Loyalty programs are an essential element of an airline operation, particularly one facing a competitor such as Qantas with a very powerful and profitable rewards business of its own.
Moreover, Velocity has been the most profitable, and consistently profitable, part of the consistently unprofitable Virgin group, and one that provides stable earnings and a degree of diversification away from the inherently volatile airline’s financial performance.
One suspects that any exploration to completely sell out of Velocity and presumably continue a contractual relationship with the business would be a largely theoretical exercise.
The most obvious option would be to find an acceptable buyer, or buyers for the Affinity stake; ideally partners that could add value to the loyalty program.
A more serious evaluation would be given to whether Virgin could afford to acquire the Affinity holding itself and bring Velocity back into the group as a fully-owned subsidiary.
In Virgin’s current financial circumstances – barely profitable and with too much leverage for an airline – buying Affinity’s interest probably isn’t a realistic option either, although the prospect of getting full access to Velocity’s cash flows and potential would be appealing.
Given that Affinity appears to want out, the more realistic scenario for Virgin to explore would relate to whether it needs to own 65 per cent of the business, or whether it should cash out some of its equity without relinquishing control.
Would it matter, for instance, if it sold down from 65 per cent to 51 per cent? It would sacrifice some earnings but release a big lump of cash.
That could be useful if Scurrah wants to fund a major restructuring of the group to create a better base for an improvement in its poor financial performance.
It might also be useful if Virgin, 91.25 per cent owned by five strategic shareholders, wanted to privatise and/or help its most financially challenged shareholder, China’s HNA Group, off its register.
Helping HNA get out
The ballpark valuation of Velocity is around $1.5 billion. That places a $525 million or so price tag on Affinity’s stake and about $975 million on Virgin’s holding. A sell-down to 51 per cent would release about $210 million. Virgin’s history of heavy losses – about $2 billion over the past eight financial years – means any proceeds probably wouldn’t be taxed.
HNA, which has a 19.82 per cent shareholding in Virgin, has sold more than $US20 billion of assets as it unwinds a debt-funded buying binge of earlier years.
There have been attempts to help it off the register at prices around the current market price of 18 cents a share but HNA wants, or needs, to get back at least the 25 cents a share or so average price it paid when it outlaid about $US300 million to buy into Virgin in 2016.
To take both HNA and the 8.5 per cent free float out and privatise Virgin at around 30 cents a share (the price at which the group bought back shares last year) would cost about $720 million. HNA alone would cost more than $500 million and the non-strategic shareholders about $215 million.
Sharper focus on privatisation
A full buyout would probably only be doable if Virgin were prepared to sell out of Velocity or its other strategic shareholders – Singapore Airlines, Etihad Airways, China’s Nanshan Group and Richard Branson – were prepared to help fund it.
Virgin did consider a privatisation last year but ruled it out, a decision said to have been influenced by the strategic shareholders’ complex and deteriorating relationship with former chief executive John Borghetti.
The issue will remain on the agenda and may be given a sharper focus if Scurrah comes up with a compelling plan to lift Virgin’s nearly non-existent returns on capital.
A period out of the sunlight provided by a stock exchange listing and without the non-strategic shareholders while the group is being restructured, with plans for an eventual return to the ASX, might make it easier and simpler to reconstruct the group.
Scurrah has hit the ground running with the MAX 8 renegotiation and last week’s restructuring of his senior management team.
The optimum affordable structure for Velocity will be a critical early decision but, to lift returns and reduce the costs and capital intensity of a group whose costs are too high and which has been over-capitalised, he’s going to have to make a lot of critical early decisions.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.