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01-July-2020: AFR: Virgin Australia handed over to Bain
by Lucas Baird, AFR Reporter.
US private equity giant Bain Capital has formally taken control of Virgin Australia and started paying the distressed airline's bills, as of Wednesday, with concerns growing among trade unions that the new owner may renege on some of its promises to workers.
Neither Bain Capital nor Virgin would comment when contacted by The Australian Financial Review, although conversations between the pair are continuing over precisely what the relaunched operation looks like.
And - as predictions circle about Bain Capital cutting up to 5000 staff - Transport Workers' Union national secretary Michael Kaine feared the buyer could institute a "cut-throat regime".
"This sale will have a profound impact on thousands of committed Virgin workers and the travelling public," he said.
"We need right-minded people at the helm who care about shaping the future of the airline, rather than implementing a cut-throat regime."
Worries among the trade unions, which are representing Virgin's 9000 staff during the voluntary administration procedure, are growing that Bain Capital may not adhere to promises issued to the workforce.
"Bain made important workforce commitments prior to its announcement as recommended bidder, and these must be honoured," Mr Kaine said.
One union source felt Bain and its representatives were softening them up to renege on some of its commitments by saying the situation at Virgin was significantly worse than initially believed.
There are additional concerns among the group because of the involvement of ex-Jetstar boss Jayne Hrdlicka, who is likely to take a leadership role at Virgin 2.0.
The union source felt Ms Hrdlicka would likely approach the bargaining table in a disingenuous and narrow-minded manner due to her history at Qantas, which has a history of bad blood with unions and infamously grounded the airline and locked out workers during a 2011 industrial dispute.
Ms Hrdlicka, who is also a former Bain & Company consultant, also did not attend meetings with the unions - at their request - in the week before Bain Capital lodged its final offer for Virgin with the airline's administrator, Deloitte.
Meanwhile, discussions continue between Bain Capital and Virgin Australia's management team about the new-look airline.
The fleet will likely be simplified to focus purely on the single-aisle Boeing 737 jets, while the number of operational aircraft is expected to be halved to around 70 planes.
Bain Capital has issued its support for current chief executive Paul Scurrah and his team, meaning they are likely to keep their jobs.
The Virgin Australia branding is also expected to remain, as the Virgin Group looks to take an equity stake in the relaunched airline.
Virgin Australia first entered voluntary administration in April, with the COVID-19 pandemic proving a step too far for the heavily geared company.
The airline appointed Deloitte as its administrator, which on Tuesday warned shareholders – including the five foreign carriers invested in Virgin - would see nothing from the sale.
Etihad Airways, which has held a stake of more than 20 per cent in Virgin since 2015, said it remained committed to the Australian market even though its investment would be wiped out.
"Etihad was not in a position to infuse further funds into Virgin Australia or participate in the bidding process under voluntary administration," an Etihad spokesman said.
"We are pleased that Bain Capital has been confirmed as the successful bidder, securing the future for Virgin Australia and its employees.
"Etihad remains committed to its commercial co-operation with Virgin Australia ... Australia remains an important market for Etihad. As a long-term partner of Virgin Australia, we will continue to pursue opportunities to create value for our joint customers."
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Lucas Baird is a journalist based in The Australian Financial Review's Sydney office.
Further Reading: 30-June-2020: Declaration by VAH Voluntary Administrators about Shares
Bear77 comments: This was one of the outcomes I warned about - PE (Private Equity) taking over the airline and Virgin Australia becoming a private company until such time as PE decided to refloat it - with new shareholders - which would likely be a couple of years away based on past experience (2 to 4 years). In that scenario I suggested that shareholders would likely get nothing, and that is indeed the case here.
I am however surprised that the major shareholders like Etihad, Singapore Airlines and the two major Chinese shareholder groups, did not fight harder for an outcome that would have seen them retain some value from their investment in Virgin Australia. Those four major shareholders each held around 20% of VAH and 20% of VAH was worth around $145 million based on their last traded price of 8.6 cps, and was worth twice that much one year ago. Admittedly, the last traded price of VAH is still going to be a lot higher than the company's actual realistic value now that they've hit the wall, but I'm still surprised to see those 4 shareholders relinquish their entire VAH shareholding without much of a whimper, let alone a decent fight. Perhaps the amount of new money required to be poured in to enable each of them to retain some ownership was just a price that was deemed too high to pay. Perhaps they never really had a choice. They would have to have acted together, or not at all, so one or two that were not prepared to tip in fresh money may have scuppered any plans the others may have had. All supposition and conjecture now of course.
I guess the lesson is that large major shareholders are no match for a badly run airline that runs into a perfect storm. Anybody can lose money when a company turns pear-shaped. And the end, when it comes, can occur fast, with little warning, and no opportunity at all to jump off the sinking ship.
In reality, VAH were bleeding for a while. This didn't come out of the blue really, as the VAH 12-month share price chart clearly shows. However, the trading halt, which led into the trading suspension that they never emerged from would still have caught most of their shareholders by surprise. It probably shouldn't have, but it probably did.
Further, Further Reading: [Virgin corporate bond holders get screwed also]
by Aleks Vickovich, AFR Wealth editor
Any rational investor will have felt a pang of insecurity at some point in the months of wild market volatility that have accompanied the coronavirus pandemic.
But spare a thought for the unsecured Virgin Australia bondholders.
Last November, just weeks before the virus first came to the World Health Organisation's attention, the ASX-listed airline kicked off a $325 million debt raising, tapping the market to help cover the costs of its dream to buy back its own frequent flyer program.
The unsubordinated notes were picked up by about 30 serious institutional investors, including a hedge fund backed by Singapore's sovereign wealth fund and $8 billion local bond specialist FIIG Securities.
But the offer also enticed thousands of individual "mum and dad" investors, who lobbed in a minimum of $5000 each for a parcel of 50 notes then worth $100 a pop. This was a rare opportunity to buy direct corporate bonds, usually an investment reserved for the big end of town.
A prospectus adorned with pearly-toothed air hostesses promised "guaranteed" returns of 8 per cent per annum, with multiple references to the airline's "obligation to repay" thrown in for good measure.
Flash forward to July 2020 and those bondholders are out of pocket to the collective tune of $2 billion. Under the weight of the global shutdown, the notes fell in value to around $38 before being suspended and Virgin Australia going into administration.
Adding salt to the wounds, efforts by the bondholders to block the sale of the company to US-based Bain Capital and a last-minute proposal to convert the owed debt to equity were rejected by the administrator, professional services giant Deloitte.
Bondholders now risk losing even more money as they weigh a legal challenge to that decision, unwilling to give up hope on the returns they were promised.
And all this from investing in corporate bonds — an asset class traditionally positioned as being less risky than shares.
A sad story
For Paul Heath, chief executive of private wealth firm Koda Capital, there is a moral to the sad story.
“Watching the Virgin saga, my thought was 'what are these people doing there?',” he tells Smart Investor Weekend. “I would question the wisdom of the advice they were provided.”
In his view, most individual investors have no business holding direct corporate bonds, not even at the more sophisticated end of the spectrum.
“The challenge is that it is very, very hard for a private investor to get an appropriate spread of bonds to adequately mitigate risk if they’re investing in bonds directly,” Heath says.
“You’re only ever going to get 8 per cent, so if you have one of [the investments] go to zero, you have to get a lot out of the rest of the portfolio. A fund manager that offers proper diversification is a much better pathway.”
In order to achieve the requisite diversification, a professional investment manager might include hundreds of bonds in a fund, he adds – something that even the wealthiest individual investor would struggle to achieve given the minimum investments ordinarily associated with corporate bonds.
Heath, a former boss of National Australia Bank's JBWere advisory firm, suspects at least some of the bondholders were victims of poor financial advice, motivated by the commercial objectives of the stockbroking firms who provided it.
He points to the disclosure in the Virgin notes' prospectus that some "syndicate brokers" were paid a "selling fee" of 1.0 per cent of their total client allocation to the offer.
“Wherever the adviser is receiving a fee provided by the product manufacturer, you need to question the impartiality of the advice they’re getting,” he warns.
The federal government recently outlawed selling fees paid to brokers and advisers recommending clients participate in initial public offerings (IPOs) for listed investment companies and trusts (LICs and LITs). The ban followed a series of reports by The Australian Financial Review revealing the corporate regulator was concerned the payments were leading to poor advice. Heath would like to see it potentially extended to other types of investments.
On top of concerns about the conflicted remuneration, he suggests stockbrokers may not have the "in-house capability to properly assess the risk and pricing of bonds", given many specialise in equities.
Black swan event
But Judith Fox, CEO of the Stockbrokers and Financial Advisers Association, says investors can expect quality advice to be provided by her members beyond matters relating to investing in the sharemarket.
“Many brokers have research for fixed interest, so any comment that they do not have the skill set is incorrect,” she says.
A former advocate for retail investors as head of the Australian Shareholders Association, Fox says the Virgin offer had some attractive elements.
The minimum investment was lower than those attached to other comparable deals and the 8 per cent yield was vastly more desirable than the 1 per cent return available to investors in government bonds in the current environment, she says.
“Brokers will have factored this into the risk/reward analysis.”
Crestone Wealth Management vice-chairman Clark Morgan, whose firm was among the co-managers of the Virgin debt raising and had a "limited number" of clients invested in the bonds, stands by the advice provided.
“No one could predict an unprecedented global pandemic that has taken thousands of lives, shaken world economies, and dramatically impacted the global airline and tourism sectors,” he says.
“Without a black swan event such as the COVID-19 coronavirus pandemic, the portfolio benefits and risk profile of corporate bonds are well understood.”
Crestone only advises wholesale clients, or those with more than $2.5 million in assets, not retail investors.
The firm's chief investment officer, Scott Haslem, agrees corporate bonds can form a valuable part of an investor's portfolio.
Like Heath, he stresses that investing in the vehicle must come as part of a diversified approach to portfolio construction. But that doesn't mean diversification can't be achieved by investing directly.
“It is entirely credible for investors to choose to select corporate bonds themselves,” he says.
While many investors would benefit from being in a professionally managed fund, he says “the benefit of holding corporate bonds is not vastly different whether you are holding them in a direct bondholding” or not.
And there are a number of benefits, Haslem says. Corporate bonds provide "risk and return characteristics" that are unique to that asset class, which means adding them into a portfolio should " help to provide better risk-adjusted returns".
They also offer an ability to generate income, especially compared with sovereign government bonds which can provide good protection to a portfolio but yields close to zero.
“In an environment where it’s difficult to get a real return, it can be advantageous to crawl a little bit up the credit curve and take a little bit of a higher yield for what is not a materially higher risk,” he says.
“Plus, if you can pick an attractively valued bond, you can get capital appreciation, the same way you would with equities.”
Security tree
For those who choose to directly invest in corporate bonds, the question then becomes how to spot value or, at least, how to avoid picking the next Virgin Australia.
Haslem says the same investigative process that an active equities investor might apply to stockpicking would be useful for selecting bonds.
“You are looking at balance sheet strength, return on investor capital, the security of the revenue stream and the sustainability of the company,” he explains.
However, while corporate bonds arguably have less risk attached, they have additional complexities that must be factored in.
For example, investors should scrutinise and understand the relevant "covenant" – the legal agreement setting out the terms of the deal between the bond issuer and bondholder – and the level of liquidity, which is likely a little lower than comparable shares.
As well as diversifying across sectors of the economy (as you should with investing in shares), you should also ensure a diversity of maturity dates – or the timeline over which the principal value of a bond is to be paid in full by the issuer. The Virgin bonds, for example, had a five-year term.
Further, bondholders should be aware of where they sit in the "security tree" under the terms of the covenant, Haslem says.
If something goes wrong – like if a global pandemic emerges, grounding all the planes and threatening a company's livelihood – he explains the security tree is usually structured as follows: “Equity is the first in the capital structure to lose out; then corporate bonds, which are generally senior unsecured; and then you start working into senior secured credit, loans and secured lending.”
Equity shareholders in Virgin, for example, have been told they will receive nothing from the proceeds of the sale of the airline, while bondholders still have a slim chance of receiving some kind of return, albeit likely a far cry from the one touted in the prospectus.
Level of security
Chris Chase, head of private credit at boutique fund manager 360 Capital, agrees it is imperative for investors to understand the capital structure and what priority has been assigned to different classes of creditors.
But just knowing where you stand is not enough. Some investors may want to ask whether the corporate bond vehicle is actually giving them the level of security they need, he says.
“It's difficult to see retail investors be exposed to capital losses, particularly on a well-known institutional name like Virgin,” says Chase. “However it does emphasise the risks associated with being an unsecured lender.”
Unsurprisingly, given his team launched a private credit income fund in May, Chase believes the answer for safety-conscious investors may lie in unlisted company debt, which can offer more security than its fixed income peers, he says.
Wealth manager Hamish Foletta of Sarto Advisory, however, says it is precisely the listed nature of bonds issued by corporates like Virgin that can make them attractive in the first place.
The ease of access and transparency benefits of being listed on a public exchange are sought after by clients, he says, which is why hybrids and corporate bond exchange-traded funds have experienced strong growth.
Though these newer investment products have been a "positive development" in democratising access to bonds, Foletta wants to see more big listed companies issue debt to regular investors, while acknowledging that Virgin has perhaps not been the best ambassador for the model.
“It would seem a shame if the Virgin story slows the growth of these kind of investment opportunities,” he says.
Like Crestone's Haslem, Foletta stresses that investors will need to be educated about the specifics of corporate bonds, especially if they opt to invest in them directly.
Amid the unprecedented market volatility, that investor education has taken on paramount importance.
“It's always difficult to forecast short- and medium-term outlooks for markets and at the moment it’s even more difficult than usual,” he says.
“All you can do is have a sensible asset allocation that is well thought out according to your personal circumstances. And corporate bonds should be part of it.”
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With reporting by Lucas Baird.
Aleks Vickovich is the AFR wealth editor. He writes about financial advice, superannuation, investment and regulation from the Financial Review's Sydney newsroom.
28-Apr-2020: https://www.afr.com/street-talk/deloitte-to-tap-big-investment-bank-for-virgin-australia-sale-20200428-p54ntx
Deloitte is calling in back-up as it seeks to sell Virgin Australia.
It is understood Virgin's administrator is seeking to appoint Morgan Stanley to run the airline's sale in conjunction with existing adviser Houlihan Lokey.
Morgan Stanley knows Virgin well. Its bankers spent the past month working with the airline's board and management as it set about finding its own rescue package, before Virgin's board handed the baton to Deloitte.
Morgan Stanley was also the bank that stitched up Arrium's sale from administration in 2016.
It is understood Deloitte has spoken to a small handful of banks about the role since it was appointed last week. Morgan Stanley and UBS were the two banks that worked with Virgin Australia during the recent restructure deliberations.
It is said to be keen to finalise Morgan Stanley's appointment within the coming 24 hours.
Should Morgan Stanley sign the mandate, it would be expected to put a big team on the deal immediately.
Deloitte has already made a seven-point pitch to potential buyers and told them to expect a detailed information memorandum outlining Virgin and its financial position this week.
Deloitte said last week that about 10 suitors had already expressed interest in the business. The tyre-kickers are believed to include BGH Capital, Bain Capital, Brookfield, Indigo Partners and Oaktree Capital Management.
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Source: AFR (see link above) - story by Sarah Thompson, Anthony Macdonald and Tim Boyd [Apr 28, 2020 – 10.55am]
Straw #1 (of 2) 26-Apr-2020:
What's going to happen to VAH?
What are the implications for existing shareholders?
The short answer is "we don't know". However, keep in mind that they might NOT trade again.
I have held shares in companies that called in the administrators and most of them never trade again, even the ones that are successfully recapitalised. One of my recent experiences was a small holding in TFS, which turned into QIN (Quintis). They grew Sandalwood trees. They still do. However, at the time, they were the subject of a high-profile short seller attack, and they subsequently called in administrators, were successfully recapitalised, but shareholders were at the bottom of the pecking order, so they got nothing. QIN are now a private company, so are no longer ASX-listed. The whole thing dragged on for about 3 or 4 years, and they were only removed from my super fund holdings about 2 months ago. See: https://quintis.com.au/ and: https://thewest.com.au/business/from-glitz-to-pits-how-quintis-went-wrong-ng-b88722895z
Most Receivers and Administrators will allow companies to continue to operate while they work through the accounts and the various options that might be available to recapitalise the company and return it to commercially successful operation (i.e. a company that can pay its bills as they fall due). That doesn't mean that they will necessarily recommence trading at some point. In the case of VAH, I think they have called in the Administrators nice and early, possibly in an attempt to try to encourage/force a government bailout.
A government bailout will NOT be forthcoming, because VAH is currently over 90% foreign owned - despite being listed on the ASX - with their major shareholders being Etihad Airways (20.94%), Singapore Airlines (20.09%), the China-based Nanshan Group (19.98%), the China-based HNA Group (19.82%), and Richard Branson's Corvina Holdings (10.42%). Corvina is ultimately owned and/or controlled by Branson's VGHL - Virgin Group Holdings Limited - as well as by other companies (Grenache, Gamay, Cougar, Plough, etc.) all controlled by Branson and his fellow VGHL executives and are all registered in the tax haven of the British Virgin Islands.
That lot account for 91.25% of the VAH shares on issue, and they're all 100% foreign-controlled companies. That just leaves a free float of 8.75% of TAH's shares - which is nowhere near enough to justify an Australian government bailout, or even a loan. Our government would effectively be loaning money to 2 large Chinese corporations (Nanshan and HNA) as well as to Singapore Airlines, Etihad Airlines and to Richard Branson's Corvina Holdings, a holding company registered in the British Virgin Islands (possibly the REAL reason for the "Virgin" name).
The reason that I think there's a better than even chance that VAH will likely trade again at some point is that those large major shareholders have too much to lose if they don't.
There are a number of both listed companies and unlisted groups (private equity firms) that would like to get hold of Virgin Australia's assets, at the right price. However, the big question is whether the big shareholders have got any rights beyond those that owning ordinary shares confers on them. If they haven't, it is entirely conceivable that Virgin Australia COULD be recapitalised via a private equity bailout that would leave shareholders with nothing. If that is indeed a possibility, then those shareholders who currently hold around 20% each of the company (Nanshan, HNA, Etihad and Singapore Airlines) - and 80% between the 4 of them - would look to find a viable alternative which would see them realise SOME value from their investment. That might mean that they have to tip in more money themselves - which might look a lot more appealing to them than the possibility of losing 100% of their investment in VAH.
Any way you look at it, if you already hold shares in VAH, it's bad; you are either going to get massively diluted by this recapitalisation, OR likely lose up to 100% if they don't recommence trading. If they get taken over by PE (private equity) they will likely never trade again, until such time as that PE mob want to put some lipstick on the pig and refloat the company (like they did with Dick Smith Holdings a couple of years after they bought it from WOW - Woolworths) to make some coin from their "investment". I see that PE scenario as less likely in this case because you've got 4 overseas companies that each hold around 20% of VAH, and together own 80% of VAH, and will want to salvage something from their collective investments, so would be unlikely to sit there passively and allow the PE scenario to play out without putting up a decent fight. This is what the Australian Government have been saying - you have some large overseas investors on the register - so get some money from them. I think that getting some more money from them is one of the more likely scenarios.
[continued in straw #2]
Straw #2 (of 2) 26-Apr-2020:
...continued from Straw #1...
How much longer this recapitalisation will keep Virgin Australia in the air for (after COVID-19), I have no idea. From all accounts, they have not been well run, they underestimated QAN as a competitor, and VAH management have made a lot of bad decisions over many years which has resulted in them making billions of dollars in losses. I don't see much evidence yet that they have a radically different business plan going forwards that's going to turn all of that around. Therefore, if I did own shares in VAH (and I don't), I would be selling them at my first opportunity, if I was to get that opportunity. That's not advice, that's just what I would do, and doesn't take into account anybody else's circumstances.
If VAH are taken over by PE or by a listed new owner, you know they are going to install new management and have a radically different business plan. They are likely to stick to the budget end and stop chasing business from businesses (no more business class). They will also likely stick to the high-traffic routes within Australia and New Zealand and reduce their services. That might mean they can sell some of their planes - if they no longer need as many, which could reduce their $5 billion of debt. Whatever happens, it will NOT be business as usual.
It's important to understand that VAH have NOT collapsed, like Ansett did. VAH will be recapitalised. They will continue to operate - in one form or another. They might get renamed, or rebranded. Their business model will get changed. However, the big question for people who own shares in them now is will they have new owners? If they get new owners, that's likely very bad news for existing shareholders, and there is always a possibility that they are recapitalised in such a way that secured creditors are looked after but that existing shareholders get very little to nothing. That could also result in them going private, meaning they never trade again - unless they are later re-floated (with new shareholders).
The best outcome for existing shareholders is probably either that the existing majority shareholders pour some more money in or/and VAH gain one or more new investors who are prepared to put in the billions required to make them commercially viable again. Both of those options result in significant dilution for existing retail shareholders, but both are preferable to some of the alternatives.
But - in terms of how long that all takes to play out, I would imagine months, not weeks, but I really can't help much more than that. We just don't know.
[Disclosure: I do NOT hold VAH shares]
Further Reading:
https://www.abc.net.au/news/2020-04-22/coronavirus-virgin-australia-airline-history/12165130
https://www.smartcompany.com.au/finance/economy/chinese-us-influence/
https://www.afr.com/street-talk/oaktree-capital-mulls-virgin-australia-take-off-20200421-p54ln5
Some excerpts from that last one:
Elephant in the Virgin Australia dataroom stumps hopefuls
Sarah Thompson, Anthony Macdonald and Tim Boyd Apr 21, 2020 – 9.35pm
Good luck to all the tyrekickers lining up at Virgin Australia.
No one party is in pole position to buy it and no one party has any firm idea about what it's worth.
Virgin Australia is the hardest company to value in corporate Australia.
The big elephant in Deloitte's data room is the company's ramp-up plans. What's the plan to get bums back on Virgin seats, what will it cost and when's it likely to be implemented?
No one can answer those three questions with any certainty – not now and not in eight weeks when Deloitte is likely to be calling for someone to put pen to paper on an acquisition.
The government-mandated travel restrictions mean Virgin barely has a business. It has a heap of contracted staff, planes, space in airports and the like, but next to no product to sell.
Sure, domestic travel is likely to come back first, but how quickly? And what about international travel?
It's a reason why Virgin spent the past few weeks lobbing proposal after proposal to the government. It's a terrible time to try to sell the airline.
Of course there are plenty of opportunistic tyrekickers lining up for a closer look.
BGH Capital, Oaktree Capital Management, Arizona's Indigo Partners are all genuinely interested. But it remains to be seen whether they will be able to both put a firm offer to Virgin and look their own investors in the eyes and tell them they've done the right thing. It's a fine line.
[click on link for more]