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Virgin America hangs as its hedge fund owners get antsy

Grandpa +65

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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 cost 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."
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


 

HighSpeedClimb

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They will come out okay. As long as no laws are broken I'm rooting for them, if laws are broken then put a hole in the life raft, or at least get a US investor to buy the whole thing.
 

Fubijaakr

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HSC,

You are aware there is a financial crisis currently going on in this country aren't you?
 

boomlrd

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I work for Spirit, the lowest of low when it comes to quality and service, but I am rooting for them as well! Have you ever jumpseated on Virgin, it is truly bringing back glamour and quality service to airline flying! I love it! I wish the other airlines out there would follow that path, unfortunately I am doomed to live a punishing life at Spirit, if its even around in a few years. If Virgin ever starts hiring again, I will be trying to get in again, crossing my fingers things go well for them!
 

On Your Six

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I've flown on VA several times as a pax. Fantastic economy-seat product (plus, the stews are hot). Very comfortable transcon flying. It would be a shame to see them go.... It surprises me that any hedge funds are willing to sink money into this industry. I wish them luck.
 

GuppyPuppy

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I rode on them once.

Amenities were very nice, but the lack of legroom in coach was a deal breaker for me. All the frills in the world don't mean much if I'm going to be very uncomfortable for a 6 hour flight.

GP
 

OurMoney1

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R u kidding me?

These guys dont pay their pilots tihs! And you guys are rooting for them??

The quest for the bottom dollar at the cost of our profesion should not be supported. I feel for the families that would be affected by a VA shutdown, however it is for the good of our pursuit for better.

Not rooting for these guys...non union who are paying their guys crap sandwiches. Wake up...
 

CosmoKramer

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holy crap, how can root for a airline with pay as poor as virgin? I don't get it. And what's even sadder their payscale is higher than spirits..
 

mvedepo

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B-J-J Fighter

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Very tough talk for a guy that's been flying for 4 years. Enjoy your vacation. :rolleyes:

I will enjoy my vacation. Many guys on here know who I am and I'm not scared to acknowledge that. I come from a family of attorneys (my grand dad, and Dad) and they are appalled at the wages we get paid now. I am as well, and as long as we have guys willing to accept Vaginal America wages it will never get better.

I'm out....
 

mvedepo

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I will enjoy my vacation. Many guys on here know who I am and I'm not scared to acknowledge that. I come from a family of attorneys (my grand dad, and Dad) and they are appalled at the wages we get paid now. I am as well, and as long as we have guys willing to accept Vaginal America wages it will never get better.

What do you get paid at the regional you work at again? LOL...Don't let the door hit you in the arse on the way out.
 

B-J-J Fighter

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What do you get paid at the regional you work at again? LOL...Don't let the door hit you in the arse on the way out.

Bwhahahahaha. good argument. Vaginal America wages are worse than horrible. I will make more money than your mom and she's pretty hot for an older women. It's the kinky she does that earns her the $$$$.
 

mvedepo

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Bwhahahahaha. good argument. Vaginal America wages are worse than horrible. I will make more money than your mom and she's pretty hot for an older women. It's the kinky she does that earns her the $$$$.

Vaginal America...

Make more money than my Mom....

WOW. You got me GOOD there. Man I have no idea how ANYONE could ever top that. Man that was AWESOME. Real zingers there! lol
 

Chief Pilot

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It won't be a sad day for this industry to see the virgin go under. It has done nothing but lower the bar for compensation since its inception. Unfortunately it is yet another glaring example of how pilots will flock to the first company that will hire them regardless of pay, benefits, and representation. Or maybe it's just an example of the type of pilot willing to help this industry spiral further downward.

Just trying to feed your family, right? How about thinking beyond the tip of your nose and realize that you not only hurt everyone else in this industry, you ultimately hurt your own future.

Good riddance to va I hope.
 

mvedepo

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I find it amusing how a 28 airplane operation seems to spell disaster for the entire industry. Seriously. Do 280 pilots REALLY have that much power?
 

Bavarian Chef

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I find it amusing how a 28 airplane operation seems to spell disaster for the entire industry. Seriously. Do 280 pilots REALLY have that much power?

JB pilots used to say the same thing, and look what JB has done to the industry.


Don't blame me tho, I was one of the 646.
 

SaabStory

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....

ualdriver

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I find it amusing how a 28 airplane operation seems to spell disaster for the entire industry. Seriously. Do 280 pilots REALLY have that much power?

You should probably mention that you work at Virgin......

A 28 airplane operation is probably not disaster for the entire industry. But it can trash yields in select city pairs that might otherwise have been profitable during times where every penny might count.

The problem is that Virgin America enters markets with labor subsidized low fares and trashes yields for everyone. Don't believe me? Google "virgin america fare wars" without the quotes. Take a look at the dates of the articles. Don't forget to scroll through all the pages because they go farther than just the first page that pops up.

After having looked at what came up when you did your Google search, do you think what Virgin America was/is doing is good or bad for the health of the industry? Do you think that is what the industry needed at the time or currently needs now? When you look at that list of articles that pop up on Google, do you think what you are reading is good for the pilots of the airlines that have to compete with those labor subsidized low fares..... or is it bad?

And that's just with the 28 airplanes you mention. How much longer does that Google list get with 50 airplanes? 100? 150 airplanes? Do you suggest we not learn from history? Should we not worry until you have 150 A320's?

Certainly you can understand the concerns many of us have about a rapidly growing airline that by every measure underpays their Airbus pilots and tends to undercut every market they enter in order to steal market share?
 
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