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Virgin Australia stake in Skywest supports long-term growth of regional and resource markets

Analysis

Virgin Australia's planned AUD8 million (USD8.3 million) investment for a 10% stake in regional carrier Skywest will allow it to further capitalise on the country's strongly performing regional and resource markets. Virgin and Skywest had previously announced a partnership and then alliance, which received draft approval in Mar-2012.

The stake follows a number of similar arrangements undertaken by airlines in deep partnerships with each other: Etihad in airberlin and then Air Seychelles as well as Air New Zealand in Virgin Australia (a move largely seen to preempt Etihad from taking a stake in Virgin). Such partnerships allow the investing airline to further gain financially from the airline it is benefitting with increased network access. Virgin ended 1H2012 with AUD851 million (USD879 million) cash balance, AUD506 million (USD523 million) unrestricted, making the Skywest stake a relatively small expenditure.

Resource-driven traffic is performing strongly – Qantas last week announced a new route from Sydney to Newman to target the sector – while the country's leisure and corporate traffic is softening.

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Virgin has slightly lagged competitor Qantas in financial investments in the country's regional and resource market, heavily concentrated on the west coast, although increasingly also in the northeastern part of the country. In addition to its wholly-owned subsidiaries serving regional markets, Qantas in Dec-2010 purchased fly-in-fly-out (FIFO) operator Network Aviation for AUD30 million (USD31 million). The following month in Jan-2011 Virgin announced its 10-year non-equity partnership with Skywest that facilitated Virgin's regional ATR operation that commenced in Oct-2011 on the east coast. Skywest operates the leased aircraft under Virgin branding.

FIFO and resource operators tend to be light on capital, either leasing aircraft or purchasing outright relatively inexpensive small aircraft like the F100 (with prices in the very low millions). The value carriers like Qantas and Virgin see in regional operators are their existing contracts, contacts and operations. The regional operators have been more entrenched and for longer in the resource sector than the country's airline operators.

An increasing consideration for regional operators is their customer proposition. As the resource market becomes more crowded and skilled labour becomes in higher demand – witness the increasing flights from Australia's east coast to mining sites on the west – there is growing demand for frills and perks. Qantas and Virgin can better cater to this with lounges, frequent flyer programmes and expertise. A financial stake, in Virgin's case, or purchase, in Qantas' case, give the carriers a resource presence without building brand new operations.

This model has been the hallmark of Virgin Australia, which has formed partnerships with Delta Air Lines, Air New Zealand, Etihad Airways and Singapore Airlines (the latter two under CEO John Borghetti and the former two under previous CEO and founder Brett Godfrey), significantly boosting its virtual network.

Virgin's stake in Skywest also quells considerations Virgin may move its ATR operation from Skywest to its own control. The Skywest partnership allowed Virgin to relatively quickly introduce a regional network, launching it in nine months. Like at Qantas, Virgin's regional network is the quiet achiever. The initial Skywest-Virgin deal in Jan-2011 promised an operation of "up to" 18 aircraft. Virgin in Feb-2012 accelerated its regional network expansion, with plans to end FY2013 with 12, instead of eight, aircraft. The target of 18 aircraft can easily be reached before the partnership nears its fifth anniversary.

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