Step up, Sir Richard the kingmaker
Richard Branson jetted into Perth this week to wave his publicity wand over Virgin Australia's latest announcement. Between poking his head out of the cockpit window, standing next to glamorous flight attendants in Virgin red uniforms and waving flags he presided over the launching of Virgin Australia's new acquisition, SkyWest.
But this time around the presence of Branson seemed a little strange. Less than two weeks ago he sold down his shareholding in Virgin Australia from 23 per cent to 13 per cent. And after speaking with him yesterday one thing clear, between the lines, was that he is not a long-term holder of his remaining stake. This poses the important question of who he will sell it to and how this can be done.
The Virgin Australia share register is tightly held between its three alliance airline partners, Singapore Airlines (which, thanks to Branson, now has 19.9 per cent), Air New Zealand with roughly the same, and Etihad with 8.5 per cent. Etihad had been in talks with Branson for more than a year to buy part of his shareholding but it appears to have been a case of tyre kicking.
So it is not surprising that Branson was open to the overtures from Singapore Airlines. Branson said: "It's always nice to have big airlines lining up for your shares."
It's an open secret in the airline industry that Etihad boss James Hogan was less than impressed that Branson sold 10 per cent of Virgin to Singapore.
Branson's decision will be pivotal to how the share structure plays out and in this sense he becomes the kingmaker.
He is already working on how to spend the proceeds. One plan under investigation is a number of upmarket (and cool) boutique hotels in Australia. But he confesses it's early days.
If Branson sells the remainder to any of these three players they would need to make a takeover bid and get Foreign Investment Review Board approval.
And even if the other airline shareholders did not accept the offer, the bidder could capture the 36 per cent held by retail and institutional shareholders. (And the fact remains that Etihad and Singapore operate in competition out of Australia beyond their hubs.)
Another possibility is a private equity play that takes out the minorities and negotiates the purchase of the majority of Virgin's frequent-flyer program. This asset is becoming increasingly valuable, thanks to the involvement of Virgin Australia's various alliance partners and its capture of a larger portion of the business-traveller market.
The valuation differs depending on which analyst one speaks to. Some analysts have called it as low as $250 million but at the upper end it has been valued at closer to $1.5 billion on a two-year prospective basis.
Unlike airlines whose cyclical earnings can be volatile, frequent-flyer programs churn out a more solid profit stream. And the value of this business tends to improve over time as membership builds.
At one point in Qantas' recent history its frequent-flyer program was its most profitable division.
Virgin Australia boss John Borghetti will be acutely aware that the ownership tectonic plates are unstable. Until something happens he has to manage these shareholders under the Virgin alliance umbrella. To have any of the three on the board would result in howls of protest from the others, who would want equal treatment.
But Virgin's purchase of SkyWest and more recently the ailing no-frills domestic minnow Tiger suggests that he is not waiting for things to happen.
While SkyWest is viewed as a West Australian regional carrier, Borghetti has plans to expand its routes. It already has one-third of its business in Queensland and operates some services in NSW. The fly-in-fly-out mining industry part of the market is worth about half a billion dollars a year and Virgin wants some of this action.
Australian Competition and Consumer Commission documents, part of its dossier on the aviation industry this year, suggested Qantas' hard and fast line in the sand to retain 65 per cent of the domestic market has already slipped a little.
From an operational perspective this is probably not particularly significant. Indeed, investors are more likely to be relieved that Qantas would prefer to manage yield rather than adhere too closely to self-imposed metrics.
There are plenty of other challenges. Both Virgin and Qantas are just coming out of a savage capacity war that has taken its toll on domestic earnings.
There is an expectation that this pressure is already easing but Borghetti concedes that only in the past couple of weeks the aviation market has become a little softer.
So even if the two airlines have started a ceasefire they will still need to contend with the broader economic conditions.
They are not alone. There have been several economic indicators over the past couple of months suggesting any tentative improvements in economic data are now stalling and business investment is about to hit a wall.
It will be a great relief to many that the Reserve Bank of Australia on Tuesday reduced the cash rate by 25 basis points.