Rebranded Virgin takes off

Virgin Australia may have been gifted windfall gains as a result of the massive disruption to Qantas' schedules last year but within the detail of the rebound in the group's profitability in the December half it would appear that John Borghetti's frenetic re-making of the airline last year is generating real momentum.

There is no doubt that Qantas' dispute with three of its unions, which caused continual cancellations and uncertainty for its core business customers, would have benefitted Virgin. Even before then, however, the repositioning of Virgin and its attempt to prise loose a slice of Qantas' stranglehold on business travel was showing some early signs of success.

Apart from re-badging the group, re-developing its product and lounges, re-launching its frequent flyer program and striking alliances and code shares with five international carriers Borghetti launched a business class product that he is steadily expanding.

With the help of the Qantas disputes, Virgin increased its corporate and government revenues by 81 per cent in the December half. Where revenue from those sources represented 13 per cent of the group's revenues last financial year, they accounted for 17 per cent of total revenue in the latest half.

Virgin claims to have lost no corporates accounts (as does Qantas) but to have gained 35 new accounts and says revenue generated by travel management companies was up 42 per cent and from governments by 22 per cent. Its business class seat factor on its initial Perth routes, it says, doubled relative to its premium economy class.

As Virgin pushes into the higher yield territory that Qantas has completely dominated since the demise of Ansett, its yields are strengthening significantly. Borghetti announced an expansion of the business class offering to its Embraer services today.

Domestic yields were up 13.7 per cent even though the group added 5.3 per cent to its domestic capacity and Virgin's overall yield improved 11.5 per cent. In its international business it added 9.2 per cent to its capacity but produced underlying growth in earnings before interest and tax of 38.7 per cent.

Overall, with revenue up 18.4 per cent to $2 billion and pre-tax profits up 34.4 per cent to $96.1 million – despite, as Virgin said, big increases in fuel costs – Borghetti's potentially quite risky re-positioning of the group appears to be gaining real traction even at this early and immature phase of its implementation. Certainly Borghetti believes it is producing financial returns ahead of schedule.

Moreover, that early success is steadily diversifying the group's revenue base away from its traditional over-exposure to the Queensland routes. It has also added an international feed for its domestic business, with interline and codeshare traffic more than doubling as a result of the virtual international network it has developed through its alliances with Air New Zealand, Etihad Airways, Singapore Airlines and Delta Air Lines and its code share arrangements with Virgin Atlantic.

Apart from producing a solid and encouraging result in a half where conditions weren't, with the exception of the disruptions experienced by its main competitor, particularly favourable, Borghetti also unveiled a planned restructuring of the group.

Like all carriers with international operations, Virgin has a 49 per cent cap on foreign shareholdings to protect the bi-lateral rights, negotiated on a government-to-government basis, to fly international routes.

The overall level of foreign shareholdings has been bumping up against that 49 per cent ceiling, mainly because of the presence of Richard Branson, with a 26 per cent shareholding, and Air New Zealand, with 20 per cent, on its register.

Borghetti said today Virgin planned to separate its international operations from its domestic business by putting them within a new unlisted entity, Virgin Australia International Holdings. VAIH would be owned by existing Virgin Australia shareholders, with Virgin making an in specie distribution of shares in the new entity. Those shares won't be able to be traded, except in limited circumstances but in any event would have only token value.

By quarantining the international operations within the new entity, Virgin ought to be free of any foreign ownership ceiling, which should improve liquidity and the demand and supply equation it the market for its shares by allowing foreign institutional investors to buy into the group.

It could, of course, be designed to enable a different kind of investor to join Branson and Air New Zealand on its register.

Air New Zealand acquired most of its stake in Virgin a year ago, with a suspicion that it moved because it believed Etihad, which is probably the closest and most important of Virgin's allies, was about to grab a stake.

By acquiring, initially, 15 per cent and subsequently adding to it, Air New Zealand left Etihad no headroom under the foreign ownership ceiling – and annoyed Borghetti, who is known to have wanted to cement the relationship he had developed with Etihad, the key to his virtual international network strategy.

It might be a coincidence, but less than a fortnight ago Etihad's James Hogan – who has a close relationship with Borghetti – mused publicly about his interest in buying into Virgin as part of Etihad's strategy of acquiring strategic stakes in other airlines and said Virgin was aware of his ambition.

The structure Virgin unveiled today would appear to create the opportunity for Etihad to realise that ambition and join Branson and Air New Zealand on a register that would be crowded with strategic players and Virgin allies, which may well have been the motivation for the proposal.