⌐ AV8OR WANNABE

Virgin America hangs as its hedge fund owners get antsy

By Elise Amendola, AP

Richard Branson, chairman of Virgin Group, relaxes in a first-class seat on a Virgin America Airbus A319 at Logan airport in Boston earlier this month.


OPERATING AT A LOSS

Virgin America released operating revenue and expenses this month after the Transportation Department rejected its request to keep the information private because it is privately owned (in millions):

Revenue
Loss

Q4 2007
$36.0
$59.9

Q1 2008
$52.8
$50.8

Q2 2008
$92.5
$62.1

Q3 2008
$114.2
$54.3

Source: Boyd Group International

By Dan Reed, USA TODAY
Its planes are packed with travelers who love its affordable, hip service. Still, 19-month-old Virgin America might be the most endangered airline in the USA.
Virgin America lost $227 million in its first 12 months of operation, far more than expected, thanks largely to last year's historic run-up in fuel prices. And now, the U.S. hedge funds that own 75% of the airline could be reaching for the rip cord on British billionaire Richard Branson's foray into the U.S. domestic market.

Should either of the funds, Black Canyon Capital or Cyrus Capital Partners, exercise unusual "put" rights in their investment agreement with Branson's Virgin Group to start the airline, the Britain-based group would be forced to buy back the shares.

Virgin America's rivals claim that would violate U.S. law that says airlines operating domestic routes in the USA must be 51% owned by Americans who have 76% voting control.

Neither Black Canyon nor Cyrus Capital will state publicly their intentions. But there are tell-tale signs that one or both are about to cash out: The biggest being Virgin America's hiring of investment banker Lazard Group to search for new U.S. investors.

Virgin America CEO David Cush says the search is "just the prudent thing for us to do, recognizing the options available to our current U.S. investors." He promises that management will remain in the hands of U.S. citizens and maintains the privately held airline could soon make a profit.

Starting up in a downturn

It's easy to see why Black Canyon and Cyrus Capital would want out now. The U.S. airline industry is caught in a strong downdraft in consumer demand caused by the faltering economy. The downturn couldn't come at a worse time for a start-up carrier.

Virgin America's best performance so far was a minus-52% operating margin in the third quarter of 2008. Cush says slight second- and third-quarter operating profits are possible this year "unless things deteriorate more than they already have." But he doesn't project an annual profit until 2010, providing the economy recovers.

The hedge funds can avoid that risk by exercising their put options. In addition to getting back what they invested, Branson's Virgin Group is required to pay them 8% interest.

"If you're one of those hedge funds, you take your guaranteed profit now and run," says airline industry consultant Mike Boyd of Boyd Group International.

Henry Harteveldt, an industry analyst at Forrester Research, agrees, though he believes that "Virgin America actually has a good story to tell."

"It's an experience, not just an airplane ride," Harteveldt says of a trip on Virgin America. "They've realized the importance of having really good customer service. It's better than what you'll find on most other airlines … and especially better than what you'll find on other low-cost carriers."

But the economy and the unusual investment arrangement Branson cut with Black Canyon and Cyrus Capital can't be ignored.

"The question remains, can they make money?" Boyd says. "Unless they can line up new U.S. investors to put money in — and I frankly question whether they can do that in the current market conditions — it raises the question of just what is a U.S. carrier?"

Cush and most of his management team are Americans. He says that even if new U.S. investors can't be located immediately, Black Canyon and Cyrus Capital would retain their voting rights if they sell their shares back to Branson's company.

But would that satisfy the U.S. Department of Transportation's definition of U.S. ownership? If not, that could make Branson's Virgin Group the carrier's majority owner and Virgin America a foreign carrier operating illegally in the USA.

The influence of Branson's Virgin Group over the U.S. airline is large. Virgin Group is the parent of Virgin Atlantic Airways. It funded the U.S. start-up and licenses the Virgin brand to Virgin America. Virgin Group recruited Black Canyon and Cyrus Capital to be its majority U.S.-based owners, and retains a 24% voting stake in Virgin America. Last fall, it lent more cash to operate the U.S. airline.

Earlier this month, Alaska Airlines, which competes against Virgin America along the West Coast, raised the legality question. In a petition to the Transportation Department, Alaska asked that Virgin America's ownership status be investigated.

Cush calls Alaska's petition "a bush-league filing. Nothing has changed with our equity structure or governance, nor will it."

Facing limited options

Analyst Roger King at CreditSights, an independent capital research firm, says finding new U.S. investors will be tough.

Weak demand and market uncertainty mean Virgin America will be hard-pressed to raise fares or significantly increase capacity. Yet it needs to do both to make itself attractive to new investors, King wrote in a Feb. 8 report.

Harteveldt says the airline cannot survive flying just across the country and on the West Coast. "They need to be in more markets where there aren't so many strong competitors," he says.

That's easier said than done. When Virgin America tried to launch service at Chicago's O'Hare Airport, no gates were available. Any incursion into other major markets could spark retaliation by the dominant competitor, Harteveldt says.

Cush recognizes the need to diversify Virgin America's routes. But his options are limited. The carrier, which today flies 28 Airbus A320s, has only four more planes on order, and they won't join the fleet until 2011.

That leaves lowering operating costs the airline's best chance to make money, Boyd says. And if Virgin America can do that, he says, "They've got a good chance of being OK."

DYNASTY HVY

You fella's still beating this horse to death are you ?

⌐ AV8OR WANNABE

I simply posted an article I saw in today's paper. Don't know enough about it to have an opinion...

deltabound

Why not? It's newsworthy. They'll be plenty of pain to go around before this economy ever truns around.

Besides, while most pilots wouldn't go so far to say they're hoping Virgin pilots will be put on the street, no one is especially interested in having to compete with yet another company that pays it's pilots 30-50% less and has much less stringent contractual work rules. No matter how "kitschy" or "hip" it may be.

It may be the ugly future of domestic travel, but no one has to like it.

River6

What you're not up for "Hope and Change"?

DYNASTY HVY

Depend's on what kind of Hope and Change one is talking about .lol

IronWalt

You people are seriously underestimating Sir Richard's resolve when you openly talk about VA's demise. This man, unlike most airline managers, has a vision and a plan. Now that he has a toe hold in the US market, the only way he would let it go would be if it jepordized the rest of his empire.

I for one, am very pleased to see companies like VA and Jet Blue show up and force the rest of this stodgy, backwards thinking industry, rethink their mediocre service. Heck even SWA has made a few adjustments as a result.

Rock on Sir Richard and VA.

757Driver

Bet you love his substandard pay too.

Al Aska

Walt..

If you want entertainment go to a movie! If you want to get from point a to b very quickly and safely buy and airline ticket! You are not paying for a 5 star hotel with wings!

VA is dropping the bar to the floor! If Branson is go rich and great how come he does not pay the best? Hip and Cool does not pay the bills!

unemployedagain

Dropping the bar is really the question, what is the bar and at what price point is a pilot above and below, some think there is no upper limit, many that follow that line of thinking have lost jobs. What I do find is that some pay rates are good for a time period, and during those time periods agendas are fulfilled, folks retire or at times move over to management positions within an organization, or move on.

Many folks who work for less have been the victim of poor planning, management, or in some cases the lack or participation on controlling pilot groups over support pilot groups at the regional levels. No one can make judgement on a group without first knowing the backround. In many cases some contracts have done too good of a job resulting in job and security loss.

I am not so sure current pay rates at the major level can be justified under each cost structure, after all when was the last time you saw profits reported.

IMHO