View Full Version : VB - its keeps getting worse.

22nd Aug 2005, 03:12
Remember this article from about 12 months ago?

Well its gone quite a bit downhill from there.

Anything but blue skies
August 30, 2004

On August 28, Virgin Blue staff will be popping corks to celebrate the airline's fourth birthday. Chief executive Brett Godfrey and a few of his most senior executives will dress up, sing, dance and entertain the crowd. But, even before the party begins, the company and staff are suffering a massive hangover. Since Virgin Blue listed on the Australian Stock Exchange (ASX) on December 8, its stock has been dogged by problems, some of its own making, among them a faulty record-maintenance system, using too many aircraft (thus encouraging overcapacity in the market), yield erosion and soaring oil prices, a problem possibly exacerbated by an inadequate fuel and currency hedging strategy.

The upshot is that Virgin Blue has been one of the worst-performing new floats in the past year. On August 20, its share price, at $1.74, was only 6 above its lowest point, 22.7% below its $2.25 issue price and 33% below its peak of $2.61 on February 2. And some analysts are warning Virgin Blue will not be a "buy" until its share price falls below $1.45.

Godfrey says the share price does not matter. "I can't spend my day worrying about day-to-day movements in the share price. The [business] model is fundamentally sound and exceedingly relevant to the market."

Try telling that to the 18,000 shareholders who bought in at $2.25 eight months ago; and to the company's employees, 93% of whom have equity. Citigroup Smith Barney analyst Jason Smith writes in a report: "Probably the smartest thing Virgin Blue did in its November 2003 prospectus was to exclude any profit guidance for the 2005 year, for, if it had, the IPO (initial public offering) would have struggled to get away at $2.25."

Most galling to Virgin Blue's staff and minority shareholders is that one of the company's founders and a key investor, Sir Richard Branson, through his company Virgin Group, was handed $775 million in cash to sell down his shares in the IPO. Branson originally planned to reduce his 50% stake in Virgin Blue to 30%, but then opted to sell an extra 5%. This was a smart move, given what has happened since. Branson invested $US10 million in the start-up of Virgin Blue and Virgin Group still holds 25%.

Branson, who is president of the company, was not at the airline's inaugural annual general meeting on August 4, at which the company shocked the market by announcing that pre-tax profit in the four months to July 31 was down a whopping 22% on the previous corresponding period.

Such bad news, coming out of the blue, spooked the market and prompted a fall in the share price and a fall in the market's consensus range of profit forecasts for the year to March 2005 to between $146 million and $203 million. Virgin Blue's profit for the year to March 2004 was $158 million. The concern is that the company will take a while to recover from the problems that led to the profit fall: excess capacity; an air fare war; the impact of oil prices, now at record highs; and the airline's inadequate hedging cover - despite the $6 fuel surcharge to offset higher fuel costs.

Even worse is that the market might still be in the dark if company chairman Chris Corrigan, of Patrick Corporation, had not insisted on disclosure at a board meeting before the annual meeting, despite management's view that there was no need to worry the market unduly about the poor start to the year.

The downgrade, coupled with question marks over Virgin Blue's future strategic growth, has prompted high-level speculation in the industry, domestically and internationally, that tensions are mounting within the Virgin Blue board and management. This would not be the first time tensions have erupted. Only last year, Corrigan and Branson were forced to go to arbitration to get a determination on a shareholder agreement they had signed in 2001.

Godfrey dismisses speculation about tensions. He will not discuss specific board matters but stresses that the downgrade was not a shock to the board. "The board every month gets the numbers. They were aware where they were trading and trending. It is a dynamic board. I can tell you the board was in absolute agreement to make the statement the business had trended relatively poorer to last year. It was supported across the board ... We are a company whose management team and board work very effectively together. I have the utmost respect for what Virgin Group and Patrick Corporation bring to this board. It is an exceptionally strong board. Are they always going to be in sync with each other's view? Of course not. Are they going to be in sync with what management brings to them? It is a case that our board has no rubber stamping."

In a statement, Corrigan says: "I'm not aware of any tensions between the board and management. As far as I am concerned, we have excellent working relationships between the directors and management. As to the AGM announcement, there was, of course, a full discussion and a range of options was considered. The board agreed on this occasion the best approach was to provide the market with the most recent numbers in the chairman's address, and we did that. We are still comfortable with that decision."

Tensions create instability in a company and its share price. In the case of Virgin Blue, if there are tensions, they will become apparent when the company's recently formed business development unit starts to bring some of its 16 projects to the market.

In aviation, there are few secrets. If management wants to set up a new airline, or fly the United States sector, it has to show the plan to certain government departments and apply for things such as routes and an air operator's certificate. Invariably there are leaks to the market. Then, if nothing happens, the assumption is that the board has rejected it.

Rumor is rife that Branson is keen on Virgin Blue forming a separate airline to fly to the United States and Corrigan is thought to be concerned that would blow out costs and take the company into a higher risk, higher cost business.

Nevertheless, Virgin Blue must develop a solid growth strategy to counteract a peaking in the domestic market. The latest Bureau of Transport and Regional Economics figures show that the average growth rate in air traffic over the past decade has been 5%. Between March 2003 and May 2004, Australia had 14 months of consecutive double-digit growth. These figures have been influenced by the collapse of Ansett and Sars (with fewer people flying overseas). UBS aviation analyst Stephen Wood says the spurt in growth is unprecedented, is running well in excess of long-term trends and, in the past couple of months, has raised questions as to how much longer it can be sustained without taking its toll of domestic yields.

ABN-Amro transport analyst Anthony Srom goes so far as to say that Virgin Blue, with its decision to boost its fleet by more than 60% (17 aircraft) since this time last year, has pushed the domestic airline industry into overcapacity. "In our view, a price-to-earnings multiple in the order of 8.5 to 9.5 times is more appropriate, implying a share price target in the order of $1.40 to $1.55. Our valuation has fallen from $1.56 a share (previously $2.15 a share)." Virgin's prospective p/e at $1.74 is 10.71. With record-high fuel prices, domestic growth peaking, Qantas's launch of low-cost carrier Jetstar in May, a downturn in the domestic economy and enterprise-bargaining agreements due for renewal between June and September next year, the going can only get tougher for Virgin Blue.

Jetstar is targeting the leisure market but industry sources suggest it is a matter of time before Qantas starts switching more passengers to Jetstar. One industry source says:

"It will snooker Virgin because it will be able to offer low air fares for a sustained period ... because it has a huge balance sheet behind it, and it will be doing all of this at a time when the peak of growth has stopped."

Godfrey says Virgin Blue has a war chest of up to $500 million to counter competition from a new entrant or a price war with Qantas or Jetstar. He says he expects the market to play out rationally but any deterioration into a price war would, "no doubt, impact our result for 2004-05".

He will be hoping air fares start to stabilise, and the company intends to slow the growth of its fleet in the next 18 months. It plans one more aircraft by March 2005 and only another two by March 2006. "Our growth spurt was last year," says Godfrey. "We are evaluating [the situation]. In the next three or four months, we will review that period for 2005-06. We can grow more if we choose. At this stage, we are seeing how the market plays out."

So far, Virgin Blue has based its cost savings on simplicity and a single-model fleet. Indeed, it has one of the best profit margins in the aviation world due to low maintenance costs and a comparatively cheaper and more flexible labor force than Qantas. However, as one industry authority says, with a young fleet of planes, costs in the early years are minimal but they eventually rise to an industry average of about 15%.

Another big cost is labor. With shares below their issue price, there is a question mark over the impact this is likely to have on staff morale. This will be particularly important as the airline renegotiates its enterprise-bargaining agreements with the unions next year. More Virgin staff are asking why they are not paid as much as their Qantas counterparts and some flight attendants are questioning why their work includes cleaning toilets.

One union official says unions will seize the opportunity to exploit any discontent to strengthen collective bargaining, so increasing cost pressures. ABN-Amro's Srom says: "With the company promoting a genuine service culture to differentiate itself, it will be important to see how senior management maintain a motivated workforce. In our view, the hard yards [operations, strategy and management] post-Ansett's collapse are now beginning for senior executives."

Airline investing is always risky. A terrorist attack, a disease outbreak, rumors of poor safety and a business whose earnings are hugely leveraged to yields, load factors, currency and oil prices, make for a rocky ride on the stockmarket. The past few years have been no exception for aviation worldwide. Added to the mix have been wars and record oil prices.

Against this backdrop, Virgin Blue came into the market four years ago. It had a stroke of good luck when one of its biggest competitors, Ansett Airlines, collapsed, leaving a 40% hole in the domestic sector. Within three years, Virgin had snaffled 33% of the market. Now that Qantas has drawn a line in the sand with the launch of Jetstar, things will start getting tougher for Virgin.

Godfrey's cocky dream two years ago to have 50% of the market by 2007 now looks just that. Today he denies ever putting a date on the goal. "You have to have mountains to climb. If we sit on our laurels, we will stagnate. The first goal was to survive 12 months. The second goal was to supplant Ansett. The third goal is to be bigger and better than our competition. It will happen no time soon.

"My stronger view is, if the market grows at 10% per annum, I expect Virgin Blue to take 50% of that growth. I'm not so focused on 50% of market share, but, if Qantas brings on two planes next year, I want to get half that growth, so I will do the same thing."

He needs to be right or Virgin Blue's share price will fall further than it already has.

Going Boeing
22nd Aug 2005, 03:55
Following the collapse of Ansett and the Tesna rescue, a rumour went around that the Federal Gevernment was uncomfortable with Qantas having 80% market share domestically. Over the next 2-3 years Virgin Blue growth was way beyond anyone's expectations (including RB and BG). What amazed the QF domestic check-in staff was why Qantas was not putting on extra capacity because almost all flights were full and potential passengers had to fly with Virgin just to get a seat (paying top dollar, not the $29 discounted fare). This was accutely pointed out during the SARS crisis when Qantas had taken capacity off the international operation (mainly B767's normally flying to Asian destinations) but failed to make any significant increase in domestic flights. During this SARS period there were some one-off events involving many thousands of visitors from overseas that had to fly some domestic sectors but Qantas did not put on any additional flights - thus forcing passengers to fly with Virgin. Circumstantial evidence strongly indicated that the rumour was true and that John Anderson (or as the QF bashers call him - The Minister for Qantas) had dictated the maximum market share that Qantas would be allowed to have.

Virgin has acquired the government dictated market share and as Geoff Dixon stated when he delivered the 2004 Profit results - he has drawn a line in the sand and he would do everything possible to prevent any further erosion of market share. Using QF mainline to protect the higher yield market and Jet* to penetrate the low yield market has forced Virgin to fight harder for market share. With the future now not looking as rosy, Brett Godfrey has suddenly gone media shy and a large number of Virgin executives have moved to greener pastures. Virgin is in a solid financial position and will generate good profits in the forseeable future but they won't experience the amazing growth that we saw during their first few years of operation.

One thing that I find amazing now is the interest of Patricks (& now Toll) is in boosting the air freight revenue, which makes sticking with B737's in lieu of changing to A320's a few years ago a wrong decision. The B737 holds are probably the worst for carrying freight on regular passenger services. Richard Branson probably didn't care about air freight as he was only interested in using Virgin Blue as a "market leader" for his other Virgin branded products which is why he was happy to sell down and become a minority shareholder.

22nd Aug 2005, 06:05
Ironic yes. A certain recently retired Flt Ops Director of VB was a very strong advocate of the A320 family (and its container holds).

If you believe all past rumours, it is still possible that an A320 family rollover could occur. Now if the Toll bid is successful and VB offloaded this probably becomes less likely.

I still believe SIA management are sitting at Raffles sipping on a Singapore Sling with big smiles on their faces.

22nd Aug 2005, 07:39
Goeing, I suspect you are right.

Governments take unoffical policy positions all the time - which is why sometimes they sit back and do nothing when a company gets in trouble, and at other times they are galvanised into activity.

These policy lines are usually treated as "conventional wisdom". Here are some old, and not so old, bits of conventional wisdom, some of which still unfortunately haunts us.

1. Due to economies of scale, Australia can only support one international airline (that was the excuse for doing nothing when Ansett went under).

2. Due to economies of scale Australia cannot support an aircraft manufacturing business (Vale CAC and GAF)

3. Australia has no competitive advantage in building light aircraft (vale Victa, and when an American company gets annoyed by competition from Gippsland Aeronautics, watch the government stand by while they buy it and close them down)

4. Australia can only support one defence shipbuilder ( Tenix - don't bother applying for more tenders - you wont get them)

This crap goes on all the time. Thye economies of scale bit is rubbish because the entire thrust of manufacturing technology for the last 40 years has been eliminate economies of scale and ensure that an economic order quantity = 1 item.

I could go on, Japanese car component companies actually send work here beacsue we can make short runs profitable.

It is entirely predictable in my opinion that the Government believes that there is only room for Qantas, and that dire things will happen if they are forced to compete.

White Pointer
22nd Aug 2005, 07:45
Of course there is no bias in your statement Sunfish as your life definantly doesn't revolve around a burning hatred of QF for some reason (despite what your posts make people think).

And VB won't be offloaded from Patrick as it forms a very important part of their future transport strategy.

22nd Aug 2005, 08:18
And VB won't be offloaded from Patrick as it forms a very important part of their future transport strategy.

But not part of Toll's............................. (bugger - I sold my Patrick's shares last week :-( )

22nd Aug 2005, 09:26
For the merged Toll/Parick Group agreement to hold a minimum of 10% of Virgin Blue for a minimum of 30 months subject to certain exceptions does not appear to me to be a prize asset.

Reminds me of the takeover of East West Airlines. The names Griffin Coal Company and Rick Stowe come to mind.

23rd Aug 2005, 22:53
And Richard Branson tries to blame Chris Corrigan for all of its woes of late, especially seeing that CC has barely had control of VB for a few months.

Branson must think the general public are idiots if he expects us to believe him.......just like when he estimated that VB shares were worth something in the order of $2.40 when Corrigan made his $1.90 offer successfully.

Hence this article from today's Australian that puts Branson into perspective:

Patrick blasts Branson comments
Steve Creedy and Blair Speedy
August 24, 2005
CHRIS Corrigan's Patrick Corp hit back yesterday at claims by Virgin Group boss Richard Branson that it was responsible for the airline's fuel woes and its recent profit downgrade. This came as concerns emerged yesterday about the effect Toll Holdings's takeover bid could have on competition in the freight market.

"Richard's comments are laughable, given that he's never attended a single meeting of the board of Virgin Blue," Patrick spokesman Paul White said.

"There never have been, as Richard claims, any strong debates on the issue of fuel hedging as all the board members, including his own representatives, have always agreed the position."

A Virgin Group spokeswoman said the company's two representatives on the Virgin Board had been vocal about the decision not to hedge against fuel price rises.

She said Virgin Blue had hedged before Mr Corrigan took control and the group's other airlines were all hedged.

Sir Richard, founder life president of Virgin Blue, has joined forces with Toll Holdings in a bid to regain his lost influence over the airline and says he disagrees with the way the airline is run.

As well as the hedging debacle - which added $150 million to Virgin's costs and resulted in another profit downgrade last week - he cites delays in taking on Qantas in the business market, introducing a frequent flyer program and moving into freight.

Under the Toll bid, Virgin Group could increase its stake from 25 per cent to 40 per cent by underwriting at $1.40 per share the sale of a 15 per cent stake in Virgin Blue through a bookbuild and taking options.

The war of words continued yesterday as former Australian Competition and Consumer Commission chief Allan Fels warned that Toll's $4.8 billion bid for Patrick could be opposed by the regulator on the grounds that it would shut potential competitors out of the market.

In launching the bid on Monday, Toll managing director Paul Little said he didn't expect any problems getting the deal past the ACCC because there was "minimal overlap" between the assets of the two companies beyond their joint venture rail freight business Pacific National.

But Professor Fels, who was ACCC chairman until 2003, said the regulator would also examine the competition impact of the vertical integration of Toll's road and rail transport assets with Patrick's port operations.

"There appear to be vertical integration issues for the ACCC to wrestle with," he said.

"It can make it harder for new players to enter. They may wish to enter at one level of the industry and then find that they can't get access to the next level of production either upstream or downstream, because their competitor owns it."

The ACCC has already raised concerns over the impact of vertical integration in transport in its analysis of Patrick's proposed takeover of FCL Interstate Transport Services.

The regulator said in June that the merger could raise barriers to entry in the interstate rail freight sector and create an incentive for Toll and Patrick to use Pacific National to keep rival operators from using the rail network.

Current ACCC chairman Graeme Samuel indicated a final decision on whether to allow the Patrick-FCL merger, which has been under consideration since April, could now be delayed while the newer deal is assessed.

"With the two being interconnected, it may be that the outcome of the FCL matter will take into account any possible outcome of the Toll-Patrick matter," Mr Samuel said.

Patrick directors reiterated their rejection of Toll's offer - of 0.4 Toll shares, 75c in cash and 0.3 of Patrick's own Virgin Blue shares for each Patrick share - after a board meeting in Sydney yesterday. The bid valued Patrick shares at $6.87 based on yesterday's closing stock prices, down from $6.95 on Monday afternoon, considering that the offer does not include the 15.5c dividend now bolstering Toll's share price.

Patrick shares closed at $7.25 - a 5.5 per cent premium to the implied offer price - narrowing from the 6.2 per cent premium of a day earlier, suggesting little expectation among investors of a higher bid emerging.