Comment: Virgin bloodletting signals private-equity hijacking

written by Adam Thorn | October 19, 2020
Virgin Blue began flying on August 31 2000. (Paul Sadler)
Virgin Blue began flying on August 31 2000. (Paul Sadler)

In this cross-posting from The Conversation, University of Sydney economics professor Mark Melatos explains why private-equity firms prefer hands-on chief executives, and asks what Jayne Hrdlicka’s appointment could mean.

US private equity firm Bain Capital won’t formally assume control of Virgin Australia until November. But its coup against chief executive Paul Scurrah, dumping him for Jayne Hrdlicka, a former Bain employee with a reputation for toughness, signals the start of a classic private equity smash-and-grab operation.

When Virgin’s administrators and creditors formally accepted Bain’s bid for the stricken airline, they did so in part due to undertakings job losses would be minimised. Administrator Vaughan Strawbridge optimistically said in September the deal would provide “certainty for employees and customers” as well as “maintaining a competitive Australian aviation industry for the benefit of consumers”.

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Now, just weeks later, Scurrah’s exit indicates Bain’s intentions. He was reportedly reluctant to undertake the cost-cutting Bain wants as part of a plan to position Virgin Australia between Qantas and its budget carrier Jetstar.

Hand-picked appointment

Hrdlicka spent about 15 years working for Bain in both the US and Australia. She joined Qantas as a senior executive in 2010, where she reportedly gained a reputation for being tough on unions. She was appointed group chief executive of Jetstar in 2012 (a position she held until 2017).

Replacing the existing boss with a hand-picked replacement is standard practice in private equity deals. It is one of the most important strategic decisions (and typically the first) a private equity owner makes.

As such, the choice says a great deal about what an owner hopes to achieve, and how it plans to achieve it.

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In contrast to the chief executive of a public company (the shares of which are traded on a stock exchange) who must act on behalf of a multitude of shareholders, the head of a private-equity company answers solely to the private equity owners.

This relationship, therefore, is an intensely personal one, with private-equity partners being very “hands-on” owners.

Urgency trumps empathy

What are the qualities private-equity owners look for in a chief executive?

According to researchers who interviewed 32 managing partners of private-equity firms to find out what they valued, a handful of key qualities are particularly sought after.

They want candidates with a track record in overcoming setbacks, who are team builders, and who won’t shy away from telling their bosses (the private equity firm) how things are. Previous experience is less important. So too is empathy. As one interviewee told them:

I’m not down on empathy, but there are times when empathy needs to take a back seat to urgency. Some highly empathetic leaders are not able to make the tough personnel decisions that need to be made – which compromises performance.

In this vein, Bain’s jettisoning of Scurrah for Hrdlicka is highly suggestive of the management approach Bain would like to see.

Among other things, it is likely to involve a more combative approach to employee relations with a view to aggressively, and quickly, driving down Virgin’s cost base.

Scurrah’s dumping has already reportedly led to the Transport Workers Union (representing the biggest proportion of Virgin Australia employees) suspending negotiations with management. Unions had reportedly been assured months ago Hrdlicka would not be made chief executive.

Private equity’s poor track record

Last week, Strawbridge again (somewhat optimistically) “reaffirmed” that “Virgin Australia will not be repositioned as a low-cost airline”:

Virgin Australia will be a ‘hybrid’ airline, delivering high value to its customers by delivering a distinctive Virgin experience at competitive prices.

But Bain’s dumping of Scurrah for Hrdlicka fits the classic narrative of how private-equity players squeeze money for themselves out of takeover targets before bailing out before those companies nose-dive.

As I wrote after Virgin Australia’s August announcement that it would axe its budget brand Tigerair and sack about 3,000 of its 9,000 staff:

Private-equity owners have a poor track record in creating strong, sustainable companies with long-term prospects. At their worst they can act a bit like used-car salesmen who know how to spruce up and turn a profit on a vehicle with underlying mechanical problems.

If the typical private-equity experience is anything to go by, Bain, having acquired Virgin with mostly borrowed money, will seek to maximise cash flow by operating only high-margin, high-volume routes (consistent with servicing “premium corporate” and “budget-focused” travellers). It will abandon other low-margin, mostly regional routes to the vagaries of the Qantas monopoly.

Bain will also likely seek to reduce staffing costs through renegotiating pilot and cabin-crew employment contracts, using the threat of further redundancies as leverage. On the most popular trunk routes, where it will provide a parallel service to Qantas, customers will face cosy duopoly prices.

The upshot of all this: to allow Bain and its co-investors to pay themselves handsome dividends upfront, thereby facilitating an exit at the earliest opportunity at a tidy profit. This would be a classic debt-fuelled private-equity play.

In public-interest terms, however, it will be a costly missed opportunity to build a robust long-term domestic competitor to Qantas.

Inevitably, once the private equiteers have left the building, a once-proud airline will be left labouring under a mountain of debt, marking time until it capitulates at the onset of the next economic crisis; the unfortunate plaything of financial, not aeronautical, engineers.The Conversation

Mark Melatos is an associate professor of economics at University of Sydney

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14 Comments

  • John

    says:

    So, the blame for the upcoming debacle lies squarely at the feet of those who short-listed private equity firms. Even I know this is how they operate so why didn’t Deloitte? Maybe they did but they didn’t care. Maybe they thought they could control it but, for certain, they’ve contributed to the workforce being done over.

  • Jason

    says:

    Can’t wait to hear the naysayers blame the government for this one, in any case the hand has been dealt and what now needs to occur is for parties to get on with it if we want to see Virgin survive. The economics of it suggest the hybrid model can exist, but a hybrid model is not a full service airline concept simply given a different tag and some need to just accept that fact.

    The reality is that the business was bleeding well before COVID, to the levels that it was likely administration or takeover was going to occur at some point. Notwithstanding this is typical behaviour of the private equity firms whichever way you cut it, an issue that is not aviation specific and shouldn’t be treated as such.

    The elephant in the room is the behaviour of private equity firms. What should happen is a bipartisan approach to changing the laws preventing private equity firms being allowed to act “unscrupulously” in their endeavour to profit out of such situations.

    In any case Strawbridge and co should also be brought to account over this, another element of a long overdue review of how voluntary administration and liquidation operates. In this instance, Deloitte had no intent on delivering what’s best for Virgin and aviation, they too are motivated by maximum returns and profits from the transaction, and private equity provided that.

  • Dennis Hume

    says:

    No discussion as to why Virgin is 5 – 7 Billion in the red before CoViD19?

  • Andy P

    says:

    Everyone has forgotten what bought virgin to its current master…. It went broke! To think everyone can carry on doing what they were doing at the same pay is crazy.

  • Disappointed

    says:

    It is such a shame. With the company unloaded of debt and bad contracts it was in a position to be a strong player in the Australian market. Now it seems Bain will strip it bare and set it up to fail. Sad times for all the employees that have had the rug pulled out from under their feet.

  • Vannus

    says:

    Since Bain was the only ‘successful’ bidder for VA, back in June, other commenters’, as well as myself, have been saying exactly what’s in this article.
    It was blatantly obvious that Scurrah would be sacked, & there’s much more to come, none of which is good.
    Those VA staff who had put in for VR, & got it, are very fortunate. Those who are left, well, it doesn’t look good for them at all.
    There are many commenters’ on this site, who’ve been in the airlines’ for multiple decades’, & DO know what they’re talking about.
    All those who ‘howled’ them down, were mistaken.

  • Steve A

    says:

    Why is anyone surprised by this?
    We all knew that this is what the outcome was going to be.
    Even me, who is just an average person, knew that this is what was going to happen.
    And an Inquiry into how Administration and bankruptcy laws allow big accounting firms to rhort everyone in order to maximise their fees,is long overdue.
    They don’t care about shareholders, employees, or even secured creditors. They care about large fees for themselves.
    Maybe they should get paid on a basis of how successful they are in maximizing the return to all of the people they have no empathy for at the moment.

  • Peter K

    says:

    What’s best for Virgin AU is that they survive.
    We currently have COVID 19 devastating airlines and Virgin was prior to this massively in debt – to the tune of about $7 billion.
    So has everyone got amnesia or something.
    It’s OK for the unions to say what type of airline they would like and that staff be well remunerated, but this was a pipe dream. It was never going to happen if Virgin was to survive.
    After an appropriate time, probably the first thing that Bain will sell off (by float or sale) will be tbe Velocity Frequent Flyer program. It has an EV of approximately $2.4 billion.

  • The Bunglerat

    says:

    As a recent ex-Virgin wide body pilot, these latest developments are heartbreaking if not at all surprising. The only thing that has surprised me is just how quickly Bain showed their true colours before the ink was even dry – but then they are nothing if not predictable. Bain is what Bain does. A month ago I was gutted to be amongst the 3,000-ish casualties of VA’s restructuring. This week I’m gutted for the many good people who still remain, all the while knowing that as long as they do, they will routinely get screwed over. Whilst I don’t relish the fact that my career was brought to such an abrupt and unceremonious end, strangely I feel quite relieved that at least I won’t be around to see Hrdlicka preside over the trashing of an airline I was once proud to work for. Not that I’m judging anyone for choosing to stay under such circumstances, as we all gotta do what we gotta do. Fate removed the choice from me to decide whether or not to stay – but I must admit that if I had, I’d just feel somehow complicit.

    Good luck to all…

  • Travel

    says:

    The problem I have with the administration process is that it essentially allowed an external body to buy Virgin Australia as a going concern at a rate arguably less than the market liquidated value of the assets.

    This in effect distorts the market and will most probably require QANTAS, an airline with three times more employees to make a competitive response.

    The question becomes, who are the winners? I don’t think there will be too many creditors laughing all the way to the bank. The employees, what ever number that ends up being will have to make some considerable sacrifices if they want to remain employed. As for the travelling public the difference between $130 and $200 isn’t much when we consider most leasure travellers only travel once or twice a year.

    I suspect once the airline is flying again and it has a few profits under its belts, the airlines assets will be refinanced so that Bain can take as much money as possible out of the company.

    When this happens, Virgin MK2.7 financial circumstances could well be heading in the same direction of VA under the previous management team.

    ….and this begs the question. What did Bain see in this airline. Was it the airline itself, its employees and culture or was it simply the opportunity to financially structure a business model where Virgin’s assets could be brought at less than market value and than turned into cash when the market rebounds.

    As such, are we going to see another AirAsia type business model where assets are turned into cash and dispersed to shareholders leaving the core business itself debt laden and financially unsound.

    Time will tell

    As a side note, the eadiestway to turn an asset into cash

  • BILL MALANDRIS

    says:

    Bain puts its adviser and former Jetstar boss Jayne Hrdlicka in charge of Virgin, Ms Hrdlicka did a good job for Jet Star over the years when she was CEO. Allen Joyce and the Qantas board were very happy with the financial results and would bring the same no nonsense to Virgin Australia.
    The TWU, which claims to also have the backing of the ASU, VIPA, and AMWU, said firing Scurrah could also mean the airline moves away from being a ‘hybrid’ and slides towards being a low-cost carrier, which would likely result in more job losses.

    The TWU and the above unions should realise there is a new owner of Virgin Australia it is called Bain Capital, it has a different way of doing business American style. Bain Capital and Jayne Hrdlicka would take the view with so many unemployed pilots, air hostess, ground staff, ticketing check in. This is your contract and conditions you can take it or leave it.
    Remember Chris Corrigan is best known for the 1998 Australian waterfront dispute, in which he attempted to sack the heavily unionised workforce and replace it with strike-breakers, eventually leading to reform and restructuring of dockyard labour practices.
    welcome to new world of doing business post Covid 19

    Once Bain Capital has done the restructure, rightsizing and the effect it will have on thousands of soon to be ex-airline staff. Bain will put it up for sale. Singapore Airlines would be a buyer for a Virgin Australia assets cheaply and without the debt (perhaps together with a strong capital partner and a financial injection from Temasek Holdings’, Singapore $340 billion sovereign wealth fund, Singapore Airlines have always wanted a domestic carrier they missed out buying Ansett Australia in 2001, they were unsuccessful with Melbourne outfit BGH Capital bidding on behalf of Temasek, maybe this could be there chance when Bain Capital puts Virgin up for sale in the next few years or sooner

    Something else the employers of Virgin should look out after the November 1st, that after March 2021 they may not be entitled to any Job keeper payment relief as Virgin becomes a foreign company (Qantas selling its Q Catering (based in Brisbane, Melbourne, Perth and Sydney) and frozen food maker Snap Fresh (based at Logan City in Queensland) to the Emirates Group-subsidiary Dnata is the catering company based in Dubai> April 2018 ?? Just saying

    BILL

  • Andrea Shearer

    says:

    I said from day one, that an ex CEO of a rival company, Jetstar, and appointed on the Bain panel appeared to be a conflict of interest. The millions of dollars to the administrator, legal advice etc, etc was obscene. Then the reports of conversations between the newly appointed Virgin CEO and the Qantas CEO. The integrity of the staff of Virgin was dealt a low blow. Well, we can only hope that karma will be on the side of the great staff and the public who will support Virgin Australia.

  • Shane

    says:

    Virgin always was a foreign owned airline with the major shareholders when entering administration being Nanshan Group, Singapore Airlines and Etihad all approx 20%, HNA group and Branson holding around 10%, (only approximate holding estimates).
    An airline only requires to be majority Australian owned if they are based in Australia and wish to operate International operations from Australia. VA got around this by spinning off their International operations to form a majority Australian owned subsidiary.
    Not sure how Job Keeper works at VA, however one difference is that Dnata is wholly owned by the UAE government.

  • Dan

    says:

    Time to give the “Singapore Airlines” wants into the Australian domestic market a rest. They’ve had 3 goes at the market and failed miserably through Air New Zealand (Ansett), Tiger Airways (wholly owned and operated) and their 20% stake in Virgin Australia.

    Had Singapore actually been serious, they would’ve bought Virgin out a long time ago. The news release saying they are not interested in helping Virgin’s financial problems and had invested in Vistara India (also having financial issues) post-COVID suggests that Australia is not as an important market to Singapore Airlines.

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