|Virgin America CEO David Cush, shown celebrating the airline's inaugural San Francisco-to-Seattle flight in March 2008, says the competition "can't handle innovation."|
The other airlines don't much like Virgin America. Citing a law that limits the percentage of foreign ownership of a U.S. carrier, the established airlines delayed Virgin America's start-up for nearly 18 months, as all six major network carriers raised objections. Recently, Alaska Air ( ALK) has taken up the battle anew, requesting that the U.S. Transportation Department review Virgin America's ownership. Last week, U.S. Rep. James Oberstar (D., Minn.), chairman of the House Transportation Committee, wrote to Transportation Secretary Ray LaHood asking him to conduct that review. Although the complaints are based on specific questions about a potential legal violation, they have a familiar ring. The airline industry has always had a low-fare outlier to dislike, ranging from Southwest ( LUV) to JetBlue ( JBLU) to Virgin America. "In general, the industry and the legacy part of the industry have made their living playing defense rather than playing offense," said Virgin America CEO David Cush in an interview with TheStreet.com. "They can't handle innovation. They always look at things as a zero-sum game, where 'If somebody else does well, that's got to be bad for me.'
"All of the innovation in the industry is occurring in the new entry side," says Cush. "Live TV was started by JetBlue. Spirit and Ryanair ( RYAAY) are very aggressive on a la carte pricing, pushing ticket prices down. It's similar to what we're doing, focusing on high-quality service at low cost." Southwest was a target in the 1990s, when it was growing rapidly and regularly revving up "the Southwest effect," forcing down fares in markets it invaded. Early in the current decade, JetBlue upset the industry template by offering low fares, comfort in coach and a domestic hub at New York's Kennedy Airport, long considered unattractive to domestic passengers.
Virgin America "is a lot like JetBlue," Cush says. "We are showing people that travel can be enjoyable." The differences, he says, include two-class service, advanced entertainment options and innovations like the ability to swipe a credit card at a seat to order food and drinks. The carrier, which began flying in 2007, operates on transcontinental and West Coast routes, pressuring fares in both markets. "The network airlines always have disliked the low-cost carriers, but over time they have accepted JetBlue and Southwest into the family," says FTN Securities analyst Mike Derchin. "JetBlue changed its business model and is operating more like a network carrier, and Southwest now is reducing capacity, rather than growing, and trying to increase average fares." As for Virgin America, Derchin says the other carriers shouldn't worry about it because it is losing money so rapidly that it cannot survive. The ownership issues are almost a diversion, he says. The law requires that a U.S.-based carrier must be at least 75% owned by U.S. citizens and also must be controlled by a U.S. citizen. In awarding Virgin America the right to operate in August 2007, the Transportation Department found that nearly all of its U.S. shares were owned by two hedge funds, which had the right to sell their holdings back to London-based Virgin Group Ltd., holder of the remaining 25%. In a filing last month, Alaska asked the Transportation Department to find that Virgin America no longer qualifies as a U.S. citizen, citing a Wall Street Journal report that the U.S. investors had indeed sold their holdings to Virgin Group.
"We asked for two things from the DOT," said Alaska CFO Glen Johnson in an interview. "We asked them to evaluate based on today's facts, because it appears that the facts have changes, and we asked that the evaluation be public." Cush, a native of Shreveport, La., says U.S. citizens still own and control the airline. A DOT spokesman says: "This is a contested matter currently under review by the department." In February, Virgin America reported a 2008 fourth-quarter loss of $27 million on $110 million in revenue. Load factor was 81.2%. Trends were positive, as revenue per available seat mile nearly doubled from a year earlier to 9.28 cents while cost per available seat was 11.57 cents, down 2 cents. For the full year, Virgin America lost $202.4 million. Johnson says the carrier prices below cost. "Any company can price anywhere it wants to, for however long the market will support that, but how do you attract investors if you have pricing that doesn't produce some level of profitability?" he asked. If the airline is indeed owned primarily by foreign investors, he adds, "then they can build and grow in a way we cannot." Experts disagree on Virgin America's prospects. Consultant Mike Boyd says revenue and load factors are strong, and Virgin America has 23% of the traffic between New York's Kennedy Airport and Los Angeles, third behind American ( AMR) with 38% and Delta ( DAL) with 25%. "Costs are high, largely because they're a start-up," Boyd says. "But their revenues and load factor are strong. They certainly don't have the problem that most start-ups have, which is no passengers."
"Anybody can have high-load factors," Derchin says. "The main thing one has to look at is how much money they are losing and how long can they keep going without a cash infusion, and confounding that is the reports that their U.S. investors want out, because those investors can't leave without putting the company out of business." In a recent report, Morgan Stanley analyst William Greene said United ( UAUA) and Alaska would be the biggest beneficiaries if Virgin America were to close. Approximately 9% of United's domestic seats and 7% of Alaska's domestic seats are exposed to competition from Virgin, Greene said. Cush says Virgin America has sufficient liquidity, reported as $68 million at year-end, to get through the next several years. "We are not profitable, and you would not expect a new airline to be profitable," he said. "But we have no debt to be renegotiated, no need to go to the capital markets and we continue to believe we will be profitable in 2010."