There are many good lessons business owners can learn from the public troubles of Virgin Australia.
How did they get here?
Virgin has spent a lot of money on expansion: New routes (many overseas and unprofitable), new aircraft and new lounges. This expansion has come at a cost, resulting in a significant debt load to fund the expansion and ramp up (losses). In recent years, the Balance Sheet was further adversely impacted by unsecured promissory note debt.
When COVID came, the music stopped and so did Virgin’s ability to continually increase the debt load.
Now, new debt from owners, financiers or the government needs to make sense in an environment with significantly reduced cashflow from operations.
Debtholders, owners and management have realised that additional finance was only going to kick the can down the road. Further debt would inevitably make the enterprise less competitive as its cost to do business would increase. Compounding this is the unlikely return to international travel demand in the near future, putting pressure on operating cashflow forecasts.
Why hasn’t the Government intervened?
As a taxpayer, I believe the government shouldn’t fund businesses already debt ridden, load them up with even more debt and then help them perpetuate a business model that lacks relevance (especially in a post-COVID world), only to see them fail shortly thereafter.
What happens next?
The owners, debtholders and management should have been working on solutions to this pre-COVID, since the writing has been on the wall for a while due to the toxic debt-level. The desperation of the unsecured promissory notes last year should have had the Board on high alert. They should have already been contemplating a new business model and restructure.
The appointment of voluntary administrators likely triggers ipso facto clauses in relation to key contracts that would mean all previous commitments are off. It forces key stakeholders to the table. The right deals will hit a “sweet spot” with the following coefficients:
New Business Model
Routes – Profitable routes, at the right times and with the right aircraft.
Wage structure and levels – An appropriate labour model for staff going forward, taking into consideration the importance of balancing the needs of older staff with their ability to mentor younger staff in key roles (e.g. pilots for company longevity). Structure should be weighted to performance if the company does well, rather than high wage costs early.
Terminal and Airport Deals – What is realistic to now ask for in a post-COVID world?
A leaner more accountable business model should emanate.
Routes for the greater good – Enhancing competition in less profitable regional routes should be directly incentivised by the government as it provides the taxpayer benefits. Tourism and trade is pushed farther and wider so government should support this for trickle down economic benefits, in particular in rural areas.
Greater Employment – In light of the above, these routes will also create greater employment and should act as a further impetus for government incentives.
Government should incentivise that which benefits the economy and taxpayers, rather than pouring money into a bottomless pit that sits behind offshore debt and equity holders.
Secured Creditors – There will need to be some compromise from secured creditors. They, along with the staff, hold the balance of power, but if they cannot come to a fair deal that allows new money to enter they will find themselves in a suboptimal position.
A compromised debt structure in light of an altered business model is critical for new investment.
New Investment (Private Equity and or Existing Debt/Equity Holders)
New Investment – new funds will be bestowed if a “sweet spot” can be reached between staff, Government, key infrastructure suppliers and debtholders. No new owners want to pay for sins of the past.
New ownership and new money will only come if a fair equity return can be made in light of a reshaped business.
To a certain degree, each stakeholder group can “blow it up” and ensure everyone loses. To avoid this, they all must “hold hands” together to make it work.
Advisers will bring the groups together, articulate and quantify the benefits of the right deals going forward and make them happen.
Imagine: A reshaped and right-sized Virgin Australia, with the best fleet, best staff, correct debt level and correct level of government support incentivising the right outcomes for the economy.
Qantas should be watching closely and making sure the capital they raise doesn’t fatten them and make them less competitive while they sleep… especially when their major competitor is in the gym.