Virgin Australia deals show China opportunity

A man peers out an observation window at Air New Zealand and Qantas Airways planes parked side by side at Auckland International Airport Tuesday, September 9, 2003 in Auckland, New Zealand. Dubai Aerospace Enterprises abandoned plans to buy control of Auckland International Airport Ltd., clearing the way for a Canadian asset manager to acquire a stake in New Zealand's largest airfield. Photographer: Brendon O'Hagan/Bloomberg News©Bloomberg

Virgin Australia’s chief executive, John Borghetti, faced a crisis a few months ago when a major shareholder tried to oust him over his refusal to rein in the airline’s expensive growth strategy.

The 60-year-old executive survived the attempted boardroom coup, and last week delivered a strong riposte: a A$ 1bn capital raising to repair the airline’s parlous balance sheet, and two new Chinese shareholders — HNA Group and Nanshan Group.

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“I’m definitely sticking around,” Mr Borghetti told reporters on a conference call.

Air New Zealand, which pushed Virgin’s board to sack Mr Borghetti, is now selling most of its 22.5 per cent stake in Australia’s second-biggest airline.

The flurry of deals will ensure Virgin remains a viable competitor to Qantas Airways, which retains 63 per cent of the domestic market. They also reflect the international ambitions of Chinese airlines, which are seeking partners to exploit a tourism boom that saw 100m Chinese travel overseas last year.

“There remains a significant growth opportunity for Chinese and Australian carriers“ on international and domestic routes, says Anthony Moulder, analyst at Citi. “Chinese visitor numbers to Australia are forecast to quadruple to 4m a year by 2030,” he said.

Just a day after announcing the agreement to sell a 13 per cent stake to HNA, Virgin applied to operate daily flights between Australian cities and Beijing and Hong Kong starting in June 2017, as part of a strategic alliance with the Chinese group that owns Hainan Airlines, China’s fourth-largest by number of aircraft.

“China is the future for inbound travel and this secures our future,” Mr Borghetti told reporters.

Since joining in 2010 from Qantas, where he was passed over for the top job in favour of Alan Joyce, Mr Borghetti has transformed Virgin from a budget carrier into a full-service airline competing directly with the “Flying Kangaroo”.

This strategy has benefited Australian consumers, who have enjoyed lower domestic airfares in a duopoly market. But the bitter capacity war with Qantas has pushed up Virgin’s net debt to about A$ 2bn, while failing to deliver sustainable profits.

Virgin reported an underlying loss before tax of A$ 18.6m for the three months through March — albeit a 16 per cent improvement on the same period a year ago. Even with its latest cash injection, S&P warns the group has only a “limited financial buffer” against factors such as volatile fuel prices, foreign exchange movements and variable passenger demand.

Up to now costs have largely been borne by Richard Branson’s Virgin Group, Singapore Airlines, Etihad Airways and Air New Zealand, which together own 85 per cent of the carrier. Chinese shareholders HNA and Nanshan, both privately owned diversified conglomerates, will now share the burden.

“This is good news for a cash-strapped Virgin, which will gain the support of Chinese shareholders with a long-term view,” says Peter Harbison, executive chairman at Capa, the aviation consultancy.

While Virgin’s restructuring will not solve the “revolving door” nature of its share register, it will remove aggravated shareholder Air New Zealand from its “stamp collection” of stakeholders, he says.

Etihad has yet to commit to taking part in the A$ 852m rights issue that forms the backbone of Virgin’s capital raising. Analysts say the Abu Dhabi-based carrier may not feel it has to stump up the cash to maintain its 22 per cent stake in Virgin in order to achieve its main strategic objective — blocking a takeover bid for the Australian carrier by a key competitor, Singapore Airlines.

Singapore has long coveted a majority stake in a carrier in the Australian market, which according to Capa data produces around a fifth of its revenues.

Mr Harbison says Singapore Airlines would be the most disappointed by Virgin’s tie-up with HNA, as it provides an alternative for the Australian airline to expand into China.

“Singapore was blindsided by the HNA deal,” he says.

Some analysts reckon Virgin’s success in attracting Chinese capital could spur interest from tier-one Chinese airlines in building a stake in Qantas, which has a joint venture partnership with China Eastern and a code share agreement with China Southern.

“China Eastern could protect its long-term interests in the current joint venture by taking a position in Qantas,” says Paul Butler, analyst at Credit Suisse.

Foreign ownership in Qantas currently stands at 44 per cent, which would permit a strategic overseas investor to buy a further 5 per cent of shares, says Credit Suisse. Foreign ownership in the carrier is capped by the government at 49 per cent.

Qantas would not be drawn on whether it would welcome a Chinese strategic investor. But Gareth Evans, chief executive of Qantas International, told the Financial Times he was not concerned about a competitive threat from Virgin’s tie-up with HNA and Nanshan.

“We’ve done a lot of work on having the right relationships in China,” he said. “The growth potential is tremendous.”

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