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

Virgin America

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 /]

51 comments on “Virgin America Wants to Go Public, But Will People Buy It?

  1. 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.

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

    2. 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.

    3. Sanjeev – Those markets are tough ones to make work. Not only are they all other airline hubs (excluding St Louis), but they just aren’t huge high revenue markets. I’m sure that has to be on the roadmap (along with Hawai’i), but I just wonder if they can support Virgin America service.

    4. 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 dont understand how VX wants to enter high competitive, low yield cities, with low frequency and expect to steal premium traffic and outperform….

  2. 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.

    1. 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.

  3. Couldn’t agree more re the <a href=""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 out slots/gates at LAX/SFO and where to actually go with the planes. DAL has no growth potential either. It is really hard to figure what the business model is on this one.

  4. 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 of the equation could be a future merger or buyout. Lots of people love to invest hoping for such an event, even though that’s usually not a good reason to buy stock in a company. There are probably enough institutional investors who view the airline industry favorably to make the IPO work.

    1. 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.

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

  5. “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…

    1. Tory – I wish I had details but I don’t. I just know that they’ve been publicly talking about this. Doug Parker brought this up again at the GBTA conference this week in his talk. He said that that LAX will be their gateway. Seems ill-advised to me, but I guess we’ll now have the chance to find out.

      1. Cool. When you hear more details, I’m looking forward to the post. Maybe a VP over there would be willing to give you a briefing?…

        It will really be interesting to see how AA-LAX vs. UA-SFO vs. DL-SEA plays out…

      2. With Seattle and San Francisco “spoken for” what alternative does American have? Of course, the devil will be in the details.

        1. I don’t agree entirely with your SFO is “spoken for” statement. If that were the case then virgin america would not have launched in the first place. true, they’ve lost money and battle United, but they are there. if american were to buy virgin american then it could add int’l service and perhaps adopt some of virgin america standard of service and apply int’l and be an alternative to United, IMO. again, just saying it is possible.

          1. I think he was referring to SFO being “spoken for” as an Asian gateway, which it most certainly is for UA.

        2. DesertGhost – Who says you have to have a west coast gateway to Asia? American has already started building up DFW which is great for the southeast. There’s also opportunity in Chicago and other hubs. The cities that are big enough can have service that way.

          From the west, focus on feeding the JAL hub in Tokyo. Put 787s into all kinds of markets, starting with Phoenix. You have a joint venture partner over there so you have great feed opportunities. If a city is big enough then it can get a nonstop to the US. But otherwise, Tokyo should work. (Delta might have felt the same way if it didn’t have to feed itself in Tokyo.)

          1. I didn’t. That’s why I mentioned the option to do nothing in the P.S. I wrote. But I do like your thoughts on the subject. Makes a lot of sense.

          2. I don’t think it’s practical to route Asian traffic through Tokyo. Most of the US-Asia traffic is going to/from the large coastal cities like LA and SF. Why fly via Tokyo when you can fly direct on some other airline? If AA wants to make headway in Asia, they need a west coast gateway.

      3. I agree that LAX will be more difficult to establish as a west coast hub for AA given that there are 3 large competitors. I think SFO is more likely to be their hub in the long run because it would only be a 2 competitor race.

  6. 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.

      1. 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.

  7. 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 name – is really worth it. JetBlue, after all, created an excellent brand without needing the crutch provided by a third-party.

    Virgin America offers a nice, if increasingly expensive product, but it is at best a marginal business with limited potential absent some major shake-ups to its business strategy and, possibly, management.

  8. 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.

  9. 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.

    1. 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.

  10. 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.

  11. 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

  12. 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 I talk to that flies VX say once they fly VX, they don’t go back to their OA, especially with several AA frequent fliers. My observation, is VX needs better revenue management. Most of the pax that fly VX are willing to pay more, even if AA or OA are less, and I don’t think they have recognized the opportunity to increase revenue.

    I truly believe they have a huge niche and a very loyal customer base, that’s willing to pay a little more (even if OA is less!). Once their revenue management recognizes that, and takes advantage of it, they will be consistently profitable!

    1. 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 the others have, but with mood lighting. The flights I’ve had with them were certainly fine, but honestly, I have much more faith in traditional carriers for what happens when there are delays or cancellations as well, since more flights, more slots, more aircraft, and a larger network are all in their favor.

  13. 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 (the demonym name) along with K standing for the last name of Ra’s al-khaimah (or Julfar) of a staging post that was used during an Islamic invasion of sasanian Iran in 637 that happen during the battle of the Ridda Wars. I sure hate to be openly gay and travel there perhaps. but with that all aside would it be nice if VX had that kind of money that the UAE has at its disposal? well then u have Richard Branson but that airline has to pay him for the naming right of Virgin and its brand so that’s not much of a help there. but with them going public this could very well be a good thing perhaps or better yet a very bad thing as another airline that dose not have the virgin brand at hart as an opportunity to eliminate a competition and grow there own along by eliminating the brand if ownership of the airline has been upheld by an buyer to the most shares of the company. so who knows what could soon happen tho this airline as time goes on.

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

  14. 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 OZ BR almost as much as LAX. If AA T4 gets connected to the TBIT post security, it could work for them. AA really doesn’t have much alternative if they want to develop TPAC service from the West Coast. And LAX is certainly a better connecting hub than DFW for the western half of the country.

    1. Carl – There really is a geographical issue. Going from, say, Denver to Tokyo via LAX requires flying 3.5% more miles. That might not sound like a lot, but in this business, that makes a big difference.

      But the bigger issue is that LAX just has a ton more competition, especially from Asian carriers that aren’t as price-disciplined. I think about things like the China Southern A380 to Guangzhou, and the now more than daily Philippine flights to Manila. The double daily Air China flights to Beijing don’t help either, neither does the double daily A380 on Korean to Incheon. I could go on and one, but these airlines keep prices relatively low.

    2. 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?

      1. 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 of the company than new public investors. If the prospects were bright, they would want to retain their ownership, and capital would be put into the company.

        1. 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.

          1. 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.

            1. 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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