A lot is riding on the success of Virgin Australia, regardless of whether it returns to the ASX this year or not. As the aviation industry braces for a potential reduction in sky-high profits amid a global cost of living crisis and rising decarbonisation pressures, a fighting fit Virgin Australia is arguably more important than ever to ensuring effective competition in Australian airspace.
Australia’s small population, large landmass, and insufficient alternative transport options means air travel is crucial to the country’s connectivity. But despite our dependency on flying, aviation is a notoriously difficult industry to make profitable, and many local airlines, including Virgin itself, have previously perished in their attempt to do so.
Much has been said about the astronomical returns recorded by airlines all over the world since the end of COVID-19 border controls in 2021. But most of the industry, including the International Air Transport Association (IATA) representing 300 of the world’s biggest airlines, fear the end of bumper profits is here.
Since it was salvaged by Bain Capital in 2020 after a stint in administration, Virgin has been pressured to meet the often-conflicting demands of its passengers, prospective shareholders, staff, and the rest of the aviation supply chain. Above all, Bain is charged with ensuring Virgin is an effective competitor to Qantas.
Some argue it won’t be clear if Virgin succeeds in this challenge until it returns to the ASX, where the nuts and bolts of the group will be bared for all to see. But others are increasingly concerned Bain may have already missed the boat, amid predictions local airline margins have peaked.
Weak IPO market spooks institutional investors
Australia has been largely starved of meaty initial public offerings for the past couple of years. Intrigue about relisting Virgin has swirled since Bain saved Virgin from administration for $3.5 billion in 2020. But amid all the hype, there is serious doubt among investors and industry experts alike about whether now is the time to list the airline business.
In February, Bain appointed Goldman Sachs, UBS and Barrenjoey to advise it on potentially taking Virgin public, and until very recently it seemed the private equity giant was committed to doing so in the second half of this year.
But fund managers and analysts who spoke with this masthead anonymously say there is little appetite among institutional investors to warrant a Virgin float in 2023. Some question whether a listing is necessary because Bain bought the airline for a low price after its collapse, and it is already making returns on its investment. Others are sceptical about the future of airline stocks more generally and argue Qantas shares have peaked.
In May, Virgin issued a $730 million capital return to shareholders which fully repaid Bain and its co-owners and leaves around $1 billion of debt inside the business. Virgin owns 5 per cent of the business, the Queensland Investment Corporation owns a 2 per cent stake and Bain owns 93 per cent. The breakdown of this $730 million figure was $430 million in cash out of Virgin and $300 million in loans from its advisors as part of the listing mandate process.
Bain has committed to retaining a large stake of the airline business in the event of a listing, keen to distance its potential float from former private equity horror listings including Myer and Dick Smith.
Some would benefit greatly from a quick listing, namely those at the helm of the carrier itself, but Virgin boss Jayne Hrdlicka told The Australian Financial Review last week the business was under no pressure to go early.
“It’s great to see the market’s open, but the timing needs to be right for us, and we’ll work our way through what that looks like,” Hrdlicka said.
Her comments were in response to the listing of chemical distributor Redox this month, the largest float of 2023 so far. Shares in Redox closed 4.9 per cent below their $2.55 issue price on its first day as a public company, indicating the initial public offering market in Australia is still suffering from a lack of investor confidence.
Tribeca Alpha Plus Fund manager Jun Bei Liu said Bain could counter the waning demand for airline stocks by offering it up at a significant discount.
“Everything has a price. If the discount is large enough, there will be interest to back Virgin regardless of whether investors accept Qantas’ share price has peaked. If I were them, I would wait until it’s less bearish, but that could be a multi-year wait,” Liu said.
Some analysts have baulked at the idea that renewed interest from foreign airlines in backing Virgin could appease potential institutional investors.
About 90 per cent of Virgin was foreign-owned when it entered administration, with Singapore Airlines, Etihad Airways, Chinese conglomerates HNA and Nanshan each owning a fifth of the group and Richard Branson’s Virgin Group owning 10 per cent.
The need for effective competition in Australian aviation
Virgin and Qantas control 95 per cent of the airline market, with the remaining 5 per cent held by Regional Express and fledgling low-cost carrier Bonza.
The Australian competition watchdog has been scathing of the state of competition in the airline industry. Some Virgin insiders protest at the accusations it’s part of a duopoly, preferring instead to frame their airline as the bolshie underdog. Whichever characterisation is adopted, robust competition in any industry protects consumers.
Virgin carries about 40 per cent of Australian flyers, but its business has been largely shielded from customer scrutiny since air travel resumed after COVID-19.
Although Virgin’s on-time performance and cancellation rate has been worse than its bigger competitor for some time, it does not attract the same level of negative attention. One of the reasons behind this is that Virgin is not bound by the same continuous disclosure requirements as Qantas as a private company.
Regional Express’s recent backflip on its earnings guidance and Bonza’s reduction in routes just six months into operations indicates just how complex it is to run an airline, let alone make money from it.
From the supply chain issues plaguing aircraft manufacturers, to the costly tasks of emissions reduction and increasing ground delays at airports, and staff attrition, Australia’s airlines have had a lot to navigate over the next couple of years.
Perhaps more challenging for Bain than the float itself is the task of ensuring Virgin is set up as a long-term competitor to Qantas. And only time will tell if it’s successful in this aim.
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Source: Thanks smh.com