Flat White

Virgin’s Bain?

30 June 2020

6:00 PM

30 June 2020

6:00 PM

Last Friday, American private equity firm Bain Capital reached an agreement with Virgin Australia administrators Deloitte to purchase the dilapidated carrier. Bain stated they’ll aim to “protect as many jobs as possible” making sure Australians “have access to competitive, viable aviation services for the long term”.

On the surface, these promises spearheaded by Bain Capital’s Australian managing director and former Olympic diver, Michael Murphy, appear to form part of a benevolent long term ambition for Virgin’s staff and Australian aviation. However, a simple look at Bain’s track record and the modus operandi of private equity shows that Virgin’s darkest days are likely ahead of them. 

Private equity typically works on a five-year model, aiming to hold investments for no longer than five years and return 20-25% annually — making it a lot more lucrative than the public markets, yet riddled with risk and most importantly, short term. 

Taking on failing companies with growth potential, profit maximisation is everything, profitability is achieved through ruthless restructuring and cost-cutting. Quite often at the expense of human capital. 

Despite this perceived risk, Bain Capital often exits its investments with a tidy profit, even when the company is liquidated. Which is often the case: 

Take American Pad and Paper. From a $5 million investment, Bain added $420 million in debt to the American stationery company. Nine years later it was liquidated, Bain walked away with $107 million. Ampad’s creditors (including employee pension funds) received two-thirds of a cent on the dollar. Or Stage Stores, purchased by Bain for $10 million in 1988 and taken public in the mid-90s, netting Bain $184 million. By 2000 Stage had filed for bankruptcy. GS Industries, acquired by Bain for $25 million, delivered $58 million in dividends. But by 2001, GS had filed for bankruptcy. 

This list is far from exhaustive.  

There is nothing necessarily wrong (depending on the orientation of your moral compass) with a profit maximisation approach. Bain, after all, ostensibly herald great risk and as such reap their just rewards. 

What is questionable, however, is applying this approach to Virgin Australia. 

Barring a recent equity investment in a small Maldivian seaplane carrier, Bain has no major airline experience. With the aviation industry shut down for the foreseeable future, Bain’s zero visibility flight to profitability is looking a lot more difficult. 

The World Economic Forum states that the worst job cuts come in the third year of a private equity buyout.  

Insiders with knowledge of the bidding process expect Bain’s job cuts at Virgin to be initially at least 50%, much more draconian than other bidders proposals. That would take Virgin’s market share down from 30-35% to roughly 15%. Qantas would likely then fast track an order made in 2019 for 109 Airbus A321 aircraft to cement Virgin at 15%, fundamentally resetting the domestic market and eroding any last iota of competition. Leveraging Jetstar, Qantas would likely win any subsequent price war. 

Part of the reason the Morrison government rightfully refused to support Virgin, was due to the years of poor management of the company and the government’s desire not to “pick winners and losers”.

Surprisingly, Bain has committed to retaining Virgin’s current management team led by CEO Paul Scurrah, a decision that might draw the ire of Canberra. 

On Monday night’s Four Corners, former Virgin chair Elizabeth Bryan said former CEO John Borghetti made a “good airline, but not a good enough business”. Borghetti claimed in a written statement to Four Corners that he first suggested leaving in 2016 but Bryan requested him to stay on an extra three years. 

It should come as no surprise then that Virgin found itself in a hole of $7 billion of debt, if Bryan’s first priority was not the business but building a “good airline”.  

Choosing Scurrah as Borghetti’s successor for a business turnaround was perhaps even more surprising, given his limited experience in airlines — sparing a stint at Ansett before and during its collapse. 

Under Scurrah’s brief tenure as CEO, Virgin re-purchased 35% of the Velocity Frequent Flyer program for $700 million, double what they sold it for back in 2014;  a questionable decision given the state of Virgin’s business and global recession forecasts for 2020. 

Virgin insiders also claim that Scurrah has halted the installation of new crew optimization and scheduling systems; systems that would have increased crew productivity dramatically and crucially cut costs. 

Despite this, Scurrah maintains a good relationship with Deloitte administrator Vaughan Strawbridge. The two clearly charmed by Bain’s offer, so much so, the administrator did not return the calls of Cyrus Capital last week, even when they added what is believed to be an extra $350 million to their offer for the airline, drawing into question the integrity of the entire administration process — a process that has already rejected multiple Australian based and funded bids, most notably BGH Capital, a bid with the backing of AustralianSuper. 

The Virgin crisis is a symptom of Australia’s wider internal conflict with its working and middle class. The nation is seemingly unphased by foreign businesses crippling the jobs of good Australian workers for profit maximisation. Whether this comes in the form of outsourcing of manufacturing, the sale of key national assets, or private equity takeovers of our Airlines. 

It’s that conflict that has led to a chasm in conservative politics and seen leaders like Donald Trump shoot to power across the Western world. 

It perhaps would come as no surprise then that Bain Capital’s founder is the conservative antithesis of Trump and one of his most vocal critics; Mitt Romney. 

As for Virgin, The Bain deal is not final, it is still subject to creditors approval in August. Should it be approved, for the workers at Virgin, their only way to know their future is by looking into Bain’s past. 

Unfortunately, that makes for extraordinarily grim reading. 

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