Virgin reveals its battle formation

Virgin Australia's deals with low-cost Tiger and regional Skywest ready the airline to take on Qantas on every domestic front – for itself and its international backers.

With a flurry of announcements this morning, Virgin Australia’s John Borghetti now has Alan Joyce and Qantas surrounded.

The frenetic pace at which Borghetti has transformed Virgin Blue from a leisure-based low-cost carrier into Virgin Australia, a serious full-service competitor to Qantas complete with a portfolio of international alliances reached a crescendo this morning with that spate of announcements.

The key, related announcements were that Virgin would acquire 60 per cent of Tiger Airways Australia for $35 million (plus another $5 million if Tiger meets some performance targets within the next five years) and that Tiger’s key backer, Singapore Airlines, would take up 10 per cent of Virgin through a $105 million placement.

Separately, Borghetti also announced the proposed acquisition of Skywest Airlines in a cash and scrip deal that values the regional operator at $94 million.

Tiger could solve a problem for Borghetti and create one for Joyce.

To reduce Virgin’s overexposure to leisure markets, particularly Queensland, Borghetti has pushed Virgin – and its cost base – upmarket. While it has a cost advantage over Qantas’ domestic fleet, it surrendered its low-cost carrier positioning in the process and left Jetstar as the lower-cost carrier in the market.

Tiger, while only a small player with about 4 per cent of the domestic market, is the lowest cost player.

By acquiring control of the airline Virgin can use it to attack Jetstar. Virgin and Tiger’s parent, the Singapore-based Tiger Airways, have agreed to invest another $62.5 million in the business (the first $20 million from Singapore, the next $30 million from Virgin and the remainder split evenly) to make it a far greater threat to Jetstar than it is today.

As the low cost carrier, Tiger will have considerable leverage over the larger Jetstar brand’s pricing. An early issue for Borghetti will be to stem Tiger’s losses which, if they escalated might otherwise destabilise Virgin which itself isn’t particularly profitable. There should be synergies, however, from bringing Tiger within the Virgin fold.

Perhaps of even greater consequence is the entry of Singapore Airlines onto the already-crowded Virgin register, joining Richard Branson’s Virgin Group, Air New Zealand and Etihad Airways. Singapore, with Etihad, Air NZ and Delta Air Lines of the US already had a strategic alliance with Virgin.

Singapore Airlines is Qantas’ biggest regional rival and has been disquieted by the build-up of Jetstar’s Asian operations from its own home base as well as by Qantas’ stated regional aspirations and the implications for them of the proposed alliance of its own with Emirates.

Singapore has long coveted a presence in the Australian market – it came close to acquiring Ansett but was outmanoeuvred by Air NZ and is the biggest shareholder in Tiger. Backing Virgin with a big lump of capital and a continuing interest in Tiger is a way of significantly intensifying the pressure on Qantas by helping Virgin compete across all segments of the market.

The other deal, to acquire Skywest (with which Virgin previously had a partnering relationship), is the final piece in the plan to surround Qantas.

With Virgin attacking the main brand and Tiger targeting Jetstar, Skywest will be re-branded as Virgin Australia and bulked up to attack the Qantas Link regional business and the lucrative fly-in, fly-out markets in Western Australia and Queensland. Again it should be the lower cost brand in those markets.

Borghetti’s strategy is ultra-aggressive but not without its risks given that Virgin will go from being a relatively straightforward business to a far more complex one, with two brands to coordinate – targeting three distinct domestic market segments – and a range of international alliances and strategic shareholders to manage. Etihad, for instance, may not be all that happy about Virgin placing 10 per cent of its capital with Singapore.

The deals make it even more important for Qantas that it gets its own alliance with Emirates past the competition authorities as that will not only help transform its international business and allow Qantas to reconfigure its regional network to expand its presence in Asia but will also help protect its core domestic business.

Most of its key international competitors, except Emirates, are now lined up with Virgin in an assault on its international business and are backing Borghetti’s attack on the domestic business that has enabled Qantas to maintain a haemorrhaging international business, albeit a diminished one.

Without the Emirates deal Qantas would be even more vulnerable to the onslaught by the "Rest of the World" team Borghetti has assembled. As it is, the already high-stakes and complex challenges Joyce and his team have been wrestling with have just got even more daunting.

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