Virgin has Qantas on the hop

For the first time in recent Australian aviation history we have a dogfight where Qantas is under real threat.

Alan Joyce and John Borghetti were the two top candidates to replace Geoff Dixon in 2008 as Qantas chief executive. Borghetti, who had spent a virtual lifetime at Qantas, lost to Joyce and left the company, only to become chief executive of Virgin a year or so later (Joyce came to Qantas in 2000 via Aer Lingus and Ansett).

When Borghetti became Virgin CEO two years ago, Virgin still had some of the scars from the days when its former chief, Brett Godfrey, used the Virgin discount model take on Qantas. Virgin lost, and lost badly.

Borghetti set about remaking Virgin in the image of Qantas with business class, frequent flyer clubs and other mechanisms to extract better margins.

While at Qantas, Borghetti had pencilled an alliance deal with Etihad chief James Hogan. Alan Joyce did not proceed with it, so as soon as Borghetti became Virgin CEO he picked up the Etihad alliance deal and then added other airlines lead by Singapore. Eitihad is now buying Virgin shares but says it is not looking for control.

It is no secret that Hogan believes Qantas and Joyce have their backs to the wall.

Joyce is now also putting together an alliance network. He has a passion for the potential of discount airlines, reflecting his time heading Qantas's Jetstar.

Borghetti is heading Virgin away from being a discount airline although, of course, like Qantas he discounts Virgin's economy seats.

So the stage is set for the battle between the two airlines.

Although Qantas is much larger and the front-runner, in many ways Joyce has the harder task. He has a staff with a culture of invincibility and work practices that are very painful to change. Borghetti has an organisation whose culture comes from knowing your origins and having experienced a drubbing at the hands of Qantas.

But the biggest difference is in the balance sheets. Qantas has shareholders funds in its books of $5.9 billion but the market values its shareholders funds at less than half that – $2.6 billion. It clearly fears Joyce might lose the battle. Moreover Qantas has net debt of $7.5 billion, which looks okay against shareholders funds of $5.9 billion but not against the market value of shareholders funds at $2.6 billion.

Virgin is less than a quarter the size of Qantas yet the market value of its shareholders funds is $1 billlion – and it's above the book value. Because it is much smaller, Virgin's debt is only $1.7 billion but at balance date it had $800 million in cash.

Virgin's combination of a more flexible staff and a good balance sheet is potentially very powerful.

Qantas has a real fight on its hands because no one knows its strengths and weaknesses better than Borghetti.