Besieged Virgin Atlantic Weighs Its Options

Virgin Atlantic’s two shareholders are likely rigorously searching for new investors, as both the Virgin Group and Singapore Airlines appear to be willing to sell their interest in the beset British airline.

Virgin Atlantic hired Deutsche Bank as a consultant to advise it on options and to potentially moderate a sale to a strategic investor. That move comes after Chief Executive Steve Ridgway indicated last year that the airline sees growth potential by becoming “part of a bigger group.” A company official confirmed that the airline has subsequently received a number of inquiries into potential tie-ups. The Deutsche Bank review is expected to continue for several more months, the airline official pointed out.

The airline lost £132 million ($209.1 million) in its financial year ended Feb. 28, 2010. That compares to a £60-million profit in the previous period. While Virgin Atlantic has benefitted from the general economic upturn this year, its strategic questions remain unanswered.

Virgin Atlantic was set up in 1984 by billionaire Richard Branson using one leased Boeing 747-100 that flew between London Gatwick Airport and Newark (N.J.) Liberty International Airport. It has grown into an airline of 37 widebody aircraft, all the while intelligently playing with the marketing theme of being the underdog that has to deal with the overwhelming power of British Airways (BA). Virgin became an even more serious BA competitor when it gained access to London’s Heathrow Airport in the early 1990s. Along with American Airlines, United Airlines and BA, it was one of the four carriers allowed to serve transatlantic routes from Heathrow under the highly restrictive Bermuda II agreement.

While Virgin managed to become entrenched in its own market niche, the competitive dynamics in its field have fundamentally changed. The open skies agreement between the European Union and the U.S. has provided state-side competitors much broader access to the London market, particularly Heathrow; the lack of slots is the only major limiting factor. For Virgin, this situation was exacerbated by the approval of the British Airways/American Airlines transatlantic joint venture that Virgin Atlantic had fought for years. Thanks to the clearance, BA has become an even more powerful competitor with the full advantages of alliance integration.

Virgin Atlantic is not the only airline that has eschewed alliances. But the other most prominent examples—Etihad Airways, Qatar Airways and Emirates—are cash-rich, rapidly growing Middle Eastern carriers in control of their own home markets. Virgin Atlantic is the only one of the three London Heathrow-centered airlines (along with BA and BMI) that is neither part of a bigger group nor even of an alliance.

Singapore Airlines (SIA) bought a 49% stake in the London carrier in 2000 for $930 million as part of a broader plan to expand internationally. But there was never any significant move into deeper integration of networks or customer services, and observers believe synergies have been very limited. SIA, which has since changed tactics to focus on its core operations, indicated two years ago that it would be willing to sell Virgin Atlantic.

The big question, however, is: Who would buy it? There are hints that Delta Air Lines and one of the Middle Eastern carriers are potential investors.

Delta did not comment on the reports, but it is the only one of the big three U.S. carriers without a local partner in Heathrow now that the alliance between American and BA has reached regulatory approval. However, many industry watchers question what value Virgin Atlantic, a purely long-haul airline, would add. On the North Atlantic, Delta is well represented by its own fleet, and Asian routes into Heathrow are offered by Skyteam partners.

From Virgin Atlantic’s point of view, local feed for its long-haul flights at their destinations could justify joining an alliance, but that would force the airline to abandon its stance that alliances tend to be anti-competitive. And becoming part of Skyteam would do nothing to resolve the pending ownership issue.

Etihad is said to have considered Virgin Atlantic in 2008 as part of its broader strategic analysis, but industry sources say there have been no concrete talks. The Abu Dhabi-based airline had been looking for local feed in Europe—and Branson’s long-haul airline cannot deliver that. Emirates has always made clear that it is not going to buy other carriers in favor of focusing on its own organic and rapid growth.

Branson has been proposing a merger with BMI for years in order to combine the long-haul network with a short-haul feeder system. But when BMI was still an independent airline, then-owner Michael Bishop never warmed up to the idea. Lufthansa, which now controls BMI, is focusing on a slow, steady financial turnaround for its acquisition and has its hands full with other tasks, such as the integration of Austrian Airlines and Brussels Airlines. Industry observers say management is not prepared to deal with another huge integration and merger task at this time.

The biggest value of Virgin Atlantic could be its Heathrow slots. Lack of slots at this facility has become a bigger hurdle for market access than traffic rights. The airline says it holds around 3%, roughly the same slot allocation as American. BA, by comparison, controls 42%, and BMI 11%. Slots at Heathrow are extremely valuable—a pair at a good time of the day sold at around £30 million before the financial crisis took effect in late 2008. That would put the value of Virgin Atlantic’s portfolio at more than of $1.5 billion today.