Virgin America is aiming to make its first ever annual profit, but an equity partner will not play a part in that plan, CEO David Cush, tells Gary Noakes.
Before David Cush left American Airlines, he could spot fellow employees flying on staff business quite easily – they were the only ones in first class wearing suits and ties. Things are a little more relaxed there now, but more so at his current employer, Virgin America, where the dress code is distinctly more casual.
Cush’s own mindset, after six years with Virgin, is probably more optimistic too, as the airline is on course to make its first annual profit since it was established in 2007. Cush’s optimism as chief executive is buoyed by the airline’s first ever second quarter net profit of $8.8 million in April, May and June, compared with a year-on-year loss of $31.7 million in 2012.
One quarter’s profit does not always signal a full year in the black, but Cush lists a 7.5% operating margin, a strong summer and good forward bookings from business travellers as reasons for his confidence and even talks of an IPO in the next few years.
“Our expectation is that we will have our first net profit in this year,” he says, although, naturally, he adds the standard airline boss caveat that “lots of things can impact that”. He is unabashed by the airline’s financial performance so far, pointing to its rapid route opening rate and its fleet expansion, both of which are now in an enforced hiatus.
“A lot of the reason we have not made a profit is the rapid growth we have gone through, but people have proven that they are willing to pay for the quality of our airline, so we generate a revenue premium to the rest of the industry. Our problem has been that we had 30% to 50% of our energy in markets that were not mature.”
The airline’s extended start-up has prompted the current period of consolidation and some negotiations with investors, including the financing of $150 million of debt in 2011. In May this year, another $290 million of debt was eliminated in return for future stock purchasing rights and an additional $75 million raised.
He is sanguine despite these apparent setbacks, however. “We are in an uncharacteristic growth low. We are allowing the network to mature, that’s why we are swinging from loss to profit. Very simply, by not taking any aircraft, we are not starting any new routes,” he says, forecasting that growth will be at a more manageable 8% a year, not the previous 35%.
“That will offset the losses caused by going into new markets.”
Convincing investors of the soundness of this model will hinge more on the bottom line than the theory. Cush’s hope is for a public offering if the ink stays black. “We have plenty of liquidity. We are still looking at the second quarter next year or some point in 2015.” However, he concedes: “We have to get a very clear path to say that this will be a consistently profitable airline in the future.”
Taking the airline public will enable easier aircraft financing, he believes. The company is keen on a diverse shareholding – its main 75% stake is held by VAI Partners, a consortium of US-based investors with four partners, while the Virgin Group holds the remainder.
Despite this, Cush bluntly dismisses the notion of attracting an outside investor, including Abu Dhabi’s Etihad, which owns a 19.9% stake in Virgin Australia.
“I don’t see us having a strategic investor at this time,” he states.
Network consolidation
As for the expansion hiatus, Cush says there is still a “reasonable chance” that one or two new cities will be introduced to the network in 2014. He adds that his demands from prospective airports are “modest”. “We don’t do beauty contests, we decide usually on a shortlist of maybe two. Usually we get co-operative marketing and landing fee forgiveness for 12 months.”
Before any airport operators think of making overtures, it is worth illustrating just how far Virgin America has been reined in. It has a fleet of 53 Airbus A320s but took just one new aircraft early this year and there will be no others in 2013. Contrast that with the 2010–2012 period, when it took 24 new aircraft, almost doubling its fleet size. A second phase order was cut from 30 to 10, with five A320s being delivered in 2015 and another five in 2016. An order for 30 A320neos has also been deferred to 2020. Cush adds, however, that he will lease aircraft in the intervening period if needed.
The pause in aircraft deliveries means any new routes in the immediate future would mean diverting capacity from existing services. If there is any expansion, he names Houston and Atlanta as places that the airline “will eventually have to go to”, but says he is comfortable with Virgin’s offering to the business traveller as it is. “We are in eight of the top 10 business markets from Los Angeles and seven of the top 10 from San Francisco. I am quite satisfied with the way the network looks now.”
Corporate customers
Like all start-up airlines, Virgin America at first got most of its revenue from leisure passengers, but Cush says business travellers now make up “a little over 50%” of revenue. “It’s a big swing from where we were when we started. Our first couple of years were probably closer to 80% leisure.”
The onboard product has doubtless been a big enticement to corporate budgets that will stretch to it, but others, notably American Airlines and JetBlue, are investing again, for example putting flat beds in first class on trans-continental fleets, meaning that Virgin’s USP is slowly being eroded.
Cush’s retort is that it is continually reinvesting, with further undisclosed innovations next year, which is likely to mean that it will also fit beds in the premium cabin. Virgin has already spent several million dollars on upgraded Wi-Fi throughout the fleet in September.
Cush believes he has shown other carriers “a different path to price-only” and says rivals are “only adapting to Virgin’s environment.” Price will still remain king for some consumers, however, and sometimes Cush has to fight on it just like any other airline, particularly on new routes.
“When we went into Newark, the average fare dropped by 30%, partially our doing, but particularly the competitive response – United went from eight a day to 16. It was a throwback to the old airline playbook.”
His business model is his secret weapon, he insists. “Newark is already profitable for us because our costs are so much lower than United’s.”
He goes on to explain how Virgin has essentially taken the Southwest Airlines model – a single fleet type, non-unionised workforce and point-to-point flying – and, unlike Southwest, easyJet and others, invested some of the savings in the onboard product and landing fees at prime airports. “The additional money we spend on things like food and IFE is a really small amount of the overall expenses,” he claims.
Industry consolidation
Nevertheless, he has to contend with the resurgent legacy carriers that are now in profit and with the threat of the American Airlines/US Airways merger on the horizon, should it be permitted. As American’s former senior vice president, global sales, he will not be drawn on the specifics of the tie-up between his ex-employer and US Airways, but backs the Department of Justice intervention in the proposed deal. Virgin has been the victim of the competitive structure that has been allowed to prevail, he adds. “We see that every day in the market.”
He believes the regulators have had second thoughts about permitting previous mergers. “You can’t turn back time. I think their view is that this [American Airlines and US Airways] will contribute to the thing they see as being already wrong, i.e. this is more of the same and, yes, maybe we should not have allowed it.”
Despite this view, Cush does not see the legacy carriers as being too much of a threat to him in the domestic market, pointing out that their focus is on international routes, unlike Virgin’s. “I’m not sure we are going to see a lot of expansion within the US, with the exception of the low-costs like JetBlue, Spirit and Allegiant.” He adds that despite the territory marking on Virgin’s new routes by incumbents “the days of having six to eight airlines all chasing each other in market share wars seem to be behind us”.
Instead, he believes the industry is learning to respond in more constructive ways when it is earning money, like investing in product and returning money to shareholders. There is, however, usually a spanner in the works, often of the industry’s own making to contend with, as any veteran like Cush will tell you. He jokes: “We have always found a way to screw it up. We will have to see if it happens this time.”
This article was reproduced and edited from an original story that appeared on our sister publication Routes News. The latest bumper World Routes edition of the official air service development magazine is available in your delegate bags or can be read online by clicking here.
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