Virgin America Wants to Go Public, But Will People Buy It?

Since the dawn of time, or, uh, the dawn of Virgin America, the airline has planned to go public. There has always just been one little problem. Virgin America was losing tons and tons of money. But after 7 years of flying (one of them profitable), the airline has decided the time has come. Virgin America filed its S-1 with the Securities and Exchange Commission (SEC) indicating that an initial public offering (IPO) is on its way. Will anyone want to actually buy the stock?

Virgin America IPO Bet on Black

The great thing about an S-1 is that it provides all kinds of fun details, explaining why a stock will be a great investment. In this case, it tries to lay out the case for Virgin America. Ultimately, however, investors want to know if they are going to make money on a stock. And that means believing the story the company is telling.

Looking backwards, Virgin America has had a couple good quarters, posting its first full year profit last year. But that does not make for a solid track record. And the airline knows that. Take a look at this statement under the doom-and-gloom “Risk Factors” section, which is an entertaining read in any company’s filing.

We have a limited operating history and have only recorded one year of profit, and we may not sustain or increase profitability in the future.
We have a history of losses and only a limited operating history upon which you can evaluate our business and prospects. While we first recorded an annual profit in 2013, we cannot assure you that we will be able to sustain or increase profitability on a quarterly or an annual basis. In turn, this may cause the trading price of our common stock to decline and may materially adversely affect our business.

Yeah. That. But, Virgin America says, it has a sustainable business model that enables the airline “to compete effectively with other low-cost carriers, or LCCs, by generating higher revenue per available seat mile, or RASM, but at a cost per available seat mile, or CASM, comparable to that of other LCCs.”

Unless I’ve lost the ability to do basic math, if your costs are the same and your revenue is higher, then you shouldn’t be lagging in profitability compared to your competitors. Virgin America posted a 5.7 percent operating margin last year. For Virgin America, that’s stellar, but it lags every other LCC in the US.

You’ll notice I’m using operating margin and not net margin. There’s a reason for that, and it’s directly tied to how Virgin America wants to use this IPO money. See, Virgin America will use a big chunk of the proceeds (though we don’t know how much is being raised in total) to pay off the debt that has kept the airline flying over the years. That means the Virgin Group will get its $400 million back (in exchange for some other favors) and Cyrus Capital will get $250 million. The interest payments on that money comes outside of operating income, so while retiring the debt would help profitability, it wouldn’t help the underlying fundamentals of the airline’s business.

For what it’s worth, I don’t blame Cyrus Capital for wanting to get its money back. Virgin America has restructured its debt several times over the years (the biggest reason, along with lower fuel prices, why the airline actually posted a profit last year), but Cyrus has remained in the mix. Now the time has come, if Virgin America can convince potential investors to buy stock. But those investors know that there’s not much to see looking backwards. Let’s look forward to see if things are indeed looking rosy enough.

Virgin America has styled itself as a low cost, high revenue kind of airline, but as we’ve already seen, its costs aren’t low enough and its revenue isn’t high enough.

On the cost side, it says it has a low cost structure due to a young fleet, single fleet type, and high utilization. But looking forward, young fleets get older and more expensive to maintain. And unless there’s a big change in planned operations, that “high utilization” thing is a myth. Virgin America’s aircraft utilization has steadily dropped from 12.7 hours a day in 2010 to 10.8 hours a day in 2013. That’s not high utilization.

The airline will rely on growth to keep its costs down and to get more scale so that unit revenues increase as the airline becomes more capable of serving business travelers on a wider variety of routes. Virgin America has 53 airplanes today, but starting next July, the airline will take 10 new airplanes within 12 months. (That may very well be why Virgin America needs this IPO now, to pay for those suckers.)

The problem is, however, that Virgin America doesn’t have a ton of places to put these airplanes. Sure, there will be a little going to Dallas to grow the airline’s new Love Field operation. But Virgin America is capped at 2 gates and much of the flying is just being transferred from Dallas/Ft Worth. Most of the rest is being funded by cutting existing flights elsewhere, like Philadelphia. So that’s not really a growth thing.

Instead, Virgin America makes it clear in the S-1 that it expects future growth to happen in its hubs in both LA and San Francisco, but how? There are gate constraints in both places, and I’m not convinced there are a bunch more markets out there that need A320s in them anyway. In general, LA is about to become a bloodbath with American now seeming dead-set on building its Asian gateway there. San Francisco may be better, but how many routes can you think of that make sense? Most are probably other airline hubs, and that doesn’t usually work out so well.

Growth is one thing, but then you also have to look at prospects for the existing operation. Other airlines are ramping up on routes where Virgin America has done well. Most importantly, the JFK-LA and SF markets do really well for Virgin America, but it’s been an arms race to create the best product there. Virgin America now has the worst seat in the premium cabin on that route. Meanwhile, JetBlue is really ratcheting up pressure with its Mint business class offering. Regardless of whether it’s good for JetBlue, it can’t be good for Virgin America as fares are low. And there’s a chance that product will expand to other markets.

The only real saving grace here for Virgin America is if the economy continues to hum as it does today. The domestic market is really, really strong so fares are high. If you think this is going to continue like this for years, then that would bode well for Virgin America’s success. But look at the history of this industry and the good times don’t tend to last all that long. Maybe it’ll be different this time with all the consolidation that’s happened. And maybe the big airlines will get too greedy and create enough of a fare canopy to allow Virgin America to thrive. If enough people believe that, then this might be an interesting IPO.

[Virgin America aircraft photo via Chris Parypa Photography, Wesley Snipes photo via Featureflash, and Richard Branson photo via s_bukley / Shutterstock.com]

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51 Comments on "Virgin America Wants to Go Public, But Will People Buy It?"

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Guest

I will signal my great faith in this IPO by purchasing one share. :)

Nick Barnard
Member

I will signal my lack of faith in this IPO by shorting one share.

Sanjeev M
Guest

If they do SFO-IAH/ATL/DEN/SLC/STL/DTW then I think they suddenly become relevant for enough business travelers to switch over from UA or WN.

Grichard
Guest

Wow; thanks for thinking of STL! We’re so used to living in airline obscurity, it’s almost startling when somebody mentions us anymore…

southbay flier
Guest

SFO-ATL/DTW/SLC will be a war with DL and DL will beat them back. B6 couldn’t do SFO – SLC and it wasn’t for lack of trying. SFO-IAH/DEN is UA and I don’t know how equipped they would be to stop that. SFO-STL could work. Their F product is better than UA and it’s a long enough flight to enjoy sleeping in the seat or watch a movie on the seatback screens.

noahkimmel
Member
the challenge is how long and how much capital needs to be invested for that to happen? That’s a lot of markets which will require a few flights per day each. The ramp up will eat millions of dollars in marketing costs and low yield / low loads. VX doesn’t have a cash cow, and its a problem. B6 can fuel growth with carribbean / dominican flights with little or no competition, high yields, and quick ramp up. Alaska has the state all by itself. Spirit cherry picks routes and adds/drops as needed. Allegiant chooses airports with no competition. I… Read more »
Will
Guest

“How do you make a million dollars in the airline industry? You invest $100 million.”

David SF eastbay
Member

Maybe some of the tech billionaires in the bay area who fly in their private jets, will buy some stock so their workers can have a jazzier airline to fly on besides the old UA/DL/AA sisters of the sky.

Southeasterner
Guest

If only they were a tech stock and then they wouldn’t even have to worry about annoying things like earnings and profits.

The only benefit I could see to buying Virgin stock is the potential for a takeover by JetBlue, Alaska, or one of the majors, who would probably be more interested in their landing slots than operations.

Seth Miller
Guest
Couldn’t agree more re the <a href="http://blog.wandr.me/2014/07/virgin-america-ipo-filing-strength-weakness/"utilization and growth at SFO/LAX issues for Virgin America. There’s also the part where they claim to be targeting business travelers but don’t really know how to classify them (they chose tix bought inside 14 days) and even when they do pick that metric they’re only seeing 30% of seats and 40% of revenue from that pool. Those numbers significantly trail the bigger players in the market. Adding 10 planes in the next couple years will help them in terms of more options for more markets to serve, but they still need to figure… Read more »
DesertGhost
Guest
A few thoughts: Investment decisions will be about more than where Virgin America flies or its current operating margin. It will be about the perceived future. It will also depend on how the proceeds will affect the balance sheet (how much debt will be paid off), the initial offering price, the amount raised versus the enterprise (book) value of the company, etc. I think your point about airline consolidation and capacity discipline is spot on. The airline industry is viewed favorably on Wall Street now, especially given the stock buyback programs and dividends the major airlines are initiating. Another part… Read more »
IO
Member

DG – I agree on the “perceived future” comment. I think it is speculative investment which depends on the items you and CF mention. I think that short term the industry/domestic conditions are the main drivers while long-term is the potential for a merger or sell/buy of the airline. I ventrue to write that the partners in the latter may be either jetblue or american. jetblue due to similar fleet/west coast weakness (off the table if Jetblue joins with Alaska) and american to establish a dueling Asian hub, IMO.

DesertGhost
Guest

The overall market strength (despite today’s selloff) is also a factor. IPOs are easier when the stock market is strong.

Tory
Member

“LA is about to become a bloodbath with American now seeming dead-set on building its Asian gateway there”

Would love to see a post with more details on this American Asian gateway initiative…

Doug Swalen
Guest

Me too…

John
Guest

I’m not suggesting this is a reason to buy the stock, but the one thing Virgin America MIGHT have going for it is the really poor customer service of the legacy airlines. Compared to everyone else, Virgin America has a cooler, more high tech, customer friendly approach that may help keep the seats filled.

David M
Guest

And thus, Cranky’s comment from a couple years ago describing VX as “the airline everybody wants to fly and nobody wants to own”.

John
Guest

I want to live in a world where airlines that people want to fly do well economically…..just not enough to invest in Virgin America.

Henry Harteveldt
Member
The only thing that would make this a bigger joke would be if the Kardashians were involved. VX claims it wants to serve the business traveler, yet on most routes lacks the frequency to be a credible competitor. VX failed to develop its SFO home hub into a hub that could truly compete with UA. VX’s first class cabin is overkill for shorter flights – and consumes a huge amount of cabin real estate. VX must also pay a hefty licensing fee to Virgin Group for use of the Virgin name. I question whether that fee – and the Virgin… Read more »
southbay flier
Guest

If VX had any original route ideas out of SFO or LAX, they might be worth investing. However, they seem to want to serve the same routes that the legacies do without the frequency of the legacies. I would not put any money into this airline.

David M
Guest

That’s the problem with setting up your base at another airline’s hub: All the good routes are already served by the other airline.

Jason
Guest

Here’s to wishful thinking that CVG-LAX and CVG-SFO are on their radar. DL serves both routes with 737s and A320s. Those flights are always full and that’s with DL pricing those directs through the roof. If F9 can fill an A320 daily to DEN, I’m wondering why VX can’t make a go of either or both of LAX and SFO from CVG. A year ago, I would have suggested MCO and FLL as well, but G4 is already reaping the benefits of adding those routes.

SteveFromCVG
Member

CVG/lLAX and CVG/SFO would be a good fit. I’m tired of creaky and worn 737s and Airbus 320s DL flys on this route.

w5030222a
Member

i am wobndering why dont they collaborate with HW?
HW can focus on west coast and asia market while virgin group operate the domestic routes.

Simon
Guest

As a moderately frequent business and leisure traveler with SFO as my home airport, I tend not to fly VX despite the superior customer service because:

-VX charges change fees, WN doesn’t
-DL has a good ” economy plus legroom” offering with reasonable pricing / availability, VX doesn’t
– VX does not fly to the southeast (except FL which does not count)
– WN has the flight frequency to make same day minor airport west coast out-and-back work, VX does not

Spirit FF
Member
Please don’t forget, network carriers like AA/UA/DL, use places like LAX as a hub and reply more on connecting traffic than local traffic (which Virgin is after). For example, DFWLAX has AA, DL, UA, NK, VX, and WN. AA is more interested in feeding DFW and LAX hubs than local traffic, DL and UA, have limited flights to connect with their LAX Hub, WN (although they claim not to have hubs), will have a fair amount of connections at LAX and DAL, so VX and NK are the only two carriers specifically interested in ‘LOCAL’ traffic (O&D). In fact, everyone… Read more »
Jason H
Guest
Other carriers do have connecting traffic, but they still have a lot of local traffic at LAX as well, especially for LAX-JFK and other transcontinental routes. Also, much of the connecting traffic is to Asia or Hawaii, so carrying connecting passengers is a strength, not a weakness, for those carriers. I, for one wouldn’t pay extra to fly VX, especially since DL and AA have been greatly improving their transcontinental flights recently, and B6 has always been pretty good, although UA still sucks. When it was launched, the product was new and fancy, but now it’s pretty similar to what… Read more »
john
Guest

AA flies 736 PDEWS in LAXDFW which is more than all other carriers COMBINED.

john
Guest

AA flies 736 PDEWS in LAXDFW which is more than all other carriers COMBINED.

jskyz81
Member
you know what its just amazing to find an airline in the middle east that hubs its operations and has the largest fleet of A380s and wide body jets to serve in a hub city that is just 31,229 less than the Metropolitan Statistical Area of Cincinnati Ohio can do so amazingly well for just being a transfer airline only along with being a gateway to UAE. How ironic that the International Civil Aviation Organization (ICAO) code for the airline is UAE along with the International Air Transport Association (IATA) code being EK possibly meaning with E standing for Emirati… Read more »
Jason H
Guest

you know what its just amazing that I have absolutely no idea what you’re trying to say in your post.

Carl
Member
Although it’s apt to be a terrible investment, somehow these turkeys also seem to get enough buyers to get public. It’s telling that most of the funds are going to go pay out current investors, they don’t want to own it, either. Why is LAX such a worse TPAC hub for AA than SFO is for UA? It’s a few miles further out of the way than SFO but really not all that much further, especially as you got deeper into China. And LAX has far fewer inbound delays than does SFO. SFO has competition from airlines like CX SQ… Read more »
Sean S.
Guest

It’s telling that most of the funds are going to go pay out current investors, they don’t want to own it, either.

While I understand why people keep saying this, it also the damn silliest statement I’ve ever heard about an IPO. IPO’s are SUPPOSED to repay the original investors. That’s the point of the damn thing. Do you think Facebook investors invested simply to sit on their stocks in perpetuity?

Carl
Member
You misunderstand the purpose of most IPOs and of the stock market. While there aren’t any restrictions on the use of funds from an IPO, in most IPOs the capital that is raised in the IPO is used to fund growth of the business. In some cases a portion of the funds is used to cash out current investors. When the majority of the cash is used to cash out current investors that is generally considered a warning sign that the current investors do not have confidence in the company or the market. They are presumed to have better knowledge… Read more »
Sean S.
Guest

Nonsense. Investors cash out because that’s the point, especially for many early investors who have, by the point of an IPO, seen their initial investment grow appreciably. Yes, depending on the company the IPO may be to initially raise capital for the company to fuel growth, but the inevitable end game is always, at some likely in the near future, to cash out.

Carl
Member

No, that’s not the primary point of an IPO or of the capital markets. They facilitate a variety of transactions, in particular raising new capital for a company that needs it. If the existing investors want to cash out, they can simply sell the entire company. And existing investors can also sell their shares in the public markets after an IPO, potentially after a lockup period and after any SEC-required holding times.

The vast majority of IPOs are to sell new shares, not to cash out existing investors.

Nick Barnard
Member

Well, the paperwork that’ll be filed should make it clear what is happening. If VX is issuing new shares (or selling treasury shares) or if its just to allow the existing shareholders to sell out.

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[…] Francisco-based Virgin America finally goes public. Would you invest in Virgin or any other airline? […]

Kailash Mansarovar Yatra
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In some cases a portion of the funds is used to cash out current investors.

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