Wirraway
17th Nov 2003, 02:52
Mon "Melbourne Age"
Dangers of flying into Branson's brand empire
By Malcolm Maiden
November 17, 2003
Virgin Blue chief executive Brett Godfrey flew out to the United States yesterday to begin the two week international leg of the airline's float roadshow. In New York, Boston, Chicago, San Francisco, and then in Asia and Europe, he will get the same questions that institutions asked him here: How much better can it get for the airline and is it possible that this share sale marks the peak?
Retail investors, many of them drawn from the pool of more than 300,000 people who are regular Virgin flyers, are expected to flood the share sale, which is tight, involving only 19 to 20 per cent of expanded share capital excluding management shares.
But Godfrey wants and needs institutions on the register and in Australia they have been asking why the deal is pitched at a slight premium to the dominant and famously profitable competitor, Qantas. Qantas shares are trading at about 11.4 times expected earnings, and Virgin Blue shares will be sold for $1.80 to $2.25 a share, or 12.8 to 15.4 times expected earnings.
The short explanation for the premium is that Virgin Blue is still growing. It has moved fairly effortlessly from a market share of 17 per cent to a share of 28 per cent since Ansett stopped flying in March last year and is continuing to add aircraft and routes.
It is not going to get another windfall like Ansett's collapse and faces competition from Qantas's own discount airline next year. Its cost advantage will also narrow over time, as Virgin Blue's spanking new Boeing 737s age and as Qantas gets its own cost base down by writing pay deals similar to those Virgin Blue already enjoys. (The key difference in this area is not pay, but flexibility; Virgin Blue's employment agreements allow multi-skilling, for example, and cabin crew can clean the aircraft).
But Virgin Blue has a big profitability advantage (at the gross profit line, it is wringing almost twice as much profit as Qantas out of every dollar of revenue) and history tells us that the "natural" share of the two big domestic carriers is closer to 50-50 than two-thirds to one-third, where it currently stands. Its market share should grow from 28 per cent and do so profitably.
Retail investors do, however, need to think carefully before they buy. They should think carefully before they buy into any airline, in fact.
As Virgin Blue's prospectus makes perfectly clear, there are significant risks, some of them peculiar to the airline industry.
Here's a selection, drawn from the 28 separate warnings that the Virgin Blue prospectus identifies.
"Future performance depends on many factors which may not be successfully addressed". Things might just go wrong, in other words. It covers elementary items such as the need to provide "high-quality customer service", to "control expenses" even the need to "react to customer and market demands".
The disaster warning. "Hostilities, terrorism, economic conditions and other external events could have an impact on Virgin Blue's performance," the prospectus says.
Aircraft do crash. And they are targets of terrorism. Statistically, the risk of either event is slim, but real. The terrorism threat is also depressing overall demand for air travel and an event of the proportions of September 11, 2001 could see traffic plummet.
Balance-sheet risk. "The airline industry is characterised by high fixed costs and low profit margins," the prospectus says. "A decrease in Virgin Blue's revenue could negatively impact its financial performance."
This is a major investment issue. Lease them or buy them, aircraft cost a lot. The Boeing 737s that Virgin uses cost around $US53 million (about $A74 million) each. A Boeing 747 costs four times as much. The high sticker number, in turn, feeds into other exposures, including maintenance costs, currency risk and interest rate risk.
Virgin Blue currently owns seven 737s and has 33 on lease. It will have 44 aircraft by the end of March, eight of them owned. Seven more are on order and the group has options over another 45, some of which would replace existing lease aircraft.
The airline's cost base is significantly lower than Qantas's. But all airlines have relatively high fixed costs and they all have difficulty cutting costs if revenue falls unexpectedly. The lack of flexibility on costs is the reason so many airlines were financially pressured when passenger numbers and revenue dived in the wake of the September 2001 terrorist attacks.
Low barriers to entry. Two versions of Compass airlines were launched against the Qantas-Ansett duopoly in the 1990s and failed. Another discounter, Impulse, fought briefly with Virgin, Ansett and Qantas before being swallowed by Qantas in 2001. Formula 1 racing team owner Paul Stoddart is now considering launching another discount line and Qantas is launching its own discount business.
This risk item needs to be considered, because new entrants inevitably spark price wars. But the threat to Virgin was greatest a year and a half ago, when attempts to revive Ansett were over and Virgin still had only 17 per cent of the market. Now it has 28 per cent of the market and Patrick Corp on board as a well-resourced 45 per cent shareholder.
The Qantas factor. The prospectus notes that Qantas's resources "are considerably greater than those of Virgin Blue". Qantas is a tough competitor and will fight to hold its market share. It will not launch an all-out price war, however. Qantas has too much to lose to make that error.
Brand risk - minimal, but fascinating. Sir Richard Branson has been the marketing face of Virgin Blue since it launched early in 2000. But the key relationship between the airline and Branson's Virgin group is clinical. Virgin Blue does not own its brand name, or the Virgin name in this country. Instead, it has licensed the right to use the names in connection with the Australian airline service until 2015. The deal does not cover the planned expansion into New Zealand, which is why the company will invade New Zealand under another banner - Pacific Blue.
Branson's Virgin group obviously wants Brett Godfrey to succeed. The Virgin group is a major shareholder in Virgin Blue and it is also receiving half a per cent of Virgin Blue's gross sales under the brand licensing deal, worth about $4.3 million in the September half-year. The equity link is diluting, however: Virgin had 100 per cent of Virgin Blue at the outset. It will own just under 30 per cent when the airline lists.
The Boeing risk. One of the ways Virgin Blue has kept costs down is by buying one brand of aircraft only - the Boeing 737. It's a smart move but, as the prospectus notes, it means that Virgin Blue is "particularly vulnerable to any problems that might be associated with the aircraft. Virgin Blue's business would be significantly harmed if a design defect or mechanical problem with the Boeing 737 were discovered, causing its aircraft to be grounded . . . (or) if the public avoids flying its aircraft due to an adverse perception about the Boeing 737 aircraft due to safety concerns or other problems, whether real or perceived."
This last risk is minimal. Lets face it - Boeing 737s are the Toyotas of the sky.
[email protected]
===========================================
Dangers of flying into Branson's brand empire
By Malcolm Maiden
November 17, 2003
Virgin Blue chief executive Brett Godfrey flew out to the United States yesterday to begin the two week international leg of the airline's float roadshow. In New York, Boston, Chicago, San Francisco, and then in Asia and Europe, he will get the same questions that institutions asked him here: How much better can it get for the airline and is it possible that this share sale marks the peak?
Retail investors, many of them drawn from the pool of more than 300,000 people who are regular Virgin flyers, are expected to flood the share sale, which is tight, involving only 19 to 20 per cent of expanded share capital excluding management shares.
But Godfrey wants and needs institutions on the register and in Australia they have been asking why the deal is pitched at a slight premium to the dominant and famously profitable competitor, Qantas. Qantas shares are trading at about 11.4 times expected earnings, and Virgin Blue shares will be sold for $1.80 to $2.25 a share, or 12.8 to 15.4 times expected earnings.
The short explanation for the premium is that Virgin Blue is still growing. It has moved fairly effortlessly from a market share of 17 per cent to a share of 28 per cent since Ansett stopped flying in March last year and is continuing to add aircraft and routes.
It is not going to get another windfall like Ansett's collapse and faces competition from Qantas's own discount airline next year. Its cost advantage will also narrow over time, as Virgin Blue's spanking new Boeing 737s age and as Qantas gets its own cost base down by writing pay deals similar to those Virgin Blue already enjoys. (The key difference in this area is not pay, but flexibility; Virgin Blue's employment agreements allow multi-skilling, for example, and cabin crew can clean the aircraft).
But Virgin Blue has a big profitability advantage (at the gross profit line, it is wringing almost twice as much profit as Qantas out of every dollar of revenue) and history tells us that the "natural" share of the two big domestic carriers is closer to 50-50 than two-thirds to one-third, where it currently stands. Its market share should grow from 28 per cent and do so profitably.
Retail investors do, however, need to think carefully before they buy. They should think carefully before they buy into any airline, in fact.
As Virgin Blue's prospectus makes perfectly clear, there are significant risks, some of them peculiar to the airline industry.
Here's a selection, drawn from the 28 separate warnings that the Virgin Blue prospectus identifies.
"Future performance depends on many factors which may not be successfully addressed". Things might just go wrong, in other words. It covers elementary items such as the need to provide "high-quality customer service", to "control expenses" even the need to "react to customer and market demands".
The disaster warning. "Hostilities, terrorism, economic conditions and other external events could have an impact on Virgin Blue's performance," the prospectus says.
Aircraft do crash. And they are targets of terrorism. Statistically, the risk of either event is slim, but real. The terrorism threat is also depressing overall demand for air travel and an event of the proportions of September 11, 2001 could see traffic plummet.
Balance-sheet risk. "The airline industry is characterised by high fixed costs and low profit margins," the prospectus says. "A decrease in Virgin Blue's revenue could negatively impact its financial performance."
This is a major investment issue. Lease them or buy them, aircraft cost a lot. The Boeing 737s that Virgin uses cost around $US53 million (about $A74 million) each. A Boeing 747 costs four times as much. The high sticker number, in turn, feeds into other exposures, including maintenance costs, currency risk and interest rate risk.
Virgin Blue currently owns seven 737s and has 33 on lease. It will have 44 aircraft by the end of March, eight of them owned. Seven more are on order and the group has options over another 45, some of which would replace existing lease aircraft.
The airline's cost base is significantly lower than Qantas's. But all airlines have relatively high fixed costs and they all have difficulty cutting costs if revenue falls unexpectedly. The lack of flexibility on costs is the reason so many airlines were financially pressured when passenger numbers and revenue dived in the wake of the September 2001 terrorist attacks.
Low barriers to entry. Two versions of Compass airlines were launched against the Qantas-Ansett duopoly in the 1990s and failed. Another discounter, Impulse, fought briefly with Virgin, Ansett and Qantas before being swallowed by Qantas in 2001. Formula 1 racing team owner Paul Stoddart is now considering launching another discount line and Qantas is launching its own discount business.
This risk item needs to be considered, because new entrants inevitably spark price wars. But the threat to Virgin was greatest a year and a half ago, when attempts to revive Ansett were over and Virgin still had only 17 per cent of the market. Now it has 28 per cent of the market and Patrick Corp on board as a well-resourced 45 per cent shareholder.
The Qantas factor. The prospectus notes that Qantas's resources "are considerably greater than those of Virgin Blue". Qantas is a tough competitor and will fight to hold its market share. It will not launch an all-out price war, however. Qantas has too much to lose to make that error.
Brand risk - minimal, but fascinating. Sir Richard Branson has been the marketing face of Virgin Blue since it launched early in 2000. But the key relationship between the airline and Branson's Virgin group is clinical. Virgin Blue does not own its brand name, or the Virgin name in this country. Instead, it has licensed the right to use the names in connection with the Australian airline service until 2015. The deal does not cover the planned expansion into New Zealand, which is why the company will invade New Zealand under another banner - Pacific Blue.
Branson's Virgin group obviously wants Brett Godfrey to succeed. The Virgin group is a major shareholder in Virgin Blue and it is also receiving half a per cent of Virgin Blue's gross sales under the brand licensing deal, worth about $4.3 million in the September half-year. The equity link is diluting, however: Virgin had 100 per cent of Virgin Blue at the outset. It will own just under 30 per cent when the airline lists.
The Boeing risk. One of the ways Virgin Blue has kept costs down is by buying one brand of aircraft only - the Boeing 737. It's a smart move but, as the prospectus notes, it means that Virgin Blue is "particularly vulnerable to any problems that might be associated with the aircraft. Virgin Blue's business would be significantly harmed if a design defect or mechanical problem with the Boeing 737 were discovered, causing its aircraft to be grounded . . . (or) if the public avoids flying its aircraft due to an adverse perception about the Boeing 737 aircraft due to safety concerns or other problems, whether real or perceived."
This last risk is minimal. Lets face it - Boeing 737s are the Toyotas of the sky.
[email protected]
===========================================