Virgin stirs new Qantas headwinds

There are two main reasons why Virgin's restructuring is angering Qantas, but there's little Qantas can do to either hold back or emulate Borghetti's revamp.

Despite Qantas’ protestations Virgin Australia is pushing ahead with its planned restructuring and the separation of its domestic and international operations via a new corporate structure.

As is the case with all airlines with international operations, Virgin has a 49 per cent cap on foreign ownership of its shares to protect the bilateral rights it has been granted after government-to-government negotiations.

Last month John Borghetti announced plans for a new corporate structure that would place Virgin’s international business within a new unlisted structure with a continuing 49 per cent cap on foreign ownership. Shares in the new entity, which would have only nominal value, would be distributed to existing shareholders via an in specie distribution.

Today Virgin announced that all pre-conditions for the proposal had been satisfied or waived and set out a timeline for execution of the restructuring, which will be completed on March 30. That presumably means that it has obtained approval for the restructuring from the Department of Transport, or at least that the department hasn’t objected to it.

Qantas has protested the restructuring, claiming it would put Virgin in breach of the air service agreements with other countries and enable foreigners to control the airlines’ international operations.

It has made a submission to the International Air Services Commission to that effect, although it would appear self-evident that Virgin’s announcement today says that it is satisfied it will comply with the Air Navigation Act and hasn’t heard anything to the contrary from Canberra.

There are two reasons why Qantas might be displeased with the Virgin restructuring.

Virgin already has Richard Branson (with a 26 per cent stake) and Air New Zealand (20 per cent) on its register, leaving little scope for any further foreign investors within the 49 per cent foreign ownership limit. Etihad’s James Hogan has made no secret of his desire to also own a slice of the group.

By freeing up the holding company from the restrictions on foreign ownership Virgin will create space for Etihad, and other foreign airlines and investors, to buy in. That will help secure and cement the raft of alliances Borghetti has negotiated since becoming chief executive but should also bring about a re-rating of Virgin’s shares once it can tap into a new source of demand.

Qantas’ frustration is that it can’t emulate Virgin because it is subject to the particular legislation of the Qantas Sales Act.

Qantas has tried on several occasions to have the restrictions on foreign ownership relaxed, arguing that because foreign ownership of its shares has generally been close to the ceiling its share price has been artificially depressed – it has said in the past by between 10 per cent and 20 per cent – and therefore its cost of capital artificially elevated.

During the ill-fated private equity bid for Qantas one of the factors that led to the offer was a view that Qantas was undervalued by the sharemarket precisely because of that distorted supply and demand equation.

While the national interest in the national flag carrier could, if Qantas were allowed to emulate Virgin’s structure, be satisfied via the creation of a ‘golden share’ or other measures, after last year’s confrontation with its unions the relations between Qantas and the current federal government are poisonous.

There is no prospect of any relaxation of the Qantas Sales Act and, indeed, there have been mutterings in Canberra about toughening the Act to impose even more restrictions on Qantas’ ability to develop new flying operations outside the Qantas brand or to conduct maintenance offshore.

Qantas’ chagrin at the prospect of its main domestic competitor being able to do what it cannot is understandable, but there’s little it can do about it other than watch as Borghetti’s frenzied remaking of Virgin continues apace.