The escalating hostilities between Qantas and Virgin Australia indicate that, while the Australian domestic aviation market might be a duopoly, it is an intensely competitive one. In the near term, that says Qantas’ pleas to Canberra for help are going to fall on deaf ears.
The fallout from Qantas’ attack on Virgin’s $350 million equity raising is getting quite venomous. Alan Joyce’s commentary on the raising and his launching of an online staff petition to pressure the federal government to intervene has Virgin’s board publicly canvassing the potential for legal action against him. Joyce, meanwhile, is reportedly personally and provocatively lobbying against the raising in Canberra.
The three big shareholders – Air New Zealand (22.9 per cent with approval to go to 25.9 per cent), Singapore Airlines (19.9 per cent) and Etihad (19.9 per cent) own 63 per cent of Virgin between them and, by underwriting the non-renounceable issue, theoretically could have lifted their combined interests to as much as 72 per cent. In practice, with Virgin’s institutional shareholders taking up almost their entire entitlements, their holdings will rise only modestly at best. Richard Branson, with 10 per cent, is the other major shareholder.
There are two levels to Qantas’ concern. The most significant is that the three shareholders, who Virgin has said will probably be given board representation, could fund a Virgin strategy designed to destabilise Qantas by decimating its domestic profitability and ending its ability to subsidise its international operations and fund the expansion of the Qantas and Jetstar brands within Asia.
Virgin’s John Borghetti addressed the insinuation that Virgin was operating un-commercially quite directly at today’s annual meeting, saying that to suggest that Virgin was driven by a ‘’strategy of uncompetitively low prices and irrational behaviour’’ was ‘’offensive and absurd’’. Virgin was being run rationally and with a view to creating a business that was sustainable and profitable in the long term, he said.
‘’When you bring competition to a monopoly, prices do go down. If this is affecting our competitor’s bottom line, I am not going to apologise. Australian travellers and the Australian economy are benefiting and ultimately shareholders will too,’’ he said.
The backdrop to Qantas’ response to the capital raising was the big Virgin-initiated surge in capacity last year, which hit both carriers, and continuing increases this year despite industry over-capacity. With Qantas’ ‘’line in the sand’’ of a 65 per cent market share, it generally responds to Virgin’s aggression with two seats for every one that Virgin adds, which exacerbates the already poor economics of the industry.
Last year Virgin lost almost $100 million, which at face value makes its strategy look odd. There were some extenuating circumstances, however, given the extent of the change to its structure as it introduced its Sabre reservations system (experiencing some costly issues in the process) and absorbed Skywest and 60 per cent ownership of Tiger Australia.
If it were to continue to increase capacity this year while continuing to lose money, Joyce’s fears might gain credibility.
The other frustration Qantas has is that Virgin is able to be dominated by foreign shareholders (strategic ones at that) while still classified as an Australian airline for international industry purposes and is able to retain the bi-lateral rights to international routes and, if it wishes, expand its international arm.
Last year’s restructuring, under which Virgin’s international business was placed within a separate structure with a frozen (but valueless) majority of Australian ownership cleared the way for the foreign airlines to dominate its register without jeopardising those bi-lateral rights.
Qantas, as governed by the Qantas Sales Act, can’t emulate Virgin. It probably wouldn’t help it much if it did. Its alliance with Emirates means it is unlikely either Emirates or other foreign airlines would see strategic value in acquiring interests in it, although some relaxation of the restrictions on foreign investment might tweak its cost of capital in the longer term.
It isn’t clear what Joyce expects to gain from his lobbying, other than an aggressive response from Virgin.
The Federal Government isn’t going to intervene in the raising, although the Australian Shareholders Association has indicated it might take it to the Takeovers Panel on the basis that it discriminates against retail shareholders and in favour of the three strategic stakeholders. Virgin needs the capital and the government needs it to be a strong and financially stable competitor to discipline airfares.
It is also unlikely that the government would amend the Qantas Sales Act, given that the practical benefits for Qantas would be modest at best and there would be no political gains from relaxing the foreign ownership limits.
The former Labor government has previously given Air New Zealand approval to increase its shareholding to 25.9 per cent, which would be difficult to withdraw. It is conceivable that the three strategic Virgin shareholders could be told by the government that they shouldn’t apply for any further approvals to increase their interests. It is also conceivable that the issue of board representation might be broached.
Virgin’s chairman Neil Chatfield said today that if the three carriers were given seats, there would still be a majority of independent directors; there would be strict boardroom governance protocols; and the board would continue serve the interests of all shareholders.
The emergence of the three strategic shareholders on the Virgin share register and the alliances Borghetti has struck with them are as much a ‘’game-changer’’ for Virgin and the domestic market as the radical changes Borghetti has made to the structure and positioning of the Virgin business.
Their demonstrated willingness to supply capital and the common interest they all have with Virgin in weakening Qantas by attacking its domestic stronghold – undermining the effectiveness of the alliance with Emirates and reducing its ability to support the Asian – makes Virgin a far more potent threat to Qantas than it could ever have been before they piled onto the register.
Virgin’s financial capacity previously constrained its ambitions and its ability to really mount a sustained attack on Qantas.
The $350 million raised from the equity issue will fund quite a lot of aggression over the next couple of years and enable Virgin to intensify its assault on Qantas’ core without fears for its own financial stability. The tinge of desperation in Joyce’s reaction to the raising might well be warranted.