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.
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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