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Singapore Airlines dilemma: Use US$3.2b cash on Virgin or China

Singapore Airlines Ltd. has a decision to make: throw more cash at Virgin Australia Holdings Ltd., which has burned up shareholder wealth in four of the past five years, or risk an unwelcome rival muscling in.

[SYDNEY] Singapore Airlines Ltd. has a decision to make: throw more cash at Virgin Australia Holdings Ltd., which has burned up shareholder wealth in four of the past five years, or risk an unwelcome rival muscling in.

A power-sharing agreement at Australia's second-largest airline - owned almost equally by Air New Zealand Ltd, Etihad Airways PJSC and Singapore Air - unexpectedly fractured last month when the New Zealand carrier said it was considering putting its stake up for sale.

Singapore Air and Etihad may have to increase their holdings or jointly buy the stake so neither gains an edge. Air New Zealand's 25.9 per cent stake in Virgin Australia is worth about US$249 million, a fraction of Singapore Air's US$3.2 billion in cash.

"Arguably Virgin Australia hasn't been a good investment for everyone," said Brendan Sobie, a Singapore-based analyst at CAPA Centre for Aviation. "But strategically for Singapore Air, a case can be made that they would need to increase their stake."

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The bigger question is whether the stock is worth buying after years of meager returns. While a purchase could lock out a foreign competitor, injecting more funds would drain cash from Singapore Air's faster-growing markets like India and China. Virgin Australia, dominated at home by Qantas Airways Ltd, last month had to borrow money from its major investors to see it through a balance sheet review. 

Richard Branson set up Virgin Australia in 1999 with a US$10 million equity investment from Virgin Group as a budget carrier with a single route between Brisbane and Sydney.

After a 2013 restructuring, Air New Zealand ended up with a 25.9 per cent stake, Bloomberg data show. Etihad and Singapore Air own 25.1 per cent and 23.1 per cent respectively, while Virgin Group's share in the Brisbane-based carrier is about 10 per cent.

Adding to the current ownership uncertainty, neither Singapore Air nor Etihad have priority rights to purchase Air New Zealand's stake.

Such a structure is enough to deter all but a select group of possible buyers, according to James Santo, who works in special situations sales at Aviate Global LLP in Sydney. If Etihad raised its stake in Virgin Australia, Singapore Air may do the same to preserve its interest, he said.

"They would not want to see a controlling stake go to Etihad," said Mr Santo. The "least aggravating" option would be for Singapore Air and Etihad to split Air New Zealand's stake between them, he said. 

Another option would be for Singapore Air and Etihad to jointly buy Air New Zealand's stake, buy out minority shareholders and delist the airline, according to Santo. That would allow a restructuring away from the scrutiny of public markets, he said.

Virgin Australia has delivered negative returns on equity for three years, mirroring consecutive annual losses in the same period. Since 2008, the carrier's return on equity has been positive only twice. By contrast, Singapore Air has generated positive returns on equity every year on record.

To be sure, Virgin Australia is expected to make money this fiscal year after a plunge in fuel prices, record Chinese tourist arrivals in Australia, and an easing of a price and capacity war with Qantas. 

And while Sydney-based Qantas controls almost two-thirds of the domestic market, Virgin Australia can still feed passengers onto the international routes to Asia and the Middle East that are run by its major shareholders, including Singapore Air.

The risk to Singapore Air is that a foreign airline buys Air New Zealand's stake and starts to attract Australian passengers away from those routes and the city-state's hub. By that measure, a Chinese carrier would present a larger threat to Singapore Air than a US airline.

"We do not rule out the possibility of Singapore Air buying over Air New Zealand's stake," Eugene Chua and Carey Wong at OCBC Investment Research wrote in a note dated April 11. They called the Australia and New Zealand region "a key market" for the Singaporean airline.

According to Australian takeover law, a company's shareholding in another is typically limited to 20 per cent. Beyond that, it can raise its stake in a takeover, or increase ownership by only 3 per cent every six months. That's known locally as the "creep" rule.

Singapore Air, which declined to comment for this story, has approval from Australia's Foreign Investment Review Board to increase its stake in Virgin Australia to 25.9 per cent.

Etihad said in an e-mail it has "an enduring commitment" to the Australian market, reflected by its Virgin Australia stake, and the airline "fully supports" Virgin Australia's strategy and management. A spokeswoman for Air New Zealand declined to comment.

Singapore Air or Etihad would need Australian government approval to buy Air New Zealand's stake or share it between them. Either airline might also need to offer to buy out all other shareholders in the company.

Singapore Air had S$4.34 billion in cash and equivalents as of Dec 31. A full buyout of the Virgin Australia shares it doesn't already own would cost about A$960 million (S$977 million).


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