VIRGIN AMERICA'S ICKY IPO
By Joe Brancatelli
July 31, 2014 --Everything that makes business travelers hate airlines— cramped seats and shriveled schedules and opaque "optional" fees—has nevertheless created a financial golden age for the U.S. carriers. They had record earnings last year, a banner first quarter and last week reported eye-popping second-quarter results.
"Never before in history [have U.S. carriers] been in such a favorable position," one securities analyst wrote earlier this month while raising his target price for surging airline shares.
So why wouldn't tiny, debt-laden, rarely profitable Virgin America Airlines pick right now to go public?
In a 210-page Securities and Exchange Commission registration statement on Monday, Virgin America's filing was shy on facts even for a placeholder initial public offering. The airline didn't say what stock ticker it would use, on which exchange its shares will trade or reveal the timing of the IPO. It naturally didn't disclose how many shares it plans to offer. The ostensible financial goal — $115 million — is most likely a stalking horse for raising around $300 million and an anticipated market value of $1 billion.
Even in these fevered glory days for U.S. airlines, is Virgin America worth it? Of course not.
The airline's filing has the normal "risks" segment — and the risks for a 53-plane, 22-city niche carrier such as Virgin America are huge. But it turns out some of Virgin America's purported market strengths aren't strengths at all, but still more weaknesses in disguise.
- Virgin America claims it offers a "premium travel experience" that differentiates it from both low-cost carriers and the legacy airlines. That's no longer true, however. On the most important and profitable domestic routes (the so-called Transcon Triangle that links New York with Los Angeles and San Francisco), Virgin trails its competitors' premium product. American Airlines offers lie-flat beds in its first- and business-classes. Delta Air Lines and United Airlines offer lie-flat beds in business class. And JetBlue Airways, JetBlue's closest competitor, last month premiered Mint, which offers both lie-flat beds and semi-private seats with doors. By contrast, Virgin can only offer the older-generation recliners that are less popular with premium transcon fliers.
- Virgin America boasts that it "does not provide complimentary upgrades to first class," but that's hardy a strength. It drives away the most frequent and profitable business fliers who expect the occasional upgrade as a payoff for their high-spending custom. Always telling those prime customers "no" doesn't engender loyalty to Virgin America.
- Virgin America claims "the Virgin brand is widely recognized and is known for being innovative, stylish, entrepreneurial and hip." It is also a marketing advantage when entering new markets. Those may indeed be strengths, but the Virgin brand comes with a built-in weakness, as Virgin America grudgingly admits elsewhere in its filing. Since it licenses the name from the self-aggrandizing Sir Richard Branson, it "is not under our control and negative publicity related to the brand could materially affect our business." Worse, Virgin America says, there are any number of factors that could cause Branson to terminate the license and strip the airline of its identity.
- Virgin America says it intends to "grow our share of business travelers," but the claim underlines the airline's weakness with those of us who fly most frequently and pay the most. Virgin says it considers fliers "who book within 14 days of departure as business travelers," yet those customers represent just 30 percent of its business and accounts for only 40 percent of revenue. That's much lower than established travel companies.
And that's the good news. The filing drones on for 14 pages in the "risk factors" section and it makes for depressing reading indeed. Many of the caveats are industry-standard boilerplate — terrorism, fuel prices, weather, etc. — but much of the risk is unique to Virgin America:
- The airline is historically a money loser. Since launching in 2007, Virgin America has managed just one year of profit, generating a razor-thin $10.1 million in net income last year on revenue of $1.42 billion. It was back in the red in the first quarter of this year, however.
- Virgin America is heavily indebted and paying over-market interest rates. Thanks to a long and messy seven-year gestation period, the airline is saddled with more than $650 million in debt. Some of the notes carry a 17 percent interest rate. Branson's various Virgin entities, which control 22 percent of Virgin America, are owed about $400 million. Most of the rest is owed to a New York City-based private equity firm, Cyrus Capital, that owns about 70 percent of the airline.
- Despite the IPO, Virgin America will remain closely held, largely a creature of Branson and Cyrus Capital. Moreover, most of the proceeds from the share floatation will go to paying down the debt owed to Branson and Cyrus, not for operational improvements or expansion.
- Branson and his related companies currently receive .5 percent of Virgin America's revenues off the top as a licensing fee. Branson's vigorish will rise to .7 percent in 2016. These fees are unprecedented — and a notable drag in the traditionally low-margin airline business.
- Virgin America is disproportionately dependent on two crowded, difficult-to-dominate airports — Los Angeles and San Francisco — for traffic. Virgin is planning to expand elsewhere, most notably Dallas, Washington and New York, but the two California cities will remain the heart of the airline.
- Virgin America no longer has a substantive cost advantage over other airlines. Its once-new fleet of Airbus aircraft is aging and that requires more maintenance at additional cost. Its largest employee group, the flight attendants, is voting on unionization. These developments are atop Virgin America's existing costs (about 11.7 cents per seat mile), which are surprisingly high for a young airline. JetBlue, which has flown for twice as many years, and 70-year-old Alaska Airlines, which competes ferociously with Virgin America on intra-California routes, have similar costs. And after a decade of cost-cutting and bankruptcies, the nation's largest carriers have driven their operating costs down to about 13.5 cents a mile.
Ethics considerations have always barred me from investing in any travel-industry stock. Even if I could, though, I wouldn't touch Virgin America. I'd hate to be Branson's junior partner, wouldn't want to be vested in a small airline with rising costs and can't imagine explaining to the nation's most profitable and influential fliers why they can't have a bed when they fly coast-to-coast on a premium fare.