Australia special: Change in the air

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With a takeover of Qantas looking likely and a different direction planned for Virgin Blue operations, a new era is dawning for Australia's major airlines

Life is changing for Australia's major carriers, with Qantas the subject of a takeover and Virgin Blue branching out into regional jet and long-haul operations. At the same time, the two carriers are about to face competition from a new entrant into the Australian domestic market. All of which suggests exciting times ahead for the country's two major airlines, which have had it good for the past few years.

The next couple of months are important for Qantas, with the airline's ownership set to be determined. The proposed A$11.1 billion ($8.6 billion) takeover bid by the Airline Partners Australia (APA) consortium, comprising Allco Finance Group, Allco Equity Group, Macquarie Bank, Texas Pacific Group and Onex, passed its first regulatory hurdles at the beginning of March, with the Australian Competition and Consumer Commission (ACCC) and Australia's Foreign Investment Review Board giving it the nod to proceed. But the bid still has other hurdles to overcome, with an Australian Senate committee inquiry on APA's plans for Jetstar due to report back by 20 March, amid concerns that it would be sold offshore if APA succeeds in its takeover.

Qantas shareholders now have a little more time to consider APA's bid and long-term intentions, with the original 8 March deadline to accept or reject the offer now extended to 3 April.

Qantas management declines to comment on any future development plans for the airline while the takeover process is under way. APA, however, has said that if it is successful in its bid, it will maintain the airline's existing highly successful strategy that attracted it in the first place. That strategy has seen Qantas embrace low-cost operations and look to northern Asia for future opportunities.

APA says it is committed to "growing and strengthening Qantas" and fully supports its existing senior management team and strategy. It says it has no intention of breaking up the airline has no plan to reduce regional services will keep the Qantas and Jetstar brands and their international, domestic and regional services fully operational has no intention of changing the Qantas strategy of continuing maintenance operations in Australia and creating globally competitive maintenance operations and will support a capital investment programme of A$10 billion over the next five years which will see more than 70 new aircraft join the fleet by 2014, including Airbus A380s and Boeing 787s.

It is Qantas's successful low-cost strategy in particular that made it attractive to APA. Jetstar launched domestic services in Australia in May 2004, adding Singapore-based Jetstar Asia operations six months later. Long-haul international services were added last November and the carrier now serves Bangkok, Phuket, Ho Chi Minh City, Bali and Honolulu, with Osaka in Japan to come this month.

Jetstar is making a considerable contribution to Qantas's strong financial position, contributing a A$51 million profit to Qantas's half-year A$523 million profit before tax, released last month. The Jetstar profit is a four-fold improvement on a year ago. Passenger revenue for the Jetstar business rose by $161 million or 55.2% on a 50.7% increase in capacity.

Agreements terminated

 
© Sam Chui   
Qantas and Virgin Blue are facing new competition

Meanwhile, Qantas's failure to win regulatory approval for an alliance with Air New Zealand has pushed it to look northwards for new opportunities. In February, Qantas formally terminated its Strategic Alliance Agreement and Tasman Networks Agreement (TNA) with Air New Zealand after a negative draft determination on the TNA from the ACCC. The TNA was devised to allow the two airlines to work together on scheduling, pricing and marketing of trans-Tasman services, but the ACCC said it could see limited public benefit and believed it would lead to higher prices and reduced travel options.

The TNA was the second attempt by the erstwhile partners to secure agreement for an alliance after competition bodies earlier rejected a proposal for a much broader alliance that would have seen Qantas take a 22.5% stake in Air New Zealand.

In Asia, Qantas already has a 40% share in Singapore-based Jetstar Asia and although that venture has yet to prove profitable for the Australian carrier, it says it remains committed to the investment.

Qantas has been seeking additional investment opportunities in the region for some time. An earlier venture in Thailand, Bangkok-based Thai Air Cargo, in which Qantas held 49%, was dropped last year after escalating fuel prices meant the airline was unable to find suitable freighters.

The airline says it is now close to finalising an agreement to buy a "sizeable minority stake" for a "substantial investment" in Pacific Airlines of Vietnam. Qantas is expected to continue Pacific Airlines' recently implemented low-cost strategy and expand its domestic and international operations in a move that could include a rebranding of the airline under the Jetstar name. The Pacific Airlines talks follow earlier discussions with carriers in Indonesia, including Adam Air and Garuda Indonesia, on possible co-operation.

Elsewhere in Asia, the Competition Commission of Singapore recently issued a draft decision approving a merger of Qantas and its 45%-owned subsidiary Orangestar, which is the holding company for Jetstar Asia and Valuair. The move is expected to bring operational improvements and cost savings and Qantas hopes it will help to stem the losses of its Singapore operation.

"These developments demonstrate how the carrier's future is linked to its direct investments in Asia," says Peter Harbison, executive chairman of the Centre for Asia Pacific Aviation. "It is a riskier strategy than closer-to-home alliances, and Qantas needs committed investors to back it up."

Qantas is also expected to continue to expand its freight business - identified as a core strategy. The airline has also suggested freight could be spun off as a separate business in the future. Last year Qantas established a new wholly owned subsidiary to manage domestic airfreight operations. Express Freighters Australia is leasing Boeing 737-300 freighters to Australian Air Express - the Qantas-Australia Post joint venture - for operation on its freighter services.

Maintenance activities

But a cloud still hangs over the long-term future of the airline's maintenance activities. At the end of last year, the airline launched a 12-month review of whether to commit investment to major in-house engineering and maintenance for the new aircraft joining its fleet, including the A380s and 787s, or opt for total maintenance solutions from aircraft manufacturers or other providers. But to justify doing the work in-house, Qantas says it needs to have the scale and efficiency to handle its own and third-party work.

Virgin Blue, meanwhile, has been moving away from the realm of the traditional low-cost carrier and is pursuing a "new world carrier" strategy, which has seen it target business travellers by introducing a frequent-flyer programme and improving customer lounges.

The strategy is paying off, with the carrier recently announcing an 80.9% increase in net profit for the first half of the year to A$124.3 million on revenues of $1.12 billion - up 16.7%. Full-year profit is now expected to be 60% up on the previous year's A$112 million, thanks to increased penetration of the business traveller market, new products and services and a new fuel-hedging policy.

Next on the cards is the launch of transpacific services to the USA, with the airline targeting a launch date in the second half of 2008, according to managing director Brett Godfrey. The regulatory process for the launch is under way, with the airline aiming to operate daily services. It has yet to divulge where in the USA it will operate to, but Godfrey says it will initially have a limited network and that will not necessarily include Los Angeles.

The airline is holding exclusive talks with Boeing to acquire seven 777-300ERS, plus options on six more for the new services, which will be operated under a new brand, with the international carrier operating separately from Virgin Blue.

The 737 operator is also moving away from its single-aircraft-type strategy with a recent order for Embraer regional jets. Last November the Brisbane-based carrier ordered 11 Embraer 190s and three 170s with options on six. Those aircraft will start entering service in October on yet-to-be-revealed routes. The airline has recently exercised all six options - three E-190s and three E-170s scheduled for delivery in 2008-9. The airline's new fleet strategy will give Virgin Blue flexibility to respond to the market and competition, says Godfrey, allowing it to match seat capacity and frequency to passenger demand more accurately.

The fleet could also see the addition of freighters or quick-change aircraft if freight synergies with majority owner Toll Holdings are pursued. Toll managing director Paul Little says Virgin Blue - of which Toll owns 62% - will play a "pivotal role" in Toll's new air freight strategy. That could see the airline operating its own freighters or quick-change aircraft, removing its reliance on Australian Air Express for the carriage of domestic freight.

The airline has not abandoned its original low-cost market, however, with price-conscious travellers still providing most of its business. But with Virgin Blue's transformation into a "new world carrier", it is even considering launching a low-cost carrier. "Virgin Blue has moved off the market as a pure low-cost carrier and we think it's prudent to consider whether or not Virgin Blue should even establish its own low-cost brand, its own ultra-low-cost carrier," says Godfrey. Acquisition of Embraer regional jets could be used in such a venture, serving regional airports currently not served and secondary metropolitan airports. The ultra-low-cost carrier proposal is just conceptual at this stage, says Godfrey, with no firm plans.

Low-cost market

Such a venture would be a world first, says CAPA's Harbison, dubbing it "Virgin Lite Blue". "This would be a reasonable response, effectively mirroring Qantas in the domestic marketplace, but at the same time it is a reflection on the remarkable pace of change in the airline industry."

Virgin Blue's latest proposal comes at a time when the Australian domestic market is facing renewed competition in the form of Singapore's Tiger Airways, which plans to launch later this year with A320s in an effort to break the "cosy duopoly" of Qantas and Virgin Blue, says chief executive Tony Davis.

Godfrey says he welcomes the competition, but Harbison says Tiger Airways and the competitive response from Qantas and Jetstar will be Virgin Blue's main test.

"A positive for Virgin Blue is that it has been able to restrict its cost increase to 1.5%, but from mid-2007 a capacity battle is looming - with inevitable pricing competition," says Harbison. "Just as Virgin Blue increases its capacity by 10% and Tiger adds 3% to the total, Qantas and Jetstar will be obliged to add seats to retain market share - by delaying retirements, bringing international capacity onshore or leasing in new equipment."