Regulator misses the point behind Virgin-Tiger deal

Every day that the Australian Competition & Consumer Commission delays a decision on a proposed merger between Virgin Australia and Tiger Airways, the worse it is for the Tiger carcass, which is already badly decayed.

The more the loss-making Tiger business deteriorates, the greater the pressure on Virgin to either renegotiate the original merger deal or pull the plug and walk away.

It has been five months since Virgin chief executive John Borghetti announced he wanted to buy 60 per cent of Tiger Australia, which is owned by the Singapore-listed Tiger Airways Holdings, of which Singapore Airlines is a major shareholder.

The game plan for Virgin was to reconfigure the Australian aviation landscape by using the Virgin brand to go head to head with Qantas and the Tiger brand to take on Jetstar, which would mean a more competitive market. It recently bought West Australian airline Skywest to challenge Qantas' regional airline, QantasLink.

But with the ACCC dragging its heels - a decision is now expected in May - questions are being asked whether the deal will fall apart and Tiger will collapse, leaving 400 staff without a job.

The ACCC has given the green light to the complex Emirates and Qantas tie-up and the co-ordination between the four Jetstar joint ventures in the region - Jetstar Asia in Singapore, Jetstar Pacific in Vietnam, Jetstar Japan and Jetstar Hong Kong. Both will change the dynamics of the Australian aviation industry.

The regulator's delay has prompted some in the market, including Commonwealth Bank aviation analyst Matt Crowe, to warn of a "significant" risk if the ACCC blocks the deal. "The ACCC is entitled to ask 'if Virgin Australia is convinced Tiger will leave the domestic market, why did it pay $72 million to buy Tiger rather than wait for it to leave, then take its place'," the CBA note says.

Crowe raises a valid question but the solution isn't as straightforward as it looks. For starters, it would take up to two years to start a new airline, including sourcing aircraft, putting systems in place, applying for a new air operator's certificate from the Civil Aviation Safety Authority and negotiating new enterprise bargaining agreements. Virgin's cost base is 15 per cent higher than Jetstar's, which would make it difficult to compete, particularly if Jetstar started throwing extra capacity into the market.

Qantas did this recently in what has become one of the most vicious airline price wars since 2004 when it launched Jetstar. It cost Qantas more than $100 million in foregone profits, and Virgin more than $20 million, as both airlines increased capacity, chased and protected corporate accounts, and offered cut-price airfares.

Qantas' justification for pushing 11 per cent extra capacity into the market was that it was protecting its 65 per cent line-in-the-sand market share as Virgin went upmarket and tried to take corporate and government clients as well as lift its game on routes including Sydney to Perth.

It explains why Virgin is interested in adding Tiger to its arsenal. By buying a 60 per cent stake, Virgin gets immediate access to 11 aircraft and preserves Tiger's existing enterprise bargaining agreements.

This would give it a standing start to take on Jetstar, which now has 60 aircraft in its fleet.

Virgin's original deal included a $35 million share purchase agreement for a 60 per cent stake and a commitment by Virgin and Tiger Airways to spend up to $62.5 million to fund growth in the low-cost carrier. At the time of the announcement, Borghetti said it could increase Tiger's fleet from 11 to 35 by 2018.

Given the deterioration in Tiger's business in the past few months and the price war that Qantas has waged on Virgin in the past nine months, the original deal is now looking pricey, and raises the question of whether Borghetti will need to renegotiate or walk away.

If he walks away, or the ACCC rejects the proposal, Singapore Airlines has made it clear it will pull Tiger out of the Australian market.

Whether the Singapore airline is bluffing and has another party lined up to buy Tiger is anybody's guess, but this is unlikely. The brutal reality is Australia has a dismal track record when it comes to a third airline. Over the past couple of decades, there have been several tries, including Compass I and Compass II, OzJet and more lately Tiger, which has clocked up accumulated losses of $216 million since its Australian debut in 2007.

For the December quarter, Tiger posted a loss of $S13 million, compared with a loss of $S8.6 million in the previous corresponding period. Conditions are believed to have deteriorated in the past few months after the airline's chief executive Andrew David quit to run Qantas' Jetstar International. Without a leader and the possibility that Tiger might withdraw from the Australian market, staff morale is believed to have plunged along with air ticket sales. After being stung by more than one collapsed airline in the past, it is possible customers are becoming increasingly wary that their tickets might not be safe if the deal collapses.

The ACCC seems to be looking at the preservation of Tiger as a separate entity from Virgin as the best way to keep the domestic aviation market flipping back into a duopoly. By viewing the market this way, it is ignoring the fact that Virgin is trying to create more competition by taking its brand upmarket to compete with Qantas, and at the lower end making Tiger compete with Jetstar. If the regulator calls it wrong and Tiger withdraws, Qantas and Jetstar will be the clear winners - again.