Virgin Australia plans to reclaim full ownership of its Velocity Frequent Flyer scheme by purchasing the 35% stake of Affinity Equity Partners, which bought into the program in 2014 for A$335 million but is now looking to offload its share.
The airline has confirmed that discussions are underway for what would be an A$700 million transaction, which would see Velocity valued in total at around A$2 billion.
In a statement issued to the Australian Stock Exchange, the airline said "The Group confirms that it has entered into a term sheet with Affinity to buy back its 35% minority investment for $700 million. Completion of the transaction is expected to occur before the end of 2019."
Earlier speculation circled around a potential IPO plan under which Velocity would be spun out with that A$2 billion valuation, allowing Affinity to cash out while also tempting Virgin Australia with a fast fund-raiser by selling down its own 65% shareholding, although Virgin Australia CEO Paul Scurrah had previously affirmed that the airline would seek to retain majority control of its loyalty scheme.
A full buy-back would demonstrate Scurrah's confidence in the longer-term proposition for Virgin Australia and growing Velocity as part of that future. Loyalty programs are usually a pillar of strength for airlines – in the 2018-2019 financial year Velocity reported pre-tax earnings of A$122.2 million (up 12% over the previous year).
Velocity members were also wary of sell-off plans, fearing that the program's core benefits – especially when it comes to the earn-and-burn equation and redeeming points for seats – might slowly be watered down by non-airline stakeholders.
However, on the back of Virgin's posted $315 million loss for the 2018-2019 financial year – and having returned seven straight years of losses adding up to $1.9 billion – attention will turn to how this $700m re-purchase will be funded.
"Major strategic investors in Virgin – Singapore Airlines , Etihad Airways, HNA Group, Nanshan Group and Richard Branson’s Virgin Group – have baulked at providing more capital since an equity raising in 2016, seven current and former Virgin managers have said," notes Reuters' chief aviation correspondent Jamie Freed.
That said, "credit ratings agencies Standard & Poor’s and Moody’s said the airline, which lacks an investment grade rating, should be able to fund the deal."
“Even if you assume 100% debt, we still believe they have the balance sheet capacity to do the buy back,” suggested S&P analyst Graeme Ferguson.
PREVIOUS [May 14, 2019] Virgin Australia could spin out and sell its Velocity Frequent Flyer program, which competes with Qantas Frequent Flyer for the hearts and wallets of Australian travellers.
The loyalty program is estimated to be worth several billion dollars to the right buyer, according to The Australian Financial Review, with that money being a welcome injection into the coffers of the parent airline.
Virgin Australia holds a 65% stake in the Velocity loyalty scheme, following the acquisition of a 35% stake by Asia-based private equity firm Affinity Equity Partners in 2014 for $336 million.
Analysts expect Velocity Frequent Flyer will report around $120 million in pre-tax earnings for the 2019 financial year, with AFR reporting that Velocity "could be worth 15 to 20-times earnings" depending on "the strength of Velocity Frequent Flyer's long-term contracts with its parent, Virgin Australia."
Recently-appointed Virgin Australia CEO Paul Scurrah "is said to have hit the ground running and is looking for ways to shore up Virgin Australia's profitability and funding position," according to the AFR, which describes Velocity Frequent Flyer as "arguably the stand-out asset in Virgin Australia's portfolio."
Virgin Australia is expected to count around $70 million in pre-tax earnings for the 2019 financial year.
Approached by Australian Business Traveller, the airline declined to comment on the potential sale of its frequent flyer program, other than describing the AFR report as “media speculation”.
For context, Qantas considered selling off its 'river of gold' frequent flyer program in 2013-2014 as the airline struggled against strong financial headwinds, leading up to a dramatic loss of $2.83 billion over the 2013-2014 financial year.
At the time, analysts valued the Qantas Loyalty division as high as $3 billion – making it worth significantly more than the airline itself.
However, selling the business was eventually seen as a quick-fix solution to bolster the balance sheet in the short term, at the cost of undermining the airline as a whole over the longer term.
"After careful consideration our judgement was that Qantas Loyalty continued to offer major profitable growth opportunities, and there was insufficient justification for a partial sale" Qantas CEO Alan Joyce said at the time.
In the 2018 financial year, Qantas Loyalty tipped $372 million into the airline's record $1.6 billion pre-tax earning, contributing almost as much as Qantas' entire international operation.