By Michael Garry and Taylor Moore
On 20 April 2020 Virgin Australia’s board placed the company into voluntary administration, handing over control to an administrator. Various commentary is reporting the company had no choice but to enter administration after its requests for financial assistance from the Federal Government were repeatedly rejected. While market factors may have indicated that Virgin Australia was simply collapsing, the entry into voluntary administration may well have given the company a strategic opportunity to force debt providers to the negotiation table, leverage the known downside risk and recapitalise a historically underperforming and heavily debt-laden business.
Virgin entered the Covid-19 pandemic heavily debt-laden. An initial review of the airline by administrators Deloitte revealed it owed $6.8 billion to 10,000 creditors. Virgin owes 26 secured lenders $2.28 billion, unsecured bondholders approximately $2 billion, a thousand trade creditors $166.7 million, unsecured aircraft lessors $1.89 billion and 81 landlords $71.2 million. The company also owes employees $451 million. This was against a market cap (based on its last trading prior to going into trading halt) of a touch over $725 million. The weight of this debt was unmanageable for an airline in the Covid-19 world of closed borders, grounded aircraft and heavily reduced cash flows. It may be counter-intuitive, but this unique set of circumstances dealt Virgin’s Board with an opportunity to use voluntary administration to their advantage.
The bondholders’ weak hand
Holders of Virgin’s unsecured bonds are the largest creditor group by number and second-largest by value. More than 5,000 individual bondholders hold debt with a face value of approximately $1.99 billion. These bonds include US-listed institutional bonds and Virgin’s ASX-listed notes (the later held mostly by retail and high net worth investors in Australia). S&P reduced its credit rating of these bonds after administrators announced they would make no further payments to creditors. S&P last applied a recovery rating of 5 – indicating a recovery as low as 10 cents in the dollar.
Under voluntary administration, the way in which a company is to move forward must be approved by a majority of creditors by value and number. Given the group’s size, the bondholders hold a good deal of power in the creditor’s vote. However, as their debt is unsecured they remain standing at the back of the queue if the company is forced into liquidation. Nomura credit analysts estimate holders may be lucky to recover 10 cents in the dollar for Virgin’s bonds if liquidation were to eventuate. The holders of these bonds will desperately want to avoid liquidation and this places them in a weak bargaining position.
Virgin’s administrator is in a strong position to leverage the significant downside risk held by bondholders in refinancing negotiations. It is likely they will force their hand in taking a substantial reduction in the overall value of their debt to help keep the company out of liquidation.
The secured lenders’ jeopardised position
Virgin’s secured lenders are the largest creditor group by value. Usually, secured creditors hold a strong position in the administration process as they can simply seize their security and sell it to recover the debts they are owed. However, the unique circumstances imposed by Covid-19 have placed the secured lenders at the negotiating table with a relatively weak hand.
The majority of the lender’s security is held over Virgin’s aircraft. Given the current market conditions in the aviation industry, there is unlikely to be a strong market to dispose of these aircraft. Planes sit grounded in airports around the world as borders remain closed for the foreseeable future. The majority of Virgin’s secured assets are therefore currently worth their weight in scrap metal. The secured lenders will be reluctant to seek market value for these assets and as a result, this creditor group would also be keen to keep the company out of liquidation.
The unique position of Virgin’s equity holders
Approximately 90% of Virgin’s equity is concentrated in five owners including Etihad Airways, Singapore Airlines, Nanshan Group, HNA Group and Virgin Group. These equity investors would, in other circumstances, be in a unique position to help rescue the Virgin business and protect the investments they have made over the last decade. However, given their involvement in the global airline industry, they likely have much bigger financial concerns to address across their aviation empires. In addition, the existence of a concentrated ownership by five large and well capitalised foreign owners (including sovereign interests) made it much more politically difficult for the Australian Government to come to the table with a bail-out package.
The Company’s advantage?
Virgin Australia has traditionally underperformed expectations, only making a positive Net Profit After Tax in two of the last eleven financial years (to FY19), and accumulating approximately $2 billion in losses over that period.
Despite a lack of performance in what is a very difficult industry, the company’s Board and its administrators are well aware that the Federal and State Governments, debt providers, equity holders and other global stakeholders – including aircraft manufacturers and domestic airport owners, are all very keen to see Virgin Australia flights again take off across the Australian skies. There is too much to lose from Virgin’s collapse.
That makes this a unique voluntary administration. The conditions that pushed Virgin toward administration have at the same time caused their creditors and other stakeholders to come face to face with the material downside risk of a traditional security enforcement. Virgin’s administrators are in a strong position to leverage this risk in negotiations with creditors to refinance the heavily debt-laden company and emerge out of administration with a more sustainable balance sheet, potentially with headroom to enable Virgin to more effectively compete in the Australian aviation market.
There will be significant losers from the Virgin administration – faithful equity investors and debt providers will all feel the pain of a restructure, but they all know that if there is any chance of a meaningful recovery of their investments, a workout that gives Virgin a long term chance of recovery and prosperity may be essential. Given the industry expertise and deep pockets of some of its current equity owners (such as Emirates or Singapore’s Temasek – which controls Singapore Airlines), an opportunity to continue to do that out of the daily eye of the sharemarket may just suit Virgin management and the Board.
As the effects of Covid-19 continue to play out in the Australian and global economies, a number of Boards will be paying careful attention to the Virgin Australia strategic playbook. Whilst Virgin Australia’s set of circumstances is somewhat unique, there will certainly be lessons for Boards on how to leverage a bad situation into one that may give a chance for a restart and brighter future.