The airline industry is exceedingly competitive, and we compete against both legacy airlines and low-cost carriers; if we are not able to compete successfully in the domestic airline industry, our business will be materially adversely affected.
It is hard to run an airline in a profitable manner. This position is rarely disputed and yet every now and then another group gets the idea that they can do it better than the others and a new airline is born. That was Virgin America some years ago and earlier this week they outlined their plans to raise capital through a public stock offering. They also noted, in the line above and in many other sections of the filing, that the competition is fierce and that it will be challenging for them to compete successfully.
The S-1 they filed with the SEC includes, among other things, sections where the company lists its strengths and challenges. It is, essentially, a list of why Virgin America believes people should invest in the company and also why those investments might not be so wise. And it is rather entertaining how often they are talking about the same thing for both sides of the discussion.
San Francisco and Los Angeles are the keys to growth, but there are significant limitations to the growth potential at those airports.
Our future network plans include growing from our focus cities of Los Angeles and San Francisco to other major markets in North America. By continuing to add destinations in select markets from Los Angeles and San Francisco, we can leverage our existing base of loyal guests and grow our share of revenue within these focus cities while also expanding our customer base as we gain new guests in new markets.
While we expect most of our expansion in the next several years will focus on the opportunities we have at Los Angeles and San Francisco…
Most of our current flights operate from our two focus cities of Los Angeles and San Francisco. In 2013, passengers to and from Los Angeles International Airport (LAX) and to and from SFO accounted for 44.9% and 53.6% of our total passengers. We believe that concentrating our service offerings in this way allows us to maximize our investment in personnel, aircraft and ground facilities and to leverage sales and marketing efforts in those regions. As a result, we are highly dependent on the LAX and SFO markets. However, both LAX and SFO are high-traffic airports with limited excess facilities and capacity, which may restrict our growth at these two bases. If we are unable to increase flights in these and other key markets, or if any events cause a reduction in demand for air transportation in these key markets or if increases in competition cause us to reduce fares in these key markets, our business may be materially adversely affected.
Two markets represent 98.5% of the total passengers and they want to grow those markets, but they are going to be challenged in doing so because access to additional facilities at those airports is limited. Of course, access there isn’t as limited as at Dallas’s Love Field, another “hot” spot on Virgin America’s map:
Through the use of recently acquired slots at New York LaGuardia Airport (LGA) and Ronald Reagan Washington National Airport (DCA), we will add service at Dallas Love Field (DAL) to these markets in October 2014. We will also move our existing service at Dallas/Fort Worth International Airport (DFW) to DAL. DAL is located in a growing, affluent section of the Dallas/Fort Worth metropolitan area and is the closest airport to downtown Dallas. In addition, the airline facilities at DAL are limited by federal law to only 20 gates, providing a structural barrier to entry. We believe this opportunity to provide service at DAL will further diversify our route network and allow us to provide service to LGA and DCA.
How do they plan to diversify and grow when they’re limited to the number of flights they can operate at Love Field and there is no indication that any more slots will become available anytime soon?
On their target customer
How does Virgin America attract customers? It is about the brand as much as it is the product.
We capitalize on the strength of the Virgin brand to target guests who value an enhanced travel experience and association with the Virgin brand. The Virgin brand has helped us to establish ourselves as a premium airline in the domestic market in a short period of time. When we enter a new market, awareness of the Virgin brand generates interest from new guests.
We have differentiated our product in all three classes of service as compared to other domestic airlines, leading to a travel experience that can only be found on Virgin America.
And that’s good because they recognize the challenges they are facing with respect to the product, particularly in the highly competitive (and high yielding) premium transcon markets.
American Airlines, Delta Air Lines, United Airlines and JetBlue Airways are increasing the quality of their seating and on-board amenities in some of the routes where they compete with us, making it more challenging to attract passengers who are loyal to those airlines.
The good(ish) news is that the company is focused on business travelers. That defines the product they offer and the markets they serve.
We target the business community by providing a premium travel service between our focus cities and many of the most important business destinations in North America, as well as key leisure destinations that we believe are important to business travelers when flying for leisure travel.
But there’s the little problem of the network being too small and not offering enough connections to actually meet that demand.
Our smaller point-to-point route network and lack of connecting traffic and marketing alliances puts us at a competitive disadvantage to legacy carriers, particularly with respect to our appeal to higher-fare business travelers.
There’s also the part where they don’t necessarily know who the “business customers” are on board and where the number of them isn’t all that high.
We consider guests who book within 14 days of departure as business travelers. Using this as a measure, we believe that approximately 30% of our guests in 2013 were business travelers, representing approximately 40% of our revenue in 2013.
On growth patterns
New markets drive growth, right? And the YoY improvements in RASM in new markets is solid, more than double the growth rate of markets which existed previously. Or is it that the intro fares were way too low so as to be able to build traffic and the “growth” is just catching up to where they should have been in the first place??
Our RASM in markets that we entered in 2011 and 2012 increased from 2012 to 2013 by 20.5% as compared to our overall RASM increase of 9.3%.
By comparison, Delta increased RASM 2.5% from 2012 to 2013. American Airlines was up 6.26%, Southwest was up 2.15% and United was up 5.1% in the same period. Definitely solid growth numbers, but the percentages don’t always tell the whole tale.
Branding costs money
Branding always has costs. For Virgin America there is an additional cost beyond just the regular marketing expenses. They pay the Virgin Group for the rights to use the name.
In connection with the 2014 Recapitalization and the closing of this offering, we and certain entities affiliated with the Virgin Group intend to enter into amended and restated license agreements related to our use of the Virgin name and brand under the Airline License and the Credit Card License. The amended and restated license agreements would provide for, among other things:
- an extension of our right to use the Virgin name and brand until 25 years after the date of this offering;
- commencing in the first quarter of 2016, an increase in the annual license fee that we pay to the Virgin Group from 0.5% to 0.7% of our total revenue until our total annual revenue exceeds $4.5 billion, at which point our license fee would be 0.5%; and
- the right to appoint a director to our board of directors, but only to the extent the Virgin Group does not otherwise have a representative sitting on our board of directors.
There’s also the part where the Virgin group can revoke the branding rights if the airline screws up egregiously.
The Airline License may be terminated upon the occurrence of a number of specified events, including if we commit a material breach of our obligations under the agreement that is uncured for more than 10 business days or if we materially damage the brand.
A smart investment??
Airlines have rarely been a smart long-term investment. The past couple years have seen solid returns in the industry but there’s certainly no guarantee that those will continue. And Virgin America has done a pretty good job of explaining why it is going to be challenged to match the pace of the others. Even the positive bits of their plans don’t seem all that upbeat.
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Personally, I would love to see an LAX to DTW route from Virgin.
They should follow the Frontier tactic and focus on United as the weakest of the legacies. With their switch to revenue based earning United offers very little added advantage to the average business traveler, and definitely worse customer service. I can’t imagine Virgin on time performance is worse than United’s. Which United hubs don’t they have a presence at?
In theory VX is been attacking UA at SFO and LAX. And I’m sure there is some success in those efforts. But UA isn’t giving away the markets and VX doesn’t really seem to be growing their biz traveler numbers too much. What else could VX reasonably do to “attack” UA? They don’t have the network and they don’t have the planes to grow it. Even when they get more planes in 2015-16 (10 more coming online) what routes would they add to beat up UA?
Also, F9’s approach is mostly irregular schedules which are not at all targeted at business travelers. A 3x weekly service option isn’t going to grab high revenues.
Great analysis Seth! I almost can’t believe I came across a solidly intellectual post on my BoardingArea visit. 😉
I fly the LAX-SFO route often and VX seems to have a lock on the Internet industry biz traveller. Fares have been pretty aggressive (expensive) the past year. I think a good fashioned fare war from Southwest/United/AA could put VX in a bad position.
FWIW, your first quote from the S-1 filing is from the Risk Factors section which is always gloom and doom, and should be taken with a grain of salt.
Not sure I get the DAL move. If you want to go to war with WN and a nearby legacy carrier in Texas, why not HOU? Less constraints on service, and you can market your upscale product offering (front cabin, at least) to disillusioned UA flyers who want an airport closer to downtown Houston. With all the energy companies, it’s not like Houston traffic is low-yielding, either. Target key domestic and nearby international business/energy markets, and offer a product (or portion of a product) that neither UA or WN can/will compete with on those routes.
Given their constraint in terms of aircraft, DAL makes a lot of sense… apply for the gates, get the couple they could get, start flying, eventually up the number of flights from those few gates. Compete against WN who doesn’t offer a premium product/experience… yadda yadda.
I totally agree that HOU would also make sense, for the same reasons, but with the small number of planes they’re able to deploy, they have to pick and choose very carefully.
I do really think that trying to nibble away at a faltering UA is a pretty solid strategy for the next couple years.
But there is no room to expand. And WN has a MUCH larger presence at DAL. How can VX compete reasonably with so few flights and no access to future growth?
I think the question is “what is winning for VX at DAL?”
Obviously they’re never going to beat WN for flights, or any other volume metrics because of gate constraints. But given their lack of aircraft, they aren’t going to beat ANY airline, anywhere in that.
With the gates they do have at DAL, they can continue to add flights for a couple years, and run it as a focus city. No they’ll never get meaningful connecting traffic through there, but I’m betting there’s enough local business willing to pay a premium over WN for VX to have profitable flights coming out of there… which is all they want for the foreseeable future, right?
If they replicate this idea in a few other airports, they’ll have enough growth runway to take them to the next phase of growth.
To put it another way, if DAL is a bad idea for VX because of limited gates/slot pairs, isn’t LGA and DCA as well?
I’m curious what your opinion of their growth strategy should be, given the constraints they have. Just keep focusing on LAX and SFO? Or try to bring more of a critical mass of aircraft to a 3rd airport?
And I do mean this all respectfully – I think they are a VERY interesting case study – no other airline has really tried their strategy as a new entrant in the US… JetBlue is pretty much locked into being a 1 hub operator, and the others have all been LCC/ULCCs. I’ve never had the chance to fly VX, but I’m very curious about them!
On the same subject, I’m guessing their bases in LAX and SFO don’t really have a significant % of connecting traffic for them? Primarily O/D passengers?
A few interesting points, Better By Design, but I’m not so sure they’re all accurate.
With two gates they can reasonably run about 18 flights at DAL. They’ve announced five destinations for that service: LGA, DCA, ORD, LAX & SFO. At 3-4 flights each it will be hard to hit critical mass and compete for the business travel market against the much higher frequencies from the other carriers. They do it today in some markets (e.g. SFO/LAX-ORD) and they pick up some passengers but the yields aren’t spectacular on those last I checked.
I do completely agree that LGA and DCA are going to be challenging for VX to build a strong market in and grow there. Just like at DAL.
Regarding JetBlue, they have two major hubs on the east coast (JFK, BOS) and FLL is coming along nicely. They also have a significant presence in SJU (most flights now, I believe; more than AA) and are growing at MCO as well. They are slot restricted at LGB which limits their west coast growth but they have way more than jut one hub.
I do think that VX needs to find other markets to grow from, but they need to be markets where there is actually room to grow, with a real O/D demand and maybe even a bit of connecting traffic to help things along. And I do not think that their current route map looks good for that right now. Nor does their documented future plans.
Appreciate the correcting me on JetBlue – not being a heavy East Coast traveler, I’ll admit my ignorance of their growth & investments. The SJU point is pretty interesting, and I’m assuming will be a target of their new Mint product going forward.
How much more room does FLL have with the expansion to accommodate growth from WN, Spirit, JetBlue etc? That has got to be a great airport for low fares!
I take it that you are not going to be an investor in VX then?
Obviously, international from HOU would hav to wait for FIS… but it is coming
Wow. Some heavy thinking here. Makes “OMG, I can’t find Vanilla Reloads at CVS” postings by other bloggers look childish. Keep aiming high, Seth.
I write some pretty silly crap too some days. 😉
(Can’t reply inline; apparently already too deep)
I don’t expect to see Mint in SJU ever, really. It is a lower yielding market made up mostly of VFR traffic. Mint is only going to make sense on high-yield business routes. BOS transcons might see it but that’s about it. I would not be surprised to see A321s in the higher density all-core config flying to SJU at high season, but I don’t expect we’ll see Mint there.
FLL has a couple construction projects going on related to runways and FIS facilities. Once those are done JetBlue expects to be up over 100 daily flights pretty quickly. That’s a pretty sizable number for an operation their size.
As for being an investor, I’m almost certainly not putting in for an IPO allotment. Then again, I rarely invest directly in stocks, especially in the airline industry.
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