Alan Joyce's Sales Act saddle

Etihad's approved increase to a 10 per cent stake in Virgin would rile the Qantas CEO because it serves as a painful reminder that Borghetti is gnawing away at Qantas' domestic market share and of its beleaguered international arm.

There doesn’t appear to be any hidden agenda behind Etihad Airways desire to own at least 10 per cent of Virgin Australia, and potentially more in the longer term. That won’t stop the increasing financial backing of Virgin Australia by his major international competitors annoying Qantas’ Alan Joyce, whose team lobbied against the approval.

Etihad emerged on the Virgin Australia register with a 4.99 per cent shareholding in June before the ink was barely dry on the clever restructuring of Virgin Australia that separated its international operations, with their 49 per cent foreign ownership ceiling, from its domestic operations where there is no foreign ownership cap.

It then applied to the Foreign Investment Review Board for approval to double that stake; approval it gained today. It is unclear why it didn’t ask for permission to own a larger holding – its chief executive, James Hogan, has indicated that he wouldn’t mind more over the longer term – although that might relate to concern that its parentage, Abu Dhabi’s sovereign wealth fund, might create some sensitivity.

The investment in Virgin Australia isn’t unusual for Etihad, which has a growing string of investments in other airlines. It owns 29 per cent of Air Berlin, 40 per cent of Air Seychelles and 2.99 per cent of Aer Lingus, as well as its Virgin Australia interest, and is constantly looking for more opportunities.

While it has been presented as a way of shoring up commercial relationships, like the alliance it has had with Virgin Australia since 2010, it could also present bigger strategic options in future, which is one of the scenarios Qantas has been concerned about.

If Etihad increases its shareholding in Virgin Australia to 10 per cent, the Virgin Australia register will be crowded with strategic players. Richard Branson, of course, has 26 per cent while another alliance partner, Air New Zealand, has 20 per cent. Other allies without shareholdings are Singapore Airlines and Delta Airlines – Virgin Australia has become a magnet for Qantas’ international competitors.

That could be important in future, given that Borghetti has precipitated a capacity war with Qantas that is slowly escalating.

It is unclear why Borghetti decided to ignite that war, which has seen both airlines ramp up their domestic capacity significantly, but he is vastly experienced and knows Qantas as well, if not better, than most of the Qantas executives.

Qantas, with its international business haemorrhaging – Qantas has estimated it lost $450 million last year – is in the midst of a massive restructuring. It may be that Borghetti believes that Qantas, more dependent than ever on the profitability of its dominant domestic business, is vulnerable to an attack on that business and its lucrative business customer base.

It is also the case that Virgin Australia’s smaller scale, and its relatively low penetration of the business travel market, provides him with leverage. While increasing capacity and sparking price competition would also adversely impact Virgin, the impact on Qantas would be greater.

Borghetti might also believe he can offset the impact on yields by shifting his messenger mix by attracting more business flyers with the higher-frequency schedules and better lounges. For Qantas, the assault on its business travel stronghold is all downside.

Having deep-pocketed allies on its register and no foreign ownership restrictions on its listed entity means that Virgin Australia has access to capital if it becomes necessary. The alliances, whether cemented with equity or not, also mean it will get some feed into its domestic operations from its allies.

The existence of the strategic shareholders, and his own internal issues and financial stresses, would certainly deter Joyce from the old Qantas strategy of dealing with aspiring challengers by flooding the market with so much discounted capacity that it forced them heavily into loss and quite quickly out of the market.

Joyce, saddled with the Qantas Sales Act, can’t emulate Virgin Australia and split the legal form of his domestic and international operations.

At present Qantas isn’t bumping up against that cap – at last report foreign ownership was about 34 per cent – but it would also face resistance to any proposed strategic investor from a federal government that remains hostile to Joyce after his grounding of the entire fleet last year.

That doesn’t mean he can’t enter more conventional airline alliances. Etihad’s Middle Eastern rival, Emirates, which has been ramping up the capacity it flies into and out of the Australian market, has made it very clear it would like to at least enter a code-sharing arrangement with Qantas.

An alliance with Emirates, while it could have implications for Qantas’ long-standing relationship with British Airways, would open up a vast array of routes via Dubai to Africa, the Middle East and, most importantly, Europe while securing Emirate’s in-bound traffic for the Qantas domestic network. It would give Qantas the kind of virtual international network to supplement its own shrunken international coverage that Borghetti has forged for Virgin Australia.

The issue of how to improve Qantas’ network without losing even more money or deploying more capital is no doubt a priority for Simon Hickey, the former head of Qantas’ frequent flyer program who was given the unenviable role as chief executive of the international business in the radical management restructuring Joyce unveiled earlier this year.

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