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There's nothing shy about this Virgin

By Shoeshine

Friday 21st February 2003

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Sir Richard Branson started the Virgin group in 1970 at age 20. He chose the name, he says, because he was new to business.

There's nothing shiny and new about him now and Virgin Blue's canny position-taking on the mooted Qantas-Air New Zealand alliance is a case in point.

Virgin contends the entire proposal is nothing more than an attempt by the partners to contain its growth in these parts. That has to be taken with a hefty pinch of salt.

Air New Zealand's case for the alliance is argued using "with" and "without" scenarios.

Without the alliance, it reckons, it faces a lengthy "war of attrition" with Qantas on the New Zealand-based networks ­ that is, domestic and key international routes ­ which can end only with its extinction.

Air New Zealand's international operations, the argument goes, are "inadequately profitable;" they are worthwhile only as feeders on to the domestic network, which provides the airline with its core profitability.

Qantas' New Zealand domestic operation loses money on a "stand-alone" basis.

So commercial logic dictates Qantas should increase capacity to service high-yield passengers. That would lead to a battle for customers that would see fares cut to the point both airlines were losing money.

As Qantas has the bigger balance sheet it could sustain those losses for longer, eventually driving Air New Zealand to the wall.

And that's the scenario even without a value-based (VBA) airline such as Virgin Blue competing with both airlines for New Zealand domestic business.

Swallow that if you will but spare a thought for Ralph Norris, his fellow directors and Air New Zealand's senior management team if the regulators knock the alliance back. Having admitted they see no way to save the airline from extinction, they could only fall on their swords and let someone else have a go.

Nor could they go looking for an outside saviour. Their submission to the Commerce Commission says an alliance with another airline (such as the Singapore Airlines alliance the previous board pursued so ardently) doesn't provide an answer.

The regulators contemplating all this will no doubt have spotted an apparent flaw in the argument, highlighted in a Virgin Blue-commissioned critique of the alliance's claimed public benefits.

Air New Zealand says it can't compete against Qantas within New Zealand, even in the absence of a VBA. And yet, in order not to make the competition picture look too bleak, it also claims a VBA will be able to prosper competing against the two full-service carriers' combined strength.

This on the face of it seems most unlikely. After all, Air New Zealand on its own saw off Kiwi Airlines and Ansett New Zealand in pretty smart order.

Nonetheless Virgin Blue has committed publicly to fly transtasman and domestically whether the alliance goes ahead or not, so it clearly believes it can make money ­ that is, cover its cost of capital ­ "cherry-picking" routes against Air New Zealand, Qantas, or both.

But, it says, it will take a lot longer to get established and it will fly only a limited number of routes unless the commission imposes a range of conditions on its approval for the alliance.

Chief of these is that Air New Zealand sells its Freedom Air low-cost subsidiary. As Virgin Blue is the only imaginable buyer it would be in an enviable bargaining position: no sale, no alliance. Ditto for the deal it would demand from Air New Zealand for maintenance, spares and parts, ground handling services and equipment.

And yes, there are a few other conditions Virgin wants.

One is that the partners undertake to the commission not to increase capacity on any route for two years following "new entry" ­ that is, Virgin's entry ­ to negate their "first mover advantage."

Another is that, "given the inherent risks to competition from the proposed alliance," it not be authorised under any circumstances for more than three years.

A third is that neither Air New Zealand nor Qantas be allowed to launch a new low-cost operator or redeploy the existing Australian Airlines, Impulse or Jet Connect brands.

In Shoeshine's eyes, Virgin's wish list translates as: we want to be able to buy a profitable New Zealand carrier dirt cheap; get dirt cheap servicing; be protected from competitive response for two years; and have the right to run to the regulators with further demands if things aren't working out after three years.

So how much risk is Virgin's shareholder prepared to bear? Not a lot, apparently. But then again, it's got Air New Zealand and the commission over a barrel ­ or so it thinks.

If Virgin gets what it wants that will bode very well for the share float Sir Richard Branson is planning. This was supposed to go ahead late last year with a value of about $A1.5 billion ($1.6 billion) but was postponed because of the post-September 11 aviation industry turmoil.

According to the Australian Financial Review the float is still "a way off" but Goldman Sachs is already installed as lead salesman and other investment banks are jockeying to get a piece of the action.

A successful Australasian operator would also act as a useful feeder on to Virgin Atlantic, of which Sir Richard owns 51% and Singapore Airlines 49%.

Virgin's alliance stance looks like a skilful piece of opportunity-taking.

But unlike Kiwi Airlines, Ansett New Zealand or the gaggle of no-hopers now running around looking for money to back startups, Virgin is a substantial player backed by experience and a strong international parent.

Its plan looks like New Zealand's best bet to keep full-service international air services and gain a strong local competitor to keep the big boys honest.

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