Flat White

Virgin no more

22 April 2020

1:13 PM

22 April 2020

1:13 PM

Yesterday, Virgin Australia announced to the ASX that it had entered into voluntary administration and that it intended to recapitalize its business, hopefully, to emerge in a stronger financial position. 

In layman terms that means Virgin has gone to bootcamp, the administrators are the professional services equivalent of Commando Steve, and hopefully, after some blood, sweat and tears, Virgin remerges much leaner as the Biggest Loser. If it doesn’t, it gets kicked out of the corporate house. 

As with all corporate collapses, the pertinent question to ask is: how did we get here?  

One side of Virgin’s corporate profile shows a company which is 90 per cent foreign owned, with over $5bn in debt, that incurred losses in eight of the last 10 years. The other side shows a company, domiciled in Brisbane, which employs just over 10,000 people and provides an alternative to flying Qantas.   

If there was an easy solution, it would’ve been sorted out by now.   

Last week, Virgin asked the federal government issue it a $1.4bn convertible note, where, if Virgin defaulted on its terms, the government loan would convert to equity. A cute play by Virgin but with zero incentive for it to performseriously, why bother paying a loan if the government will just end up taking equity and bailing out their *sigh* investment anyway. Inevitably, the taxpayer would’ve been handballed a corporate turd after a bloated Virgin had come off its cash high. And a turd it would remain given nothing discourages corporate efficiency quite like government ownership. If anyone is responsible for reviving and tightening up Virgin, it’s its foreign owners, not the Australian taxpayer. 

So far, the government has refused to bail out Virgin as it doesn’t want to pick favourites. That’s a fair position – no sane government wants to become the not-so-proud owner of a hodgepodge of distressed assets. Despite this, supporters of Virgin argue that Virgin is different and it only collapsed because of government imposed travel bans.  

Well, yes…and no.  

Virgin was in a precarious financial position before coronavirus. Its annual reports make for interesting reading once you scroll past the indulgent self-serving drivel. In 2019, Virgin recorded operating revenue of $5.83bn, total assets of $6.47bn, debt of $5.85b and total equity of $618m. Notably, that total equity position has deteriorated from $1.09bn in 2018, and $1.57bn in 2017. Similarly, for the last three years its recorded losses have been $221m in 2017, $427m in 2018 and $444m in 2019. In short, Virgin was already tanking and coronavirus just put it out of its misery a little quicker. Conversely, many other businesses have also gone to the wall since the government-imposed restrictions, but not because of any existing structural inefficiency or mismanagement. Rather their demise was caused by, and not simply correlative to, the government shutdown. It’s those companies, not Virgin, who are the real corporate victims in this economic cluster situation.  

It’s also argued that our aviation industry needs to retain competition otherwise we will see price rises reminiscent of the bad ol post-Ansett days.  

Again, yes…and no.  

First, two airlines in a market isn’t actually competition: it’s a duopoly. And a duopoly is basically a monopoly with split personalities. Usually, the two competing parties either collude on price or one undercuts the other and drives it into the ground. Second, real competition occurs when numerous players keep pressure on prices while remaining economically viable. That doesn’t reflect the aviation landscape in Australia. The decline in Virgin’s financial position shows it was keeping Qantas’ pricing under pressure while sawing off its own leg. Regardless of current economic conditions, that strategy runs out of puff eventually. Rather than bail out Virgin, we can encourage competition by letting foreign carriers pick up domestic routes. That also has pitfalls but it would sure pour cold water over any monopolistic wet dreams Qantas executives may be having. 

Finally, it is argued that a bailout of Virgin by the government is necessary to save 16,000 jobs. 

Hmmmm, yes…and no. 

While no one wants to see mass job losses, 16,000 jobs in the context of 780,000 jobs lost between 14 March and 4 April is not remarkable. To maintain short term operations, Virgin says it needs a $1.4bn bailout, which crudely works out to $140,000 per head. Despite Labor’s A-grade attempt to emotionally blackmail the government into providing a bailout, those numbers together with the bleak outlook for aviation, render a bespoke bailout totally unjustifiable.  

So where to now? 

Going into administration allows Virgin some breathing space while administrators try to save it. No one can commence proceedings against Virgin without approval, and recent amendments to the Corporations Act means that, on certain contracts entered into after 1 July 2018, Virgin won’t trigger an automatic default simply by entering administration.  

The aim for administrators is to restructure and recapitalize the business under a deed of company arrangement (DOCA) or scheme of arrangement (Scheme). Usually, a proposal to restructure is put forward by a prospective buyer. Both these mechanisms compromise or vary the terms of debts and claims between the company and its creditors, make provision for any capital injection and determine how the company’s business will continue to operate. Both require approval from creditors, and a Scheme also requires court approval. In the case of a DOCA, any dissenting secured creditors are not bound by the terms of the DOCA, whereas a Scheme can alter the rights of secured creditors without their consent. Generally, DOCAs are more commonly used, however schemes are sometimes preferred for complex insolvencies and necessary for pre-administration restructures.   

Anyway, the administration period will likely see a menagerie of prospective buyers turn up on the administrators’ doorstep. And while it might sound like the Magic Millions, truth is most of them will be mules and the administrators will struggle to find a middling runner amongst them. That said, in this economic climate and with a weak global outlook, a middling runner still beats liquidation.  

Caroline Di Russo is a lawyer, businesswomen and unrepentant nerd.

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