News analysis

In search of the perfect match for Virgin

SYDNEY • At times, international aviation seems less like a modern high-tech industry and more like mediaeval European diplomacy.

All those state-controlled carriers tussling over territory at airports and control of trade routes.

There is even the odd arranged marriage to cement relationships between fractious powers.

Under chief executive officer John Borghetti, Virgin Australia has played the marriage game with skill. Nominally listed on the Australian Securities Exchange, it is almost a joint venture, with free- floating shares representing just 14 per cent of the total.

Mr Richard Branson's Virgin Group has another 10 per cent, with the remainder split about equally between Air New Zealand, Etihad Airways and Singapore Airlines (SIA). The four have a common enemy in Qantas, Australia's largest carrier. A couple of years ago, the arrangement was working so well that Qantas claimed the group was conspiring to drive it into bankruptcy. 

But Virgin's attempt to crack Qantas' stranglehold of the domestic market failed, and while Virgin's stock has slumped almost 30 per cent in the past 12 months, Qantas is up 11 per cent.

Qantas expects to chalk up a profit in the current half while Virgin is expected to dip into a loss in the six months through June.

Airlines can carry on unprofitably for an astonishingly long time, but there are limits.

Last month, Virgin announced an ill-defined "review of its capital structure", the first stage of which was a A$425 million (S$439 million) loan from its big four shareholders.

Having signed up for its portion of the debt, Air New Zealand - whose revenues are about US$90 million (S$121 million) less than Virgin's, while its net income is about US$380 million greater - decided enough was enough.

Nine days later, chief executive officer Christopher Luxon quit Virgin's board and announced he was looking at options for selling its holding.

That move risks upsetting the delicate balance among Virgin's shareholders, who compete with each other as much as with Qantas.

While Australia may seem like a global backwater, its domestic carriers can provide a steady stream of passengers for big airlines, and equity stakes help cement such relationships.

One option would be for SIA to buy the entire stake, OCBC analysts wrote in an April 11 note. That could create problems of its own, though. Etihad competes with SIA on "kangaroo route" flights between Australia and Europe, and may reasonably fear that a Virgin controlled by its rival would divert flights towards Singapore's network. That could be resolved if the two carriers divided up Air New Zealand's stake and left Virgin with the balance of power, in a 45-45-10 structure.

There is another option. Think of other international carriers with an interest in the Australian market and a rivalry with Qantas' alliance partners, and one obvious name pops up: China Southern.

It is the largest of China's state- owned carriers and has the most ambitious international expansion plans. Although it has a small code-share deal with Qantas, that relationship has drifted, while its Shanghai-based rival China Eastern has upgraded its marriage with Qantas into a major alliance.

Such a deal would fit nicely with China's voracious overseas merger appetite. Like its peers China Eastern and Air China, China Southern is knee-deep in debt, but that is generally not a bar to well-connected Chinese businesses. With five A380s and 36 A330s in operation and Chinese tourist numbers to Australia growing, it certainly has the capacity and the demand to benefit from such a relationship. 

Perhaps Virgin, with its string of losses and its complicated board, is not the perfect match. But as Cardinal Wolsey would have told you five centuries ago, these marriages are not about love or money. The grand strategy is all that matters.

BLOOMBERG

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A version of this article appeared in the print edition of The Straits Times on April 14, 2016, with the headline 'In search of the perfect match for Virgin'. Print Edition | Subscribe