Just over one week after providing Virgin Australia with a financial lifeline, Air New Zealand’s move to explore options for its 26% stake in the carrier shows that the Kiwi carrier’s patience has finally run out.
The Star Alliance carrier made it clear that “a possible sale of all, or part of its shareholding” in Virgin is on the cards, having appointed First NZ Capital and Credit Suisse to advise it of its options.
At the same time, Air NZ chief executive Christopher Luxon stepped down from Virgin’s board, in the clearest sign that it intends to play no further part in the Australian airline’s wider board affairs.
Luxon had previously been content to rely only on management-level relationships to keep its transtasman alliance with Virgin in check. But as it raised its stake above the 25% mark, Luxon and his counterparts at fellow shareholders Etihad Airways and Singapore Airlines were invited to join the board.
In its statement, Air NZ noted that the airline is looking at “possible alternative uses of capital currently deployed in Virgin Australia”. Some of that capital could be used for Air NZ’s large delivery stream of Boeing 787-9s, Airbus A320neos and ATR 72s due over the next four years. Capital expenditure on these aircraft are pegged at around NZ$2.3 billion ($1.59 billion).
Taking that into account, it seems clear that Air NZ is keen to cut its losses with the Australian carrier. Since taking its stake above the 25% level in 2014, it has had to equity account for Virgin’s losses, which have taken some of the shine off of its own performance.
Although outwardly expressing support for Virgin chief executive John Borghetti and his ‘Virgin Vision’ strategy, Luxon has reportedly been frustrated at the slow pace of the Australian carrier's recovery from a brutal capacity war with Qantas in the domestic market.
Although it returned to profit over the six months to 31 December 2015, the low level of cash flow from operations, followed by the recent announcement of a capital review and the A$425 million ($326 million) loan facility from its four largest shareholders, showed that it still has some way to go before the carrier can, financially speaking, stand on its own two feet.
Given that Air NZ has announced its intentions so early into the review indicates that the prospect of being asked to put in more cash – on top of its A$131 million portion of the loan facility – seems thoroughly unpalatable to its management and board.
Virgin’s major shareholdings have been a turbulent affair. Having been established in 2000 by Sir Richard Branson’s Virgin Group as Virgin Blue, it stared down a takeover bid from Ansett Australia, before floating on the Australian Securities Exchange in 2003.
It was then subject to a takeover offer from ports operator Patrick Corporation in 2005, which saw it take a 62.2% stake in the carrier. Patrick was then taken over by Toll Holdings, and its controlling stake in Virgin given to Toll's shareholders through an in-specie dividend in 2008. Air NZ, SIA and Etihad took major stakes in Virgin earlier this decade.
A sale of Air NZ's stake wholesale to SIA or Etihad, or for the two carriers to split pie, appear to be possible scenarios. With only around 15% of the carrier free-floated, a bookbuild or open share sale on the market appear to be unlikely.
How open are the two shareholders to take up more stake is however debatable.
Etihad has been the more active of the two carriers in recent years, using ‘creep provisions’ to up its stake to 25.1%. Nevertheless, at a function in December last year, Etihad chief James Hogan indicated that the airline was done with growing its Virgin stake, having gained a board seat and an extension of its alliance, which helps feed its growing Australian network.
SIA’s Goh Choon Phong has made no secret of his desire to seek to grow the group through acquisitions and strategic relationships. It has also used share swaps and other on-market purchases to raise its Virgin stake to above 25%, albeit lagging behind Air NZ and Etihad at times. With large amounts of cash at its disposal, and an already strong relationship with Air NZ, it could certainly be in the market for more.
Australian media has meanwhile speculated that Etihad and SIA could team up to mount a full takeover bid for Virgin, which would give both greater control over their Australian partner, and potentially present a greater threat to Qantas. For now though, that seems little more than speculation, and regulators would no doubt take a very close look at the potential competitive issues involved.
A takeover would also have to be attractive to Virgin Group, which maintains a 12% stake in the airline. While certainly not a core investment, the group appears to be motivated to protect its brand position at the carrier. Nevertheless, as Air NZ has shown, one does not have to hold a board position or a direct stake to protect its interests.
Any moves on Virgin’s share register are likely to be on hold, pending the airline’s review of it capital structure. The review will likely determine how much more investment will be required to help rebuild its balance sheet, which is a likely catalyst for SIA and Etihad to consider doubling-down on investments in the carrier, or, alternatively, seek their own exit paths.
It seems logical, then, that the review will not only look at what capital structures are required, but also touch on the Virgin Vision strategy. Further cost cuts across the Virgin Australia group are expected, which could have bigger implications for both core unit Virgin and its budget unit Tigerair Australia. At worst, it could be forced to scale back its operations to save costs, or defer deliveries of aircraft, such as the 40 737 Max 8s it has on order.
For Air NZ, selling its stake in Virgin means it is unlikely to re-coup the money it has sunk into the carrier. This will no doubt be painful for the Kiwi carrier, but faced with the prospect of further investments ahead, may just be the right move.
Source: Cirium Dashboard