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Virgin America: An Airline Sprouts in California

SAN FRANCISCO (TheStreet) -- The story of how Ben Baldanza, David Cush, Tom Horton and Doug Parker all worked together at American (AAMRQ.PK) in the 1980s is well-known. Today, Horton is credited with guiding a successful bankruptcy, US Airways' (LCC) Parker is about to run the world's biggest airline and Baldanza heads a successful start-up that has captured Wall Street's affections.

Then there is Cush. His success has come a bit more slowly. He left American in 2007 to become CEO of Virgin America. For 18 months, other airlines had resisted the start-up effort, citing lack of clarity about Richard Branson's ownership and the potential violation of the limitation on foreign ownership of U.S. carriers. Once it began flying, Virgin America encountered rising fuel prices, a bad economy and the usual intense competition on the trans-continental routes it initially targeted.

"We knew it was going to be a long path," Cush said in a recent interview. "Growing an airline is difficult in the best of times, and we haven't been in the best of times. We've had a huge recession and high commodity prices. We fought our way through those."

Now, finally, Virgin America's financial results are picking up and the airline industry has become a profitable place to be. The possibility of an IPO looms, with Baldanza's Spirit (SAVE) providing an attractive model, even if the two carriers could not be more different. Virgin America lures customers with cost-free comfort, including leather seats and high-level connectivity, while Spirit does the opposite, luring customers with the promise of no comfort at all.

"Spirit and Virgin are completely opposite in the spectrum," Cush said. "(But) Spirit had a great IPO. They took it public with a small initial float and a secondary offering after that. It turned out to be a great strategy. We're taking a very close look at that."

Although "going public brings a lot more headaches," Cush said, it also "opens up large pools of capital, not only in the equity markets but also access to debt markets, (so that) financing aircraft costs less." Last week, Virgin said it negotiated $300 million in debt reduction from its investors, reducing second-half interest charges by about $20 million. The changes "are a first step toward preparing the company for access to the public markets at a future date," Virgin said.

Now, Cush said, the issue for Virgin "is that we have to have our performance up to snuff. If we hit our triggers, we will have a very nice operating profit in the second quarter, a net profit in the third and fourth quarters and a string of profitable quarters in 2014." Currently, Virgin America's principal owner is New York hedge fund Cyrus Capital, with about 50%; Branson's Virgin Group has about 46%.

"The key thing is we had to get to critical mass," Cush said. "That's why we've been expanding by 30% to 35% per year. In the last few years, we've gotten to a size where we could protect ourselves competitively." Between the second quarter of 2010 and the second quarter of 2012, the carrier took delivery of 25 Airbus A320 family aircraft. Now, with the fleet at 53 planes, deliveries have been curtailed until 2015.

In the first quarter, Virgin's operating loss narrowed to $15 million from $49 million while revenue per available seat mile grew 18%. Operating revenue grew 13% to $301 million; cost per available seat mile excluding fuel grew 8%, primarily due to reduced aircraft utilization. During the quarter, aircraft utilization decreased by 17% to 10.3 hours a day, close to the industry norm.

For the full year 2012, Virgin reported an operating loss of $31.7 million. Revenue grew 29% to $1.3 billion as capacity grew 27%.

Aviation consultant Robert Mann said Virgin America has made incremental improvements, but clearly needs to show the consistent financial performance that Cush projects before it can mount a public offering. "They haven't really established a track record," Mann said. "Until you can really show that you are performing well for a year or so, I think it's a stretch.

" I wish them luck, they clearly appeal very strongly to their loyalists, and they have clearly outlasted the expectations of those who figured they would be gone by now," Mann said. "But they lack the size or scope of network that would make it more than a boutique offering."

At San Francisco International Airport, Virgin America carried 8% of all passengers in March, second only to hub carrier United (UAL), which had about 45% of the passengers including commuter passengers on SkyWest (SKYW), according to airport statistics. Virgin America has 54 daily SFO departures. On Tuesday, it will begin service to Austin, Texas, its 21st non-stop destination, and on June 6, it will begin seasonal service to Anchorage, Alaska. Mann said Virgin has "a foot in the door in San Francisco, which is a place where a tech savvy airline can really earn its stripes."

Meanwhile, at expanding LAX, Virgin has 46 daily departures to 15 destinations. Intra-California service to feed the long-haul flights seems to be lacking, but Cush noted that Virgin has 25 international code-shares and interline partners. The biggest deals are with Air New Zealand, Singapore and affiliate Virgin Australia .

Virgin started out with a leisure orientation. But today "we're not the fun party airline anymore," Cush said. "We have much more of a focus on business travelers and we are a serious airline for them. Connectivity has really allowed us to reposition the airline." In expanding to Austin, for example, Virgin competes with four daily United flights, plus one on JetBlue (JBLU). "The key thing is that neither of them have Wi-Fi on the airplanes," Cush said. "This is a four-hour flight. Our passengers live and work in the tech industry. Being without Wi-Fi for four hours makes them crazy."

-- Written by Ted Reed in Charlotte, N.C.

>To contact the writer of this article, click here: Ted Reed

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