines to 35 per cent. Interestingly, while VAH is attracting dynamic interest from its three airline investors, Qantas has no airline investor at all.
But hypothesising, if Joyce and the Qantas board had a freer hand at raising capital through foreign airline investment, would they do so? Another case of if you can’t beat ‘em, join ‘em?
Rewind the tape just three years and Emirates was one of those state-owned foreign demons that Qantas had issues with. Now, with Emirates delivering a lifeline to what was a failing international business for Qantas, history has been conveniently erased. And, of course, in the process, Emirates has gained entry to the lucrative Australian domestic market – in the same way Etihad, Air New Zealand and Singapore Airlines have – but without spending a single dirham.
And what of Qantas’s own role as a foreign airline investor in its various Jetstar franchise across Asia?
There is a story about the pot, a kettle and the colour black. Is it being republished with a kangaroo on the cover, or is Joyce right to argue for a level foreign-investment playing field?
And so what is VAH going to do with all this cash?
A $1 billion-plus cash war chest for the purposes of competing even more vigorously with Qantas? That’s a lot of blood to be let and more recent signs of the capacity/demand equation reaching better equilibrium suggest this would not be the strategy, with both airline CEOs having seen the deleterious effect capacity dumping at any cost has.
Is VAH going to buy precious corporate business that Qantas has hung onto tenderly in the face of rising competition? That’s an unsustainable proposition that in the end – again – would benefit no-one. So $1 billion is a lot of competitive collateral.
In reality, both carriers have little room to expand further in the domestic market and any growth by either would be at the expense of the other.
“The landscape of Australian aviation has changed forever. It no longer is a monopoly,” Borghetti declared.
Virgin Australia has accomplished what it set out to do. It has wounded the roo and created the need for Qantas to refine its own domestic business and make it a better product for the benefit of travellers.
More likely is that VAH’s spree on Skywest, Tigerair, new global distribution system and rising internal costs are the real reason for its being close to catching a financial cold. That, together with opportunities eyed astutely by Etihad, Singapore Airlines and Air New Zealand to seize more of the competitive landscape in an expansion of their astute strategic arrangements.
But behind the rhetoric of foreign ownership claims and counter-claims, seats on the board and pursuit of protecting the national interest, what lies beneath is the undeniable trend of apparent high urgency of VAH to raise cash, reinforced by company statements about the need to boost liquidity. They lend a worrying perspective on the airline’s otherwise splendid rise in recent years at the hands of Borghetti.
Regardless of recent history at VAH, one aspect of history that can be guaranteed to repeat is Qantas’s abject objection to a competitor strengthening its position.
“I am not sitting by while the future of Australia’s Qantas is snatched away. No other country on earth would passively allow such a foreign takeover to happen,” Joyce resounded.
That is, of course, unless he can get the Qantas Sale Act abolished or amended.