What’s an airline worth? Virgin Australia to test the market

Virgin Australia employees. Picture: AAP

A clearer picture could soon emerge as to the price that Virgin Australia’s final bidders are prepared to pay for the airline.

But already, the guessing game has started, with some estimating that offers will likely be in the ballpark of $3.5bn to $4bn.

Bids from four short-listed parties are due on Friday, with the number of contenders in the mix expected to be reduced to two by Monday in a competition overseen by the airline’s voluntary administrator Vaughan Strawbridge, of Deloitte.

They have been asked to provide more detailed information about their proposals.

The final bidders are BGH Capital with Australian Super, Bain Capital, supported by the Future Fund, Cyrus Capital Partners and Indigo Partners backed by Oaktree Capital Management.

One topic of debate among market observers is whether the suitors assess the value of the airline based on the earnings that are expected to be generated or what each part of the business is worth from the perspective of a break-up scenario.

If they come from the angle of earnings assumptions, some take the view that the carrier could be worth about $3.8bn.

This is based on Virgin Australia generating earnings before interest, tax, depreciation amortisation and rentals for the 2019 financial year of $843.9m.

An empty Virgin Australia check-in area at Brisbane domestic airport, Tuesday, April 21, 2020, the morning the airline announced it had gone into voluntary administration but would continue to operate. Picture: AAP

In the past, Qantas — a larger and in recent times more lucrative competitor — has traded at about 4.5 times its EBITDAR.

Ascribing a value to Virgin based on the Qantas trading multiple, it puts Virgin’s value at about $3.8bn.

However, the variables are exactly how Virgin Australia trades in the months ahead, with uncertainty around COVID-19 travel restrictions.

International business exit

It is also worth taking into account that suitors would likely exit the bulk of the international business, which accounted for about $138m of EBITDAR last financial year.

Another unknown factor is how cost cuts and the exit of onerous aircraft leases or the removal of other expenses could boost profitability.

When looking at the business another way, a buyer may ascribe a value to the Velocity frequent flyer program and calculate the cost of the aircraft and the leases (it is expected that up to 40 aircraft will be retained by a successful bidder with more than 6 larger aircraft to be let go).

Then a bidder has to take a view on the working capital needed and the value they are prepared to ascribe to the remainder of the business, which determines how much is paid out to the airline’s creditors.

Virgin Australia collapsed into voluntary administration in April, owing $6.8bn to creditors, after most of its fleet was grounded due to COVID-19 travel restrictions.

Central to the consideration, according to sources, is the value ascribed to the Virgin frequent flyer program Velocity.

Virgin paid $700m to buy the remaining 35 per cent interest in Velocity that it did not own last year, which assumes that the frequent flyer program then was worth about $2bn.

But that was when it was attached to an operational airline.

Now some estimate its value could be around $1.4bn.

If Virgin Australia returns as almost a domestic-only carrier, there could be a view that it will attract fewer customers who might prefer being attached to a program where they can take long-haul flights.

If bidders offer about $4bn for Virgin Australia, as some suspect, it could involve a proposal comprising about $1.5bn of equity and $2.5bn of debt, and should that be the case, it begs the question as to what lenders would provide the funding.

Australia’s largest bank CBA is understood to be open to an involvement, while it will be interesting to see if any industry funds stump up financing, while US and Japanese banks might also tip in for some debt.