Qantas Keeps Sliding

Its landmark alliance withEmirates was meant to stop the bleeding from the international business that had been to blame for earlier losses – and the deal did produce a round of renewed optimism – but it also starkly illustrated Qantas’s new place as very much the junior partner. And so, after all that, December’s return to red ink – and the scale at which it had mounted – could only have felt like a kick in the gut.

In the lead-up to and wake of the news, it was certainly a wounded-looking kangaroo that lashed out at its increasingly bitter rival and lobbied furiously for government help. None of its arguments were

Bad blood between the airlines has been on the rise for several years.

exactly new. Qantas has held for some time that restrictions on foreign ownership place it at an unfair disadvantage against Virgin Australia, which is under no such restrictions and has used foreign investment to fuel its dramatic transformation into a formidable full-service competitor. But the scathingly public way that Qantas began making those arguments seemed to reveal something resembling desperation.

Writing in The Australian, Qantas CEO Alan Joyce argued that a 2012 restructure of Virgin’s business model designed to allow a greater degree of foreign investment had enabled Virgin to “circumvent Australian law and pretend to be an Australian airline when it is majority-owned by three foreign government-backed airlines”. Through Virgin, Joyce continued, those airlines are “pouring money into our domestic market to weaken Qantas and ultimately funnel Australian traffic on their airlines and through their hubs”.

That had followed Virgin scion Sir Richard Branson, not known in the calmest of times for mincing his words, using a post on his website to give Qantas a whack. “If Qantas was better managed and offered the public a decent service it would not be in the financial mess it is currently claiming it is in,” he wrote.

Bad blood between the airlines has been on the rise for several years amid an ongoing fare and capacity war that has damaged both carriers’ bottom lines, and which each blames the other for starting. According to Qantas, Virgin has used its foreign capital to prop up an otherwise unsustainable battle for domestic share. According to Virgin, Qantas has used its bulk to try to squeeze it out of the market.

The acrimony increased this year as Virgin, fresh from losses of its own, leaned on its foreign investors to raise $350 million that, in Qantas’s view, would allow Virgin to continue feeding the blood-bath.

An uneven playing field?

The not-so-subtle subtext of the latest round in this battle is that Qantas is now feeling real and serious pain at the heart of its business. In Virgin’s view, that makes Qantas’s recent outburst little more than the whinging of a losing side that has been happy to make the most of its own substantial competitive advantages. As Branson was quick to point out, the then-Virgin Blue launched in Australia with two aircraft and one route against a “giant” Qantas determined to “bleed [Virgin] dry”. Flying in Australia, Branson added, has sometimes been akin to having a “bleeding contest with a blood bank”.

Still, it is also a matter of fact that Qantas and Virgin operate under different legal regimes. Under the Qantas Sale Act, passed alongside privatisation of the formerly national carrier in 1992, overseas ownership cannot exceed 49 per cent and any single airline’s investment in Qantas is capped at 25 per cent.

Virgin’s 2012 restructure split its international and domestic businesses into technically separate holdings, freeing the domestic business from government regulation that caps foreign ownership of an Australia-based international airline at 49 per cent. This opened the way for effectively unlimited foreign ownership of Virgin. At present, Virgin is 80 per cent owned by four overseas groups: Etihad, Singapore Airlines and Air New Zealand, in addition to Branson’s Virgin Group. With Branson seen as losing interest, the three airlines have all ramped up their investments as part of a broader strategy of equity-based alliances that has enabled Virgin’s dramatic transformation both domestically and overseas.

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The restrictions of the Qantas Sale Act have not prevented Qantas from taking on overseas investors or raising money. As Virgin is keen to highlight, large globally focused institutional investors make up more than half of Qantas’s share register and the airline has managed to raise more than $1. 2 billion in equity capital from global investment markets over the past decade.

In essence, Virgin argues that it’s just doing what Qantas has always done. But there is a difference. Though Virgin argues that two of its three airline partners are publicly traded companies that are “expected to make a profit and a return on their investment”, just like any other investors, there’s little question that their broader alliance with Virgin makes them more generous and more tolerant of short-term risk. Such tolerance is only bolstered by the fact that both Air NZ and Singapore Airlines are majority government-owned (53 and 55 per cent respectively), while Etihad is fully owned by the UAE government.

Qantas, on the other hand, has to rely on investors more squarely driven by profit – the main reason it has been so covetous of its investment-grade credit rating, which is a rarity in the airline world. With that rating now a casualty of its latest financial results – Standard & Poor’s having downgraded Qantas stock to junk status and Moody’s having placed it on negative watch while maintaining its investment-grade rating – it’s likely that raising further capital would come at an increasingly unsustainable cost.

If the degree to which the Qantas Sale Act is to blame for the airline’s overall problems can be debated, there’s little question that the restrictions do place Qantas at a disadvantage. Moreover, the act’s view of Qantas as a strategic national asset seems out of step with Australia’s increasingly liberal economic policy framework. Still, changes to the law do not appear imminent. While the Coalition has expressed an openness to consider such changes, it says it lacks the votes to get them through the Senate without Labor support.

Into this breach, Joyce has launched himself with desperate energy, lobbying the government to either change the sale act, impose similar restrictions on Virgin or, failing either of those, make up the difference by guaranteeing Qantas’s debt or taking a stake in the airline. Joyce insists Qantas is not after a government subsidy, simply a “fair go”. Pointedly, he added: “Qantas is not Holden. ” Not surprisingly, however, the proposals for direct government intervention were quickly rebuffed by Prime Minister Tony Abbott and Transport Minister Warren Truss. Indeed, it seems unlikely Joyce seriously thought a Liberal government would go along with what amounts to a partial re-nationalisation of the airline. Instead, such public noises seem intended to increase pressure in favour of changing the sale act. In a similar vein, Qantas has let it be known that the sale act’s restrictions have scared off potential airline investors such as China Southern.

Joyce’s pointed comparison of Qantas to Holden came before the car maker announced its plans to cut its Australian workforce injaworskia move that followed weeks of government pressure for Holden to declare its intentions. With the Abbott government now on the defensive over Holden, it could be more sensitive to charges of doing nothing to help a failing Qantas, and perhaps a strong push to change the sale act could emerge as a palatable means of presenting at least a semblance of action.

But the politics of such a push are far from easy. With Joyce already the subject of deep union ire, such groups are likely to see a change to the sale act as one more prong in J

oyce’s master plan to replace Australian workers with cheaper overseas alternatives.

For now, Qantas still has plenty of options. Parts of its business are thriving, notably its frequent flyer program and Jetstar. A partial sale of one or the other has been widely discussed as one way for the company to raise capital, though from a purely economic standpoint it’s hard not to feel like such a move would amount to chopping off the healthy tissue to save what’s rotting.

The ultimate source of the rot remains a subject of endless contention largely reflecting the speaker’s viewpoint. For some, the problem is Joyce himself, or long-term strategic mistakes like the decision to opt for A380 superjumbo jets over the nimbler 777, or a strategy of cutbacks that has undermined the premium product needed to justify Qantas’s premium costs. For others, the problem comes down to those costs, which according to one recent analysis remain 17 per cent above Virgin’s.

Whatever the case, the increasingly real danger for Qantas – or at least for Alan Joyce – is that this debate becomes a postmortem.