It is ?game on?, indeed. Following successfully achieving the 20% corporate market share earlier than originally envisaged which saw the increasingly stiff competition in the lucrative business travel market pushing down domestic business fares to an unprecedented low level since the collapse of Ansett Australia in September 2001, Brisbane-based Virgin Australia did not stand still. Neither did its aspirations stop soaring when Australia?s second-largest carrier recorded a 113% in the number of high-yield fares and an?underlying profit before tax (PBT) of A$82.5 million in FY2011/12, a remarkable reversal from the prior financial year?s A$66.6 million loss before tax, nor was it deterred by the game-changing Qantas/Emirates partnership announced in August that seemingly dwarfed its longstanding partnership with Abu Dhabi-based Etihad Airways.
In a wide-ranging move, Virgin Australia has agreed to acquire 60% of loss-making low-cost carrier (LCC) Tiger Airways Australia which was grounded by the country?s Civil Aviation Safety Authority (CASA) in July 2011 over serious safety concerns and has since struggled to return to profitability, as well as acquiring 100% of the shares of Skywest Airlines in order to reap the benefits brought by an expanding regional and fly-in fly-out (FIFO) market primarily driven by air travel demand from the mining industry.
At the same time, Virgin Australia and its partner Singapore Airlines (SIA) have struck a deal under which the Star Alliance member will acquire 10% of Virgin Australia?s shares via a special placement of?245.6 million new shares at A$0.4288 per share with anti-dilution rights regarding the aforementioned Skywest Airlines acquisition and invest A$105.3 million (US$109 million) into the Australian carrier to fund its ambitious future growth.
Importantly, this game-changing three-way deal will not only consolidate the Australian domestic airline industry, but also strengthen the solid foundation Virgin Australia has built since its up-market move and rebranding effort in 2010, especially cementing the full-service carrier?s position in the domestic market with the acquisition of Tiger Airways Australia enabling it to focus on the premium market and the development of better premium products.
Image Courtesy of flyertalk
Virgin Australia?s low-cost root to aid Tiger turnaround
In what might seem to be an exactly opposite direction since the undertaking of Virgin Australia?s ?Game Change? programme, Australia?s second-largest carrier has agreed to pay A$35 million (US$36.2 million) for acquiring 60% of Tiger Airways Australia from its Singapore-based parent Tiger Airways, which Singapore Airlines (SIA) in turn owns 33% of its shares.?As part of the deal, Tiger Airways Australia will pay A$5 million to Tiger Airways, should the specified financial targets be met within the next 5 years.
Tiger Airways Australia will continue to operate under the Tiger Airways brand for 20 years and pay an annual licence fee, Tiger Airways said in a statement.
However, while at first glance this looks to be a complete reversal in strategy, Virgin Australia is arguably strengthening its solid foundation, especially in its domestic business by forming an airline group that is able to compete with Qantas Domestic and Jetstar across two product segments.
?Tiger will allow us to compete against the Jetstar brand much stronger.?I think we are a formidable group now,? Virgin Australia chief executive John Borghetti commented.
Most importantly, despite some of the analysts? concerns about the difficulty in turning Tiger Airways Australia around whose restructuring efforts may distract Virgin Australia?s management from fiercely competing in the premium segment with Qantas for high-yield business traffic, Virgin Australia?s historical roots and its ultimate decision to move up-market imply that a great opportunity exists for Virgin Australia in turning Tiger Airways Australia around despite the great challenges, as greater return on investment (ROI) is typically accompanied by greater risk in the financial world.
First of all, Virgin Australia started in 2001 as low-cost carrier (LCC) Virgin Blue and under the new 3-way accord, the chief executive of Tiger Airways Australia is going to be appointed by Virgin Australia whereas the chief financial officer (CFO) position will be appointed by Tiger Airways. Chairman of the board of directors, meanwhile, is going to alternate between persons appointed by the two parties, with Virgin Australia chief executive John Borghetti being the first chairman.
With Tiger Airways Australia?s undeniably lower cost base than Virgin Blue where its costs were increasing even before the 2010 rebranding, let alone Virgin Australia?s up-market moves which inevitably lead to an increase in unit cost, Tiger Airways Australia could gain better insights into the culprits behind the cost creep and hence could take preventive and proactive measures that could ultimately prove to be a differentiator and enhance its competitive edge against its rival Jetstar Airways.
This key knowledge in the cut-throat low-cost competition, coupled with the separate management and the independence promised by Virgin Australia, may eventually be invaluable in boosting the possibility of successfully charting a new course for the wounded Tiger.
?In effect, Tiger will be run as a separate business with a separate board? it will not be polluted in any form of distraction and will remain true to the from the low-cost carrier?concept,? Virgin Australia chief executive John Borghetti was quoted as saying in the Australian Business Traveller.
?By partnering with Tiger Airways, we can use our expertise to leverage Tiger Australia?s competitive cost base and build a sustainable budget carrier. We are committed to maintaining the Tiger Australia business model and brand, and we look forward to collaborating with Tiger Airways as the business grows,? Borghetti said in a company statement.
?This transaction enables Virgin Australia to access the budget market and enables Tiger Australia to expedite its growth, providing greater competition to this important market segment,? Borghetti asserted.
Tiger Airways is already showing an improvement in its bottom line, with the second-quarter FY2012-13 net loss narrowing to S$18.3 million from S$49.9 million a year earlier on a still recovering Australian operation and the airline is currently operating around 450 weekly flights with 11 Airbus A320 aircraft. Now that Virgin Australia has committed to invest up to A$62.5 million in Tiger Airways Australia and expand its fleet from 11 aircraft to 35 aircraft by 2018, with Tiger Airways contributing the first injection of A$20 million followed by Virgin Australia?s A$30 million before the final A$7.5 million and A$4.5 million investments by Virgin and Tiger Airways, respectively; Tiger Airways Australia is likely to be a significantly stronger and meaner animal than it used to be when it is wounded tremendously by the dramatic 2010 grounding.
?This is a significant step forward for us. The joint venture will bring about a stronger and more competitive Tiger Australia, and allow us to deploy more capacity and attractive budget offerings to our customers.?We are committed to growing Tiger Australia?s fleet, network and flight frequencies, and expanding to more destinations in Australia,??Tiger Airways Group chief executive Koay Peng Yen said.
Crucially,?Aspire Aviation believes that the commitment made by Virgin Australia and Tiger Airways to expand the Tiger Airways Australia operation significantly will create more, not less, low-cost competition and that the intensifying competition in the corporate sector is likely to naturally see continued competitive fares in both market segments, thereby allaying regulatory concern, whose approvals are still required by the Australian Competition and Consumer Commission (ACCC) and the Foreign Investment Review Board (FIRB).
?Having a third player in there like Tiger does discipline the other two players. If you have that taken out you do lose that discipline,??chairman of the Australian Competition and Consumer Commission (ACCC)?Rod Sims said in a Bloomberg interview.
?[However,] you can?t segment it to say there is an absolutely separate premium and low-cost carrier market. They do cross over,? Sims conceded.
By the same token, it is likely that there will continue to be a competition between Virgin Australia?s most price-elastic and low-yield passengers and Tiger Airways going forward, evidenced by the airlines? reiteration that there is no codeshare agreement, a separate management team in addition to the separate headquarters of Tiger Airways Australia in?Melbourne and two operational bases at Melbourne?s Tullamarine airport and Sydney.
Moreover, a combined Virgin Australia Group comprising the Virgin Australia, Skywest Airlines and Tiger Airways Australia will remain substantially smaller than the Qantas Group domestically even after the acquisitions, with Centre for Aviation (CAPA) reporting a combined 35% capacity share for Virgin Australia Group compared to Qantas Group?s 60.6% share. Virgin Australia currently has a 29.5% capacity share, Tiger Airways Australia and Skywest Airlines 4.6% and 0.9%, respectively, versus the dominant 41.7% and 18.9% shares held by Qantas Domestic and Jetstar, respectively.
Even taking into account the proposed 218% growth in Tiger Australia?s fleet from 11 to 35 units and factoring in a proportionally less increase of 150% in capacity by the LCC and assuming an average annual capacity growth of 5% at Virgin Australia over the next 6 years, despite the 8%-9% domestic capacity growth measured in available seat kilometres (ASKs) in FY2012/13, the combined Virgin Group will only control 47.9% capacity share, very close to a duopoly with Qantas Group by then.
Image Courtesy of Seth Jaworski
Two tales at two different players
Meanwhile, the latest Virgin Australia acquisition of Tiger Airways Australia and Skywest Airlines have symbolised the two decidedly contrasting tales at Qantas and Virgin Australia.
On the Qantas side, it is full on its plate in turning around its loss-making international unit which lost A$450 million (US$461 million) with the Qantas/Emirates partnership (?Qantas/Emirates partnership to reshape competitive landscape?, 10th Sep, 12) while defending its home turf against an aspiring rival in Virgin Australia.
The flying kangaroo has withdrawn its request for interim authorisation to the competition watchdog Australian Competition and Consumer Commission (ACCC) over the proposed Qantas/Emirates alliance as the carrier said switching the London Heathrow flights from Singapore to Dubai does not require regulatory approval and Qantas has won a significant backing from the Australian government?s Department of Infrastructure and Transport over the deal.
?Australia is a key market for a range of international airlines and they are unlikely to cede ground to Qantas and Emirates. [The QF/EK alliance will]?enhance consumer choice, deepen competition in a number of markets and broaden Qantas? international network at minimal capital cost,? the transport department said in a filing to the ACCC in early October.
?There is no going back, and there is no alternative for us to make Europe work except this arrangement. And that?s fairly clear in the submission to the ACCC,? Qantas chief executive Alan Joyce claimed in a National Press Club event on 10th October.
Ironically, Virgin Australia delivered attacks over the proposed Qantas/Emirates alliance the same way Qantas did in opposing the initial Virgin Australia/Eithad Airways tie-up and the Abu Dhabi carrier?s subsequent acquisition of more shares in Virgin Australia.
?Virgin Australia considers that the decline in Qantas?s market share has been the result of increased competition from international and domestic carriers that have entered the market over the past 10 years.?This competition and consequent decline in Qantas? market share has not been to the detriment of Australian consumers. To the contrary, competition has brought significant benefits to Australian consumers, resulting in lower fares, more choice of carrier and service model,? Virgin Australia said in an October 12 submission to the ACCC.
?Virgin Australia considers that, given the number of markets affected by the proposed conduct and the breadth of the proposed conduct, if authorised, the competitive effects and public benefits should be tested over a shorter period,? Virgin wrote.
?Virgin continues with its thinly veiled attempt to have the applications rejected.?This is a clear attempt to minimise Qantas International?s competitive position so the combined, formidable Virgin/Singapore Airlines/Etihad/Air NZ alliance will not need to respond as vigorously as it would if the [alliance] is authorised,? Qantas rebutted in an early November submission to the ACCC.
Domestically, not only is Qantas facing declining yields amid stiff competition with Virgin, Qantas is also coping with the challenges of a declining freight business and cost-cutting drive.
Profit at Australian air Express fell to A$2 million this year from A$11 million in 2010-11, which Qantas has fully acquired from the Australia Post on 2 October and sold its 50% stake in StarTrack to Australia Post.?Separately, Qantas has announced to cut 200 line-maintenance jobs at Sydney, 250 contractor jobs at Avalon albeit 100 new jobs will be created at its Brisbane heavy maintenance base as the airline begins to consolidate its heavy maintenance activity to only one base in Brisbane to tame its maintenance cost which Qantas Domestic chief executive Lyell Strambi said is 30% higher than its competitors and partly attributed the cuts to reduced demand for heavy maintenance owing to a more modern fleet.
In contrast, Brisbane-based Virgin Australia has achieved its target of having a 20% corporate share 1 year ahead of schedule,?increased the number of high-yield fares by 113% and the number of Velocity frequent flyer programme members from 2.5 million last year to 3.2 million this year.
With Qantas being locked to maintain its 65% profit-maximising domestic market share, the latest Virgin Australia/Tiger Airways Australia/Skywest Airlines deal will enable Virgin Australia to rely upon Tiger to compete on the low-end of the market and focus on improving its lucrative business travel segment and the fly-in, fly-out (FIFO) segment.
Virgin Australia is already deploying the Airbus A330-200 widebody service on transcontinental routes with complimentary hot meals, whereas its arch-rival Qantas responded by accelerating the refurbishment of the interior and in-flight entertainment (IFE) system with QStreaming on iPad tablets on 16 Boeing 767-300ER aircraft, with the last 767-300ER being refurbished and entering into service by the end of March 2013, 6 months ahead of the schedule before the eventual retirement of all 767-300ERs by mid-2015.
This is likely to result in further pressure on the domestic business fare as Virgin Australia, with the Tiger Airways Australia acquisition, could compete more directly with Qantas than it otherwise could and roll out more initiative such as invitation-only ?The Club? which is poised to open in Sydney next month and possibly increasing the number of partners of the Velocity frequent flyer programme.
According to the Bureau of Infrastructure, Transport and Regional Economics (BITRE), the domestic business fare index has slumped by 40.3% from 108.0 in October 2011 to 64.4 in October 2012, whereas the restricted economy fares similarly staying low versus a year ago, only marginally 2% higher but significantly lower than the 93.1 recorded in May 2011, after which the restricted economy fares never recovered since.
Qantas used to enjoy a 30%-40% revenue premium despite a 20% cost disadvantage, but the persistently lower business class fares mean this revenue premium is all but evaporated, let alone the cost of refurbishing the 767s, increasing the domestic capacity by 9%-11% in FY2012/13 versus Virgin Australia?s 8%-9%.
And there is more to come in the aggressive race to lure business travellers.
?If it has slowed down, I haven?t seen it in terms of aggressive competition between the two of us,? Virgin Australia chief executive John Borghetti was quoted by the Sydney Morning Herald as saying.
?It is very aggressive, but you would expect it to be because for a decade there hasn?t been any competition.?We will continue to compete as aggressively as need be,? Borghetti declared.
Source: BITRE
Setting sights on Asia
In strengthening an already solid foundation with the latest acquisitions, not only has Virgin Australia gained competitive edge against Qantas, but also the strategic advantages in having the ability and flexibility to expand internationally whereas Qantas is squarely focused on paying down debt, reducing capital expenditure at A$1.9 billion and incurred self-inflicted damage by cancelling the orders for 35 fuel efficient Boeing 787-9 Dreamliners that promise to cut fuel burn and maintenance cost by 20% and 30%, respectively, in addition to opening up new long-haul thin markets that were previously economically unfeasible.
?As a result, we are turning our attention to paying down debt, mindful of the volatile economic and financial environment.?We will invest only where we can be confident of sustainable returns, and we retain the flexibility to adjust capital expenditure as operating conditions demand,? Qantas chief executive Alan Joyce said in the carrier?s annual general meeting (AGM) on 2nd November.
?We recognise that this has been a difficult period for shareholders ? however, the significant steps taken over the past 12 months have been consistent with the group?s goal of building long-term shareholder value.?We remain committed to the resumption of dividends at the earliest opportunity. The quantum and timing of this will depend on the group?s future earnings performance, balancing future capital requirements and funding commitments, the availability of franking credits and overall market and economic conditions,? Qantas chairman Leigh Clifford said.
Unlike the Qantas/Emirates alliance which promises to allow Qantas International to expand in Asia but the only detail available so far is it will re-time Qantas flights to Singapore and Hong Kong, Aspire Aviation believes Virgin Australia has secured the right partner with Singapore Airlines (SIA) being positioned in a strong transit hub in the Asia/Pacific region.
And the Singapore Airlines investment has cemented the strong alliance between Virgin Australia and the world?s highly-regarded carrier which will strengthen the balance sheet of the Australian carrier and provide a good growth outlook in Southeast Asia for Virgin Australia.
?This major development demonstrates the importance and strength of the partnership between our two airlines, and our shared commitment to an alliance that provides a wide range of consumer benefits.?Singapore Airlines fully supports the ongoing transformation at Virgin Australia, which has already resulted in a more competitive aviation market in Australia. With this investment, there is no?doubt that Singapore Airlines and Virgin Australia intend to remain alliance partners for the long haul,??Singapore Airlines chief executive Goh Choon Phong said.
?Singapore Airlines is an important strategic alliance partner of Virgin Australia and we are very pleased to have their support as an investor. We believe this investment demonstrates their confidence in our strategy and it enables Virgin Australia to fast-track its growth plans,? Virgin Australia chief executive John Borghetti said.
The importance of the Singapore Airlines alliance extends beyond code-sharing on flights to Europe via Singapore, such as the recently announced codeshare services from Adelaide to?Amsterdam,?Barcelona,?Copenhagen,?Frankfurt,?London Heathrow,?Manchester, Moscow, Munich, Paris and Zurich in addition to interline services to?Milan, and Rome, but also the codeshare flights to burgeoning Southeast Asian economies such as China, Indoensia, Myanmar and India.
Virgin Australia currently has codeshare flights with Singapore Airlines to Delhi, Ahmedabad, Mumbai, Bangalore, Kolkata and Chennai in India, Kolkata, Colombo in Sri Lanka, Yagon in Myanmar, Guangzhou, Shanghai and Beijing in China and other growth markets such as Kuala Lumpur, Ho Chi Minh City and Hanoi in Vietnam and Jakarta and Denpasar in Indonesia.
Looking ahead, it is likely that Virgin Australia and Singapore Airlines will further deepen their alliance and extend the partnership to include more SilkAir destinations, such as Chengdu, Chongqing, Wuhan, Xiamen, Kunming in China, Kochi and Hyderabad in India and the 9 Indonesian cities that SilkAir currently serves.
This bodes well for Virgin Australia before it eventually decides to order the Airbus A350 and Boeing 787, which will enable it to expand internationally and fly directly to thin destinations that the high fuel prices make current-generation widebody aircraft uneconomical such as Beijing which Qantas and Air New Zealand (ANZ) have both withdrawn from.
This is particularly true as SilkAir plans to more than double its fleet to 54 aircraft from 21 A319s and A320s and another 3 examples being delivered in 2013, as it seeks to tap into the growing regional premium travel demand with a new fleet of 23 Boeing 737-800s and 31 Boeing 737 MAX 8s.
Image Courtesy of Bloomberg
Over the long term, however, Virgin Australia has to find a Chinese partner as part of its China strategy.
Chinese carriers have grown at a blistering pace in Australia over the past year or so in order to tap into the growing air travel demand spurred by the mining boom in the resource-rich country to fuel the growth of the world?s second-largest economy. According to BITRE figures, Guangzhou-based China Southern Airlines has carried 407,389 passengers in the first 8 months of this year, up 27.4% from 319,708 passengers in the prior-year period, followed by Shanghai-based China Eastern Airlines (CEA) with a 26% growth that saw 219,915 passengers in the eight-month period from 174,496 passengers being carried a year earlier. Chinese flag carrier Air China, meanwhile, carried 194,702 passengers in the first 8 months of this year, up 4.5% from 186,252 passengers carried a year ago.
This outpaced a 0.3% drop in Qantas? Australia-China operation which saw the number of passengers carried declined marginally from 93,474 passengers in the first 8 months of this year to 93,800 passengers last year, as well as a 10.5% growth in the number of passengers carried by Singapore Airlines excluding Scoot Airlines and SilkAir to 1,592,152 passengers in the same period this year from 1,441,244 last year. Dubai-based Emirates Airline, meanwhile, carried 14.6% more passengers to 1,601,542 in the first 8 months of this year from 1,397,590 last year.
As the Chinese economy continues to expand at a 8%-plus pace despite the recent economic slowdown weighed by a decline in foreign export to Western economies, the air travel demand between Australia and China means direct services to China will inevitably become necessary in order to compete effectively. In addition, while Singapore Airlines and SilkAir will undoubtedly expand in China over the next years, notably in markets to some of the fastest-growing secondary cities such as Chongqing and Chengdu, SIA?s Chinese network is nonetheless inferior to an unmatched Chinese domestic network offered by one of the ?Big Three?. Securing a Chinese partner ensures Virgin Australia can reap the benefits from the astonishing growth in the China-Australia air travel market using a ?capital-lite? model before ultimately flying Virgin?s own aircraft to the major cities such as Beijing, Shanghai where passengers could seamlessly connect onto its Chinese partner?s domestic flights.
Interestingly, this is one area where Virgin Australia?s shareholder structure becomes somewhat tricky. With UK?s Virgin Group holding a 26% stake, Air New Zealand (ANZ) 19.9%, Singapore Airlines (SIA) and Etihad Airways each holding a 10% share, Virgin must ensure that these shareholders will not jostle for positions internally to benefit oneself more. Simply put, Virgin Australia must ensure that its interests are placed above the shareholder?s individual interests.
While this could increase the pool of capital Virgin Australia is able to use for expansion and both Etihad Airways and Singapore Airlines (SIA) publicly expressed that they will have no involvement in the management of the airline, it is not an absolute guarantee that a particular shareholder may increase its shareholding to gain more influence at the airline in the future.
?At this point, we are comfortable with 10%. This is strictly a strategic investment in Virgin Australia.?We will not have a seat on the Virgin Australia board and are not involved in the management of the airline,? a Singapore Airlines (SIA) spokesman reassured in a reply to a flightglobal enquiry.
For example, while Singapore Airlines and SilkAir have a more extensive Southeast Asian network, especially in Indonesia and India, Cathay Pacific?s wholly-owned subsidiary Dragonair has a considerably more extensive Chinese and Northeast Asian network, such as Haikou, Sanya, Guilin, Hangzhou, Xi?an, Nanjing, Ningbo, Fuzhou and Qingdao in China, Busan, Taichung, Kaohsiung which neither SilkAir nor Singapore Airlines currently serves.
Given the rivalry between Singapore Airlines (SIA) and Cathay Pacific, whether Virgin Australia would be able to partner with the Hong Kong-based carrier and maximise the benefits brought to Virgin Australia such as the recent Cathay Pacific/Air New Zealand (ANZ) code-share deal remains to be seen.
In conclusion, with the Virgin Australia/Tiger Airways Australia/Skywest Airlines deal cementing its position in the domestic market, this lays a strong foundation from which to grow internationally. As it pursues opportunities in Asia with its strong Singapore Airlines (SIA) alliance, Virgin Australia should not overlook the importance of formulating its China strategy and the need of finding a Chinese partner. It is indeed impressive that just after 2 years since the rebranding and the ?game change? programme, Virgin Australia?s chief executive John Borghetti is taking the repositioning next step forward that is poised to rewrite aviation history in Australia.
It is round two of ?game on?.
Image Courtesy of JUBES747
Source: http://www.aspireaviation.com/2012/11/12/virgin-australia-acquisition-spree/
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