News: Dealers make a meal of joining forces
 

Dealers make a meal of joining forces
Feb 16
Jane Boyle

The courtship between Tesna and Virgin Blue began over a dinner in early December. At the table were Solomon Lew; Alastair Walton, the head of investment banking at Virgin Blue's adviser Goldman Sachs; and a mutual friend, Liberal powerbroker Michael Kroger.

Lindsay Fox and Solomon Lew's Tesna had been anointed the preferred buyer of Ansett, while Goldman Sachs was sounding out potential investors to take a stake in Virgin Blue to fund its expansion plans.

In the preceding eight months two Australian airlines - Impulse, then Ansett - had collapsed in a brutal four-way battle for market share against Virgin and Qantas.

With Ansett's relaunch threatening to spark a new air-fare war, the three men decided over dinner it would be smart to look at ways to join forces.

There was sporadic contact between the parties during December and January. Fox, a former director of Continental Airlines, approached Virgin Blue deputy chief executive Rob Sherrard - who was known to him through Melbourne aviation circles - for a coffee and there were a few telephone conversations between the parties.

The discussions between the airlines became public when Fox, Lew and United States partner David Bonderman had a meeting with Richard Branson at his London home last weekend.

Fox and Lew warned Branson that a relaunched Ansett would severely damage Virgin Blue and asked what it would take for him to sell or go away.

Branson argued that Virgin had successfully competed against Impulse, a larger Ansett and Qantas, so why should he fear Tesna's slimmed-down Ansett?

But he was sufficiently interested to continue talks.

Over the past week, talks between Virgin Blue chief executive Brett Godfrey, Sherrard and a team from Tesna have continued in Sydney, with Fox and Lew dialling in between meetings with Ansett's administrators and nervous unions.

Key to the talks is what a return to a two-airline market is worth to the respective valuations of the airlines, and who has most to lose in a three-way battle that most airline analysts believe would result in one of the two airlines collapsing or a merger anyway.

Fox and Lew claim Tesna's advantages are a $400million war-chest, control of Ansett's terminal facilities - in particular the $250 million-plus Sydney terminal - and a 25 per cent lower cost base than that of Qantas.

They believe their bargaining strength is the pressure for cash Branson faces from his other global businesses, and his presumed unwillingness to pour additional funds into Virgin Blue.

But Virgin claims it has the financial wherewithal to withstand another discounting war.

It is now a net creditor to Branson's Virgin Group. In October it paid a dividend of more than $15million back to the Virgin group to fund a new telecommunications venture in the US. The dividend compared with the $11million in start-up costs it had written off earlier in the year.

Branson's cash pressures from Virgin Atlantic - which was highly exposed to the drop-off in the US market after the September 11 attacks - are said to have abated. Five months after Branson "ripped up" a $250 million cheque from Ansett's parent, Air New Zealand, for Virgin Blue, the discount carrier claims to have about $85million in cash and draw-down facilities.

Since Ansett's collapse its financial position has strengthened and it is targeting a profit of $32million to $35million for the year to March.

Tesna is paying Ansett's administrators $270million for the airline's assets and has committed to provide $400million.

Where Tesna's money is coming from remains unclear. Fox and Lew claim they will retain a controlling stake and invest what it takes, with their US backers Bonderman and Bill Franke investing a sum commensurate with a 35 to 49 per cent share of Tesna.

Fox and Lew have repeatedly vowed they will complete the Ansett purchase regardless of the outcome of talks with Virgin, but some of Ansett's suppliers have begun to question the commitment of Bonderman and Franke.

Each of Australia's four major banks claims not to be involved in Tesna's funding. The Victorian Government is said to have agreed to a hefty support package but has denied reports of a $90million incentive deal.

The two parties are exploring options ranging from a full merger to sharing of costs or aligning their networks, but there are some major sticking points.

Fox and Lew want control. For them, the jewel in the Ansett deal is its terminals. They are also attached to the idea of taking on Qantas in the full service market, creating opportunities to add value to the terminal facilities such as converting them to international Star Alliance terminals.

Virgin Blue also wants control. Godfrey believes his low-cost, single-class product is a winning formula.

It is believed Virgin's preference would be to take over Ansett's terminals and take on some of its staff, and ramp up Virgin's operations.

Tesna has budgeted to lose $120million in the first year of operation, near break-even in the second year and turn a $50million profit in the third year. If it goes it alone it faces a major battle. To justify its full service cost base it must prise back the premium corporate market from Qantas, a task that proved impossible for the old Ansett.

Most corporations are not bound by long-term contracts to Qantas and Tesna believes it can woo them with its yet-to-be-revealed frequent flyer program and top service and on-time reliability.

But Qantas, which has announced a $50million upgrade of its lounge facilities, pitched at the premium market, will match any frequent flyer initiative, and its much larger fleet gives it a major advantage in providing the network breadth and frequency crucial to business travellers.

How Ansett, with initially just 16 jets to operate between 11 ports, will match that is unclear.

Tesna's other claimed advantage is costs. It commissioned Airbus, supplier of the 29 new jets it is acquiring, to prepare a report comparing the old Ansett's cost base with world's best practice.

It has reviewed the old Ansett's deficiencies - such as a productivity rate in line maintenance of 4.5 to 5 person hours per flight hour compared with world's best practice of 1.5 person hours and addressed them in the enterprise bargaining agreements it has struck with key unions, as well as in outsourcing and supply deals.

Tesna got close to the three-year wage freeze it wanted, in return for offering staff 5 per cent of the airline. The only guaranteed distribution, of $4million to staff in the second year after a performance review, amounts to an average $1,333 for the 3,000 staff it says it will employ. A further review in the third year is also subject to performance.

Discussions between Tesna and Virgin will continue over the weekend.

Even if they do agree to join forces, any merger would require the approval of the Australian Competition and Consumer Commission.

The watchdog might not like such a deal, but if Ansett and Virgin slug it out in the market there's a strong chance that one will fall over, putting thousands more staff out of work and leaving Qantas once again with most of the market.