Will SingAir's Pain Become Delta's Gain?

By Stephen D. Simpson, CFA | December 04, 2012 AAA

Plenty of investors, analysts and commentators have noted that the airline business is fundamentally lousy and one of the fastest routes to losing large amounts of money. There's ample evidence that that is more than just simple grousing over sour grapes - Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) has struggled to make any real profits from its various investments in the sector, and even the well-respected Singapore Airlines (OTC:SINGF) has seen its nearly $1 billion investment in Virgin Atlantic do it almost no good at all. Now there are stories that SingAir is ready to cut its losses, and that American air giant Delta Airlines (NYSE:DAL) is eager to pick up the asset.

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Virgin on the Block?
It's not altogether "new news" that SingAir is looking to do something with its sizable Virgin stake. SingAir bought 49% of the airline back in 1999 (Sir Richard Branson's Virgin Group owns the rest) for nearly $1 billion, but has received little from it. Europe-Asia routes have not proven all that lucrative for SingAir, and the company has been focusing more on its business within Asia and across to North America in recent years. What's more, the performance of the investment has been such that SingAir has repeatedly written down the value of the investment over the year, with most of the remaining goodwill getting written off last year.

Now, SingAir is willing to move on and try to monetize an asset that it can't really use. To be sure, there is value in Virgin Atlantic. While the airline may have had a net loss in its last fiscal year, the airline is the second-largest owner of slots at Heathrow ((behind British Airways parent International Consolidated Airlines Group (OTC:ICAGY), which controls more than half of them). Those slots are precious to airlines, particularly those who want to build on lucrative trans-Atlantic routes.

Will Delta Step Up?
This is where Delta comes into the picture. Delta would definitely like to expand its access to Heathrow and use it to strengthen its European business. What's more, Delta is a company with a history of being opportunistically aggressive when rare opportunities arise.

Given that Delta's interest is just a rumor at this point (albeit a very logical one), it's hard to say just what sort of transaction Delta would contemplate. While the company has nearly $10 billion in net debt, more than $13 billion in pension liabilities and negative shareholder equity, the history of the airline industry suggests that the company will nevertheless be able to raise the funds if they want to do so.

Some, Most or All?
An interesting facet of the rumor is that this transaction could go beyond Delta simply buying SingAir's stake and bringing Virgin Atlantic into the company's alliance with Air France-KLM (OTC:AFLYY). There are at least some rumors that with Virgin Atlantic struggling to compete as an independent against air alliances like Star Alliance ((which includes United Continental (NYSE:UAL) and US Air (NYSE:LCC)), SkyTeam (which includes Delta and Air France-KLM) and Oneworld (which includes International Consolidated), and the upcoming retirement of the CEO that Branson/Virgin may be willing to sell a meaningful part of its stake as well.

Time will tell on that one. EU regulations wouldn't let Delta own a majority of Virgin Atlantic, and debt covenants will limit Air France-KLM to a 20% ownership, so I'm not sure that Delta would really need (or want) more than 2% of Virgin's stake - just enough to move a combined Delta/Air France-KLM buyer over that 51% control threshold.

The Bottom Line
Whether or not Delta ends up being the leading bidder, it seems pretty likely that SingAir is going to look for a buyer for its Virgin Atlantic stake. It will be interesting to see what sort of bid it fetches; industry valuation metrics would point to a price tag of between $850 million and $1.8 billion, with the non-controlling stake, the company's losses and a weak non-alliance position arguing for lower and rarity of those Heathrow slots arguing for higher.

Delta shareholders ought to stay tuned; the opportunity to gain slots in Heathrow is likely too good to pass up without at least an exploratory bid, but those long-term benefits have to be set next to the cost to the company's liquidity and increase in near-term risks.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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