News Backgrounder
Separation but not divorce across the Tasman
Will Singapore Airlines (SIA) buy Air New Zealand’s (Air NZ) holding in Virgin Australia? At press time, the question was exercising the industry after the dramatic March resignation of Air NZ’s chief executive, Christopher Luxon, from Virgin’s board.
May 1st 2016
The aviation chattering classes came alive when Air NZ’s CEO, Christopher Luxon, suddenly announced he was resigning from the board of Virgin Australia (VA) and that the Auckland-based carrier was considering selling its 25.9% investment in the airline. At one stage, it was reported Luxon had “cleared his diary” and was heading overseas to finalize a quick sale. Read More »
The report was speedily denied by Air NZ, who said Luxon was not going anywhere. Instead Air NZ signalled it was going to take its time in working through its plan to divest some or all of its holding in Virgin Australia.
Selling, or not selling the shares, remains under review with First NZ Capital and Credit Suisse appointed to advise on the options.
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Nevertheless, with most observers believing the airline would opt out of its shareholding, a fierce debate is continuing about the future shape of VA’s ownership registry. Would SIA, which increased its holding in VA from 22.91% to 23.11% shortly after Luxon resigned, buy up the entire Air NZ package?
And would SIA insist on showing Borghetti the door and appointing their own CEO?
Other options include Etihad Airways, with 25.1% of VA, buying the surrendered Air NZ shares. Or might each of the two airlines purchase half of Air NZ’s 25.9% of VA? Could Delta Air Lines, a major VA alliance partner, join the ownership club? Or would the big Chinese carriers, who have shown interest in investing in Australian airlines, become part-owners of VA?
Most analysts see SIA as the most likely buyer, although the Singapore carrier is not commenting. “Essentially, it would make sense for SIA to raise its stakes in VA and I believe they are deliberating taking their stake above 23%, indeed as high as possible,” said Shukor Yusof, head of Kuala Lumpur-based consultant Endau Analytics. “Australia/NZ is a key plank in SIA’s strategy. SIA has deep pockets and the favorable exchange rate makes a possible purchase all the more alluring.”
He added Chinese airlines have “money to burn”, but asked if buying into VA made economic case. “Not a compelling one, in my view,” he said.
Air NZ’s departure from VA was not a surprise to the industry. As long as a year ago Luxon had declared that “now is the time” for VA to “get profitable” and that “there is certainly a lot more to do”.
The VA investment has never given Air NZ or its other shareholders any returns and Luxon reportedly stepped down from the board after failing to convince the airline that VA chief executive, John Borghetti, should be replaced. Air NZ is understood to believe the money from a share sale, estimated to bring in around $300 million, can be better used in investing in its own growth.
Borghetti, (60), who has overseen an impressive transformation of the former LCC, Virgin Blue, into the full-service Virgin Australia, has made it clear he does not plan to quit. “I don’t intend to go anywhere. I’ve still got things I need to get done. This week is just one more week,” he said after the Air NZ events developed.
But he clearly has challenges ahead of him. Since December, VA has undertaken a major assault on costs, including outsourcing back office financial functions to India and a cracking down on any non-essential travel for staff.
The airline has delivered negative returns on equity for three years, mirroring consecutive annual losses in the same period. Since 2008, the carrier’s return on equity has been positive only twice.
In contrast, SIA has generated positive returns on equity every year on record.
VA returned to profit after years of losses when it posted US$63.5 million in net income for its latest first half, ended December 31, but the result failed to impress analysts concerned about cash flow at the airline.
In the first half, Virgin reported negative free cash flow of $197 million and its unrestricted cash balance fell to $423.5 million from $559.7 million a year earlier. Borghetti cited negative working capital as the problem because its increased share of business travellers meant more late bookings.
Nevertheless, analysts found the trend concerning. VA’s latest accounts show it took out a $125 million secured bank loan in the first half, which is listed as due for repayment within a year. In total, it has $487.5 million in current liabilities.
Last month, ratings agencies, Standard & Poor’s and Moody’s, downgraded VA’s credit rating from stable to negative. A week before Luxon’s resignation, the airline’s four major shareholders - Air NZ, Etihad, SIA and Sir Richard Branson’s Virgin group – lent the airline $330.9 million to repair its balance sheet.
At press time, uncertainty about VA’s future dominated industry discussion. However it evolves, it will be complicated. VA has a unique ownership structure that was designed to allow foreign partners to play a major role in the carrier.
In 2012, it separated its international arm into a company with a separate board. If SIA wants to significantly increase its shareholding in VA, it will require Australian Foreign Investment Review Board clearance. Under Australian law, the domestic arm of VA can be 100% foreign owned, but the international arm must remain 51% Australian-owned to retain its traffic rights.
Etihad chief executive, Australian-born James Hogan, who was in Melbourne when Luxon resigned from the VA board, indicated he would not go after the shares. He said Etihad was “a partner, not a predator”. He was positive about the partnership with VA and added Etihad was “committed for the long term”. A spokesman for Delta said it was not considering an investment in VA, but did not rule out a future investment in the airline.
As for the events at board level, it also has to be made clear that this does not affect the critical cross-Tasman alliance VA has with Air NZ. In a statement after stepping down from the VA board, Luxon said Air NZ looked forward “to continuing our partnership on the Tasman alliance providing customers with the most comprehensive trans-Tasman network”.
The partnership offers customers on Air NZ and VA more than 200 flights a week to more than 60 destinations across Australia and New Zealand as well as flexible fares, reciprocal lounge access and frequent flyer benefits.
It is due for renewal next year, but in purely commercial terms it is highly doubtful either carrier will want to end it. Sources at the airline in Auckland confirmed the shareholding in VA is entirely separate from the trans-Tasman alliance and that agreement was “business as usual”.
