A different spin in today’s Australian
What the Virgin bidders really fighting over
TERRY McCRANN
The funniest — sick — joke going around at the moment is the idea that we have two groups in an auction to buy Virgin; to take their chances on running a weak second airline against the dominant, financially strong and superbly structured and focused Qantas, into the challenges and monumental uncertainties facing airlines in the post-virus world. In fact, the only thing they are “bidding” to buy is the right to get a range of other parties to donate their money to ensure that one of these Wall Street vultures can extract the greatest profit with the least risk and indeed the smallest financial contribution from the Virgin carcass. The latest group who they want to put their hands in their pockets to ensure higher profits for them is you — the taxpayer. They want the government to give them — either Bain Capital or Cyrus — another $180m or so by exclusively extending JobKeeper for Virgin Two. To have the taxpayer effectively pay the airline’s salary bill for the first six months of its life under its new owner. The best way to understand what is going on in the auction behind closed doors is by way of this example: consider two people bidding to buy a house worth around, say $2m. The one offering, say, $2.01m ends up winning over the other bid of, say, $2m flat. The $2.01m is paid; they own the house free and clear. In the Virgin case the $2m “house” comes with a, say, $4m linked mortgage. It also comes with an order to spend $1m in mandatory repairs. Clearly no one in their right mind would happily pay the $2m for the house, only to also pick up an immediate $5m liability. They’d in effect be paying $7m for a $2m asset. That is to say, the house is really worthless unless and until those liabilities can be separated or cancelled. That is exactly the same with Virgin, except we are talking in billions, not millions. The “cleanest” way to resolve the Virgin situation would be to put it into liquidation; cashing in the assets (essentially, half the planes; in liquidation, the other assets would all but evaporate); and paying varying cents in the dollar (down to zero) to the various liability tiers. This worst-case “doomsday” outcome provides the opportunity for main-chancers like Bain and Cyrus to make two and two add up to not just five but at least six, as the “better” alternative. They do this by creating a dynamic where those creditors will be offered variously more cents in the dollar (with some very small crumbs for shareholders, who would otherwise get zip) than would be likely to happen under the “doomsday” alternative. Now some of the “maths magic” is real: those assets which have value in a continuing Virgin but which would go to zero in a liquidation — its airport slots, it’s broad IP, its software, its ticketing, its global partnerships, indeed the sunk costs in its staff, and so on. Then there’s the 60 or so owned planes — their value in a continuing revenue-generating business as opposed to what you could sell them for, at a time when there is going to a be a lot, and I mean a lot, of planes for sale. But that aviation reality introduces a huge and I mean huge risk on the other side of these valuation scenarios: that you could buy cheap but end up losing money and losing buckets of it from the new get-go . To go back to my housing example; it would be great to get the $2m house for, say, $1.5m upfront and without any of those $7m in liabilities. But not so good if you locked yourself into $200,000 a year of maintenance and repairs; you’d quickly chew away your $500,000 upfront profit. That’s the key point to understand about the so-called bidders for Virgin. What they are really bidding to buy is that upfront profit. It is the (reasonable and risk-adjusted ) value of the “new” Virgin entity less the equity they have to put in and could lose. The winner will be the one of the two prepared to “bid” the lower comparative upfront profit — a profit that is going to come out of the pockets of the various parties owed the bits of the $7bn of Virgin liabilities. All these creditors have to not only lose some percentages of the money owed them (in aggregate, the difference between Virgin’s assets and liabilities), they also have to contribute to the winning bidder’s upfront profit. The offsetting lure is that in doing so they still get a higher figure than would theoretically otherwise be the case. Three components are critical for the winning “bidder” . To minimise the amount of capital they put up and is at risk. The less the capital, the smaller the dollar upfront profit they need to be gifted by the creditors to get the same rate of profit return. They have to optimise the Virgin Two operating structure and dynamics: how many aircraft, staff numbers, IP, ticketing, relationships. The post-virus uncertainties present both huge challenges and even greater opportunities precisely because of the financial engineering in and around the “offer” process. The more money you can get third parties to contribute directly or indirectly the better. It not only does the obvious — put more money into the pot — but allows more financial engineering and leverage. Like with JobKeeper, the extra $180m coming from the taxpayer might be able to be leveraged into, say, a $360m additional benefit to the buyer. Win-win . But it all hangs on getting to first base. We are yet to see whether there is a “there” there for a future Virgin. This is not like 9/11, which was ultimately if indirectly airline-friendly . Just as the post-virus world more generally won’t be like the post-GFC one.