Stock swap: Delta, Virgin Atlantic, Air France/KLM making moves on each other

Delta Air Lines has a ton of cash these days thanks to record profits. In addition to buying back shares of its own stock it is also keen to buy up other airlines. That trend continues this week with the announcement of a 10% stake in Air France/KLM for $375mm euro (~$440mm), giving Delta a seat on the board and greater influence over its European partner. Delta’s investment will be matched by China Eastern – also a SkyTeam partner and also a Delta equity airline – bringing AFKL approximately 750mm euro in new capital.

AFKL will use some of that money to purchase a 31% stake in Virgin Atlantic from the Virgin Group. When the transaction closes Richard Branson’s company will no longer directly control the fate of the airline as it will hold only 20% of the shares. That deal is priced at 220mm GBP (~$290mm). AFKL could make the purchase with just the money Delta is providing and still have plenty left over to launch Joon or whatever else it wants to spend cash on. AFKL will have representation on the Virgin Atlantic board matching Delta’s despite holding a smaller ownership stake.

The ownership shift in the Atlantic market will also see a change in the way the marketing Joint Venture deals currently in place are structured. Today the four airlines (plus Alitalia) have two different JVs. One covers only Delta and Virgin Atlantic while the other covers the four SkyTeam member airlines while excluding Virgin Atlantic. The new plan is to consolidate to a single JV arrangement covering all five airlines. Or maybe only four if Alitalia is no longer a viable entity by the time it is finalized. If approved the JV would have the number one or two position at some of the largest hubs in Europe: London-Heathrow, Amsterdam, and Paris-CDG. It would be the largest JV across the Atlantic, both in routes and passenger capacity.

While not yet specifically announced the investments and realignment of the JV operations suggests that Virgin Atlantic is likely to seek membership in SkyTeam in the not-too-distant future. Both that and the JV shift make a ton of sense as the ownership structure adjusts.

Delta is not shy about taking an equity stake in partners and it has the free cash to do so. Just last week CEO Ed Bastian noted in the company’s earnings call that “[O]ur ability to drive value is much greater once you get inside the boardroom than it is through a pure contract in terms of aligning ownership and driving value in a consistent manner and being able to invest truly for the long-term together. We’ve seen that in Aeromexico, which drove the higher-level investment. We’ve seen that in GOL. We’ve seen that in Virgin Atlantic, certainly.” That comment was in response to a query about the Korean Air JV, not Air France/KLM, but the same reasoning applies.

As for Virgin Group, this is the second airline Richard Branson has lost control of in recent years. With Virgin America the brand will die completely as it is subsumed into Alaska Airlines. The Virgin Atlantic brand does not appear set for a similar fate, at least not yet. For his part, Branson is quoted in the Independent saying, “This is a fantastic opportunity to extend our network and create a stronger customer champion, as well as being extremely beneficial to our people and the Virgin Atlantic brand that our customers love dearly.” No doubt the network improvement options exist. It is less clear how the move further props up the brand.

Delta’s JV and equity positions are substantial according to the company:

The Atlanta-based airline’s existing joint venture with Air France-KLM dates to 2009, with the addition of Alitalia in 2010. In 2012 Delta launched a joint venture with Virgin Australia followed in 2013 by both a 49 percent investment in, and joint venture with, Virgin Atlantic. In 2015, Delta entered into an enhanced marketing arrangement with, and acquired a 3.5 percent stake in, its SkyTeam partner China Eastern. In 2017, Delta launched its joint cooperation agreement with Aeromexico and increased its equity stake in the carrier to 49 percent. Also in 2017, Delta announced a joint venture with Korean Air Lines. Delta also holds a 9.5 percent equity interest in Brazil-based airline GOL.

There is also a certain amount of irony in the timing of this cash and ownership shuffle. Earlier this week Delta issued a “story” mocking Etihad’s losses that come in large part from investments in Alitalia and Air Berlin.

For AFKL the deal also brings stronger ties to China, thanks to the China Eastern investment. Per CEO Jean-Marc Janaillac, “With China Eastern, we are consolidating our position on a high-growth market. The commitment and efforts of Air France-KLM staff have enabled an improvement in our performance and the securing of these strategic partnerships. These agreements accelerate the value-creation initiatives deployed through the Trust Together project.”

The new investments in AFKL must be approved by shareholders in a special meeting on 4 September 2017. The investment by AFKL in Virgin Atlantic is expected to receive regulatory approval and close in 2018. The JV adjustments and any potential SkyTeam move would come after that.