Investors sceptical of Virgin’s IPO after their previous grounding
Virgin faces a challenge getting investors onside as it targets a November 2023 listing on the Australian sharemarket.
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Virgin Australia could be earning so much cash it’s having to stuff it in wheelbarrows and it
still won’t assuage the concerns of some investors who are sceptical about giving the
airline another chance at its initial public offering – coming as soon as November.
Australia’s second biggest airline collapsed in 2020 and its were shares delisted from the stock
exchange after pandemic-related border closures and rolling lockdowns kept its
aircraft on the tarmac, and the Brisbane-based carrier was unable to service heavy debt levels.
Bain Capital jumped in and bought the airline from the administrator for a price of $3.5bn
including debt. It has already earned enough money from the now-profitable carrier to
pay itself a capital return in less than three years – worth the entire $731m it paid in equity.
The structure of the Australian market is too deeply skewed in favour of much larger
rival Qantas to make Virgin an attractive proposition, according to Steve Johnson from
Forager Funds, which owns shares in Qantas.
“Qantas has such a dominant market share that they can make money charging the same
price that other airlines are at best break-even on, and we’ve seen that many times over
the past 20 years,” Mr Johnson said.
The Flying Kangaroo rakes in profits from the high-margin Sydney, Melbourne, Brisbane
business routes – which are considered among the world’s most profitable – and uses its low-cost unit Jetstar to rub out competition on the low-margin, high-volume leisure routes.
Qantas Group had 61.7 per cent market share in January, according to the competition
watchdog, compared with Virgin on 33.4 per cent.
On Tuesday, Qantas forecast it would make a record underlying profit of as much as
$2.48bn in the current financial year, a massive $1bn more than its previous best result.
The airline has been benefiting from extremely strong demand for travel post lockdowns, coupled with less-than-usual domestic and international competition.
Virgin would no doubt be enjoying the same benefits as Qantas in the domestic market –
having scaled back its international intentions from its former operating self. Earlier this
year the airline announced its highest profit margins since 2007, pulling in estimated
earnings of about $125m from first-half unaudited revenue of $2.5bn.
It’s been a dramatic bounce back for Qantas and Virgin after several years of losses.
However, there will likely be less cream for the airlines by the end of the year when both
take possession of new aircraft, leading to a normalisation of available seat kilometres and
a likely decline in load factors.
One senior Virgin insider, speaking on the condition of anonymity, said the airline
would directly address concerns about the likelihood that margins would come off current highs when it restarts its “non-deal” roadshow in just over a month’s time.
Virgin senior executives had already met with potential investors in the US, Europe and
Asia, but the domestic leg of its investor meetings was put on hold following the death of
chief executive Jayne Hrdlicka’s husband.
While the final timeline of the IPO is not yet set in stone, the source said the airline planned a restart of its roadshow in late June or early July, which “gives investors a chance to give
feedback”, before a prospectus is issued and an IPO roadshow begins as soon as October.
The airline will then be racing to hit a November IPO date so that it has a good trading window before professional and retail investors take Christmas vacations.
Veteran investor Geoff Wilson from Wilson Asset Management said he believed the
destructive price wars that Qantas and Virgin engaged in during former times were over and
that at the right price he would be a buyer.
I am “very interested if it is well priced,” Mr Wilson said. “We have had two profitable
airlines before and it looks like the price wars on airfares are years behind us.
“Duopolies can be very, very profitable. The only structure better for profitability of the participants than a duopoly is a monopoly.”
Price will also be a big factor for Hugh Dive from Atlas Funds Management, who points to
the fact that Virgin shareholders were wiped out last time around and bondholders got
between 9c and 13c in the dollar.
“While it was tempting to blame Covid, the airline was in dire straits before Covid hit,”
Mr Dive said.
“The question for investors will be what sort of efficiencies Bain has managed to make over the 2.5 years they have owned the airline and what sort of corners have been cut that may land new shareholders with significant capex bills in the future.”
Along with the issue of what Virgin’s private equity owners may have done since bringing
the airline back to profitability, Mr Dive said when analysing IPOs it was also worth
considering the words of famous value investor Benjamin Graham who wrote in his 1949
book “The Intelligent Investor” the following: “Our recommendation is that all investors should be wary of new issues – which usually mean, simply, that these should be subjected to careful examination and unusually severe tests before they are purchased.
“There are two reasons for this double caveat. The first is that new issues have special salesmanship behind them, which calls therefore for a special degree of sales resistance.
“The second is that most new issues are sold under ‘favourable market conditions’ – which means favourable for the sellers and consequently less favourable for the buyer.”
No doubt market conditions for the aviation industry are very favourable at the moment.
But it sounds like this time around, investors will be much less taken with any Richard
Branson-style antics from Virgin and want to see a float that prices at a multiple of
earnings in normal trading conditions, rather than the current aviation cash bonanza.
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