AVIATION

January 03, 2011|By Brad Stone, Bloomberg Businessweek

On a sunny, windswept December morning, Virgin America kicked off a day of festivities along the otherwise unfestive runways of Dallas/Fort Worth International Airport.

Four longhorn cattle lolled in a pen while dignitaries such as Dallas Mayor Tom Leppert lunched on pulled pork and ribs. The main attraction was the host, 60-year-old Sir Richard Branson, billionaire bon vivant and founder of the Virgin Group. While he was at the center of the celebration, he was also making an incursion into enemy territory.

American Airlines dominates air traffic at the airport. The 80-year-old airline and its affiliates send about 765 flights out of Dallas every day, making up more than 85 percent of traffic at the nation's fourth-busiest airport. Virgin America - with its 36 planes and 1,700 employees - was initiating just four daily flights, two each to Los Angeles and San Francisco.

Geek love and awards, though, can only get a young airline so far. The skies are a brutally competitive marketplace in which the legacy behemoths corner routes, dominate major airports and lock in customers with frequent-flier programs. Since deregulation of the airline industry in 1978, more than 100 small airline startups have come and gone. JetBlue is among the very few to have survived.

Makes first millions
In November, Virgin America announced its first quarterly profit, $7.5 million, on $202 million in revenues, but it lost $22.5 million over the first half of the year and has lost $400 million or more since its founding in 2004. David Cush, Virgin America's CEO and a former American Airlines executive, promises that the airline will turn a profit in 2011.

Virgin America's small profit seems less hopeful in light of the extremely positive environment for airlines. The entire domestic airline industry is in one of those hearty periods when it makes good money. The Bloomberg U.S. Airlines Index of 12 carriers climbed 22 percent in 2010.

"They've created a niche, but I don't think it's sustainable," says Mo Garfinkle, chief executive officer of GCW, an aviation consulting firm. "If something happens - and something always seems to happen in this industry, whether it's fuel prices or war or SARS - they're in trouble."

Virgin America does have at least part of one big asset: Branson. He is a renowned salesman with a special love of aviation. Over the past two decades, Branson has applied a focus on customer service and industrial design to an array of businesses. His Virgin Group has started companies, or licensed its brand to startups, in such fields as mobile phones, trains, hotels, soda, vodka, magazines, condoms and, most recently, space tourism.

Branson first tried to start a domestic U.S. airline in the 1990s and discussed teaming up with former Southwest Airlines executive David Neeleman. Branson was concerned, however, about a U.S. law restricting foreign ownership of domestic airlines, which would require him to turn over control of the Virgin brand to Neeleman. The Federal Aviation Act of 1938 limits foreigners to owning 49 percent of a domestic airline. Neeleman went on to start JetBlue, which went public in 2002.

Branson says he lost faith in the possibility that the law would be changed and by 2004 had decided to take a different approach. To finance the new effort, Branson hired the investment bank Lazard to canvass U.S. private-equity firms. Two firms with no prior history in the aviation industry finally pledged backing: Cyrus Capital Partners in New York and Black Canyon Capital in Los Angeles. Branson also poached charismatic Delta Air Lines President Fred Reid, who started his career as a reservations agent for Pan Am and was later an executive at Germany's Lufthansa.

With startup capital in hand, Virgin America ordered 16 Airbus jets and set about making them Virgin planes. There would be plush leather seats, a touch-screen entertainment system that offered dozens of on-demand movies and the ability to order snacks and meals from your seat at any time.

Airlines battle Virgin
the spring of 2006, with Virgin America applying for certification from the Transportation Department, Continental and American Airlines led a battle to block Branson from U.S. skies, questioning Virgin America's compliance with the foreign ownership law.

The ensuing regulatory fight, waged with lobbyists in Washington, Sacramento and San Francisco, lasted 18 months. Through it all, most of Virgin America's 16 planes sat unused.

To win its flying certificate, the Virgin Group had to make accommodations, including forfeiting the right to veto decisions about plane purchases. Fred Reid was forced to resign as CEO; the legacy carriers accused Branson's handpicked chief executive of being too close to foreign interests.

With David Cush newly installed as CEO, Virgin America's inaugural flight, from JFK to San Francisco, finally took off in August 2007. For the first nine months of 2008, Virgin America announced a $175.4 million loss on $259 million in revenue.

After such a tortured launch, both U.S. investors exercised the option to sell their stakes back to the airline. The company faced a simultaneous cash and regulatory crisis, because Branson's stake now exceeded 50 percent. In the ensuing refinancing, the Virgin Group lent Virgin America another $60 million, and Cyrus Capital agreed to step back in with a $20 million loan and assume the majority ownership position.

Expansion delayed
But the damage had been done: By the time the company got the Transportation Department to confirm the legality of its new ownership structure, Virgin America was far behind on its own plans for expansion. It initially predicted it would fly to 10 cities in its first year of service and 30 cities within five years. The airline didn't hit city No. 10 - Fort Lauderdale - until two years after it started flying. Dallas is just its 13th destination.

Mo Garfinkle and other analysts worry that the young airline has not grown fast enough to sustain a profit and has only $25 million in the bank. David Cush says the airline also has a $75 million line of credit, though he concedes that any airline exec will tell you more cash is a good thing. Don Carty, the chairman, says an initial public offering "is at least 18 months away."

Still, Virgin America has aggressive plans for expansion, with orders for 56 new jets over the next six years. It wants to introduce service next year to airports in Houston (where Continental is based), Atlanta (home of Delta) and Chicago (a major United hub). Virgin hopes its distinctive service is enough to lure travelers from those airlines.