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New players circle ailing Virgin

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Over the years private equity operators have been described as barbarians at the gate, vultures and corporate raiders. They buy distressed assets, slash costs and restructure businesses to bring them back to profitability before returning them to the market, hopefully at a huge profit. Some of their biggest successes included Myer, which made private equity a profit of more than $1 billion in a short period of time.

A private equity consortium APA, led by Ben Gray, tried to buy Qantas in 2006. After the failed bid, Qantas boss Alan Joyce said: “It would have been a disaster in the end.” Joyce took over as boss of the airline just after the global financial crisis. “What happened that year, we lost $1 billion of revenue almost overnight. It was a big hit to our cash flow. If we had have been in APA we would have had around $11 billion of debt, which is more than twice what we have today.”

If Virgin was placed in administration and ended up in private equity hands, the existing shareholders would be wiped out. They include Singapore Airlines, China’s HNA Group and Nanshan Group, Etihad and Richard Branson, which together hold 90 per cent of the company, along with its thousands of individual shareholders. Before the company’s shares were suspended on the ASX its market value was $726 million.

Richard Branson, a shareholder in Virgin Australia.

Richard Branson, a shareholder in Virgin Australia. Credit:James Morgan

Debt would also be restructured with billions of dollars of senior unsecured debt potentially wiped out and secured debt taking a severe haircut.

Strip it back to .. a domestic operator… a full-service airline focused on key routes and simplify the aircraft and staff arrangements.

Private equity operator

Contracts could also be rewritten, including the $15 million a year in payments to Branson for use of the Virgin name and logo.

The spectre of this playing out will undoubtedly focus any negotiations it is having with its current debt holders about restructuring the debt to stave off administrators taking control of the situation. It would put a question mark over the credit notes and vouchers offered to customers when most of Virgin’s flights were cancelled due to the coronavirus pandemic.

In terms of how the operation would look, the likely playbook would turn it into a domestic operator. One private equity operator’s suggestion would be to “strip it back to what it started as, a domestic operator, but not a low-cost carrier, a full-service airline focused on key routes and simplify the aircraft and staff arrangements”.

This could include closing down its low-cost carrier Tigerair, with thousands of people losing their jobs. It could also involve closing some of its less profitable or loss-making regional routes, which would have an adverse impact on rural Australia.

Internationally, it would likely close its international arm and do a deal with the government to allow Singapore Airlines to step into the breach but Virgin keep three wide-body planes and continue to run the lucrative Australia to the United States route.

Other cost-cutting initiatives could include further simplifying its fleet, slashing its 16,000 staff and flying key routes, which have high occupancy and are highly profitable. How far it goes would depend on the new owners.

Virgin would be highly profitable but it would come at a cost. Less profitable routes wouldn’t be serviced, which would reduce competition and undoubtedly result in a price rise in air tickets. Put simply, there may be two airlines but Virgin would be a shadow of its former self and Qantas would be more dominant than ever.

Indeed, if private equity cut too deeply Virgin could lose some of its more lucrative corporate accounts, which would further change the competition dynamics between the two airlines.

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Virgin is running out of options. The government seems adamant that it won’t give it a $1.4 billion loan to help it over the hump of the global pandemic which has left most airlines poleaxed. Airlines are highly capitalised and have high fixed costs. For Virgin, which also has massive debt costs, it is burning tens of millions of dollars a week just standing still.

To put it into perspective, consultants, including the Centre for Aviation (CAPA), predict that by the end of May most airlines will be bankrupt without coordinated government and industry intervention. The United States, Singapore and New Zealand governments have all helped their ailing airlines.

Despite this, the government appears content that as long as Australia has two airlines, whatever the second airline looks like will be good enough.

There is no doubt that Virgin needs to cut costs and restructure its debt and equity. It has turned to its shareholders but four of the five have ruled out tipping in any more money, with speculation that the fifth shareholder, Branson, may do something.

There is also industry talk that if Virgin goes into administration Branson may join forces with a private equity consortium. For now, that is just a rumour. But every day a new rumour emerges and new players circle.

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