Is Qantas flying into a fresh air assault?

Qantas would have far more to lose than Virgin from the all-out domestic war Alan Joyce says his rival is preparing for. But without its capital raising, Virgin would be extremely vulnerable.

Is Alan Joyce paranoid, or are ‘’they’’ really out to get him and Qantas?

They, of course, are what would appear to Qantas to be the ‘’rest of the world’’ – its foreign competitors on the Virgin Australia share register.

Last week’s $350 million Virgin equity raising, sub-underwritten by Air New Zealand, Etihad Airways and Singapore Airlines, has triggered an aggressive and desperate response from Joyce.

He has written to the federal government urging it to halt the raising, describing it as a ‘’virtual takeover’’ and characterising it as an attempt by the foreign and state-owned airlines to destroy Qantas and take over its domestic and international routes.

Joyce isn’t the first Qantas chief executive to exhibit paranoia about the rise and rise of state-backed competitors. Geoff Dixon was often accused of ‘’crying wolf’’ about the emergence of the Middle Eastern airlines. Given the decimation of Qantas’ international market share over the past decade by those carriers, however, he may well feel vindicated.

The three big strategic Virgin shareholders (Richard Branson, with a 10 per cent stake is the fourth) today own about 63 per cent of the group. Air New Zealand owns 22.9 per cent and has approval to add a further three per cent, Etihad owns 19.9 per cent and Singapore 19.8 per cent.

Depending on the size (if any) of the shortfall to the non-renounceable issue, the three major shareholders could end up owning as much as 72 per cent of Virgin. There has been plenty of speculation that their role in the issue is the penultimate step in them – or at least two of them – privatising the airline. Virgin has said it will give the shareholders board representation.

At the heart of Joyce’s concerns is a fear that his main competitors will use their dominance of Virgin and potential control of its boardroom to pursue strategies that aren’t conventionally commercial. These strategies may not necessarily be in the interests of Virgin itself, but they may further their own interests.

Fuelling the Qantas disquiet is the experience of last year, when Virgin sparked a capacity war that saw it lose nearly $100 million (about $150 million pre-tax). Even though the market still has substantial excess capacity after adding about 8 per cent last year, Virgin has continued to add new capacity and is ramping up its Tiger Australia brand to target Qantas’ Jetstar.

The heart of Qantas’ profitability is its domestic dominance, particularly of business travel. Its long-held ‘’line-in-the-sand’’ is a 65 per cent domestic market share, which it says optimises its profitability.

Virgin and its shareholders know that cracking that dominance would destabilise Qantas and that Qantas’ domestic strength actually gives Virgin leverage, provided it can afford to fund the losses it generates when capacity-based competition breaks out. Qantas has more to lose, while Virgin can call on its strategic shareholders – as it has just done – to fill in the holes in its balance sheet.

Whether the federal government could or should do anything to prevent Virgin raising the new capital is a different matter. Without that capital, Virgin wouldbe extremely vulnerable, as would the source of competitive tension within the domestic sector. Also, the regulators and the government have approved the existing foreign shareholdings.

With Etihad and Singapore seeking Foreign Investment Review Board approval for an increase in their shareholding, there will be a forum or process within which Qantas’ claims – that foreign shareholders are using Virgin to dump capacity into the market, purely to damage and destabilise Qantas – can be assessed.

Of particular interest to the government and FIRB will be the Virgin decision to allow shareholders board representation and therefore a direct and formal voice in its affairs.

In 2012, Virgin was restructured into two entities, distancing Virgin’s international business from the listed entity and limiting the foreign ownership of Virgin Australia International Holdings to 49 per cent to protect the group’s bilateral rights. The majority of VAIH’s shares were distributed to Australian shareholders, but those shares have only token value and can’t be traded.

The structure was clever because it essentially allowed foreign investors to own up to 100 per cent of the listed business without jeopardising Virgin’s ability to fly internationally.

To get access to international routes, bilateral agreements have to be negotiated on a government-to-government basis for airlines majority-owned by their domestic shareholders.

Virgin could be 100 per cent foreign-owned but VAIH would technically still be regarded as an Australia carrier, giving the foreign shareholders an indirect entry to Virgin’s international routes. These include the lucrative trans-Pacific route.

Almost since the moment of its privatisation in 1993, Qantas has been lobbying to have some of the foreign ownership restrictions it faces within the Qantas Sales Act removed, arguing that allowing greater foreign ownership would lower its cost of capital and potentially enable it to do what Virgin has done and negotiate strategic alliances with other carriers or merge with them. There is a foreign ownership ceiling of 49 per cent in the Act and a 25 per cent limit on single foreign shareholdings.

The national interest, and its own bilaterals, could be protected by a ‘’golden share’’ structure or by emulating the Virgin structure if the restrictions were lifted.

Qantas’ entreaties, however, have been rejected and the group’s particular place within the Australian consciousness continues to make the prospect of allowing majority foreign ownership a difficult one for politicians.

This is the case regardless of whether they subscribe to Joyce’s fears about the motivations of three of his biggest international competitors in recapitalising his only real domestic competitor so that it can continue its assault on his key market.