Tuesday 05 April 2016 by Company updates

Air New Zealand announces potential sale of Virgin stake


Air New Zealand is considering options in relation to its 26% ownership of Virgin Australia, including a sale. The associated uncertainty has triggered negative outlook responses from both credit rating agencies. We look at the potential scenarios for Virgin Australia bondholders in relation to Air New Zealand’s equity stake and impacts on the credit.


Recently, Virgin Australia’s (‘Virgin’) major shareholders injected AUD425m through a subordinated loan, which we viewed as a credit positive event. Surprisingly, not long after, Air New Zealand (Air NZ) announced it is exploring options with respect to its shareholding in Virgin Australia, including a possible sale of all or part of its circa 26% stake. With a current market capitalisation of AUD1.32bn, Air NZ’s equity stake is valued at around AUD340m. A link to the announcement is available here. 

From media reports and the announcement, it would appear that the motivation behind Air NZ’s sale was twofold: 

  1. Air NZ needs to free up the capital to battle intense competition in its domestic market and pursue its own growth opportunities 
  2. Air NZ was becoming increasingly frustrated with Virgin’s financial performance and was concerned about having to inject more equity as part of Virgin’s forthcoming capital structure review (to be completed in the coming months). It would also appear from media reports that both Etihad and Singapore Airlines remain relatively comfortable with their ownership stake in Virgin. 

Air NZ’s announcement and the associated uncertainty around the ownership structure has triggered negative reactions from both rating agencies: 

  • On 31 March, S&P placed Virgin’s B+ credit rating on negative outlook reflecting a degree of uncertainty over Virgin Australia's near term funding requirements and future ownership structure. While S&P views Virgin's operating performance to be fundamentally sound, it expects adverse currency and working capital movements, as well as increased capital expenditure relative to previous forecasts, to affect the airline's current debt and liquidity levels. This may require a sizable new funding commitment over the next 12 months. S&P views shareholder support as the most reliable source of funding as prevailing credit market conditions may render bank or debt capital markets issuance unfeasible. S&P could lower the rating if they assess shareholder support to have diminished, or if the group fails to strengthen its liquidity position over the next 3-6 months. A downgrade would result Virgin’s corporate credit rating falling to B, while the bond rating would fall to CCC+
  • On 4 April, Moody’s placed Virgin’s rating on review for downgrade, citing uncertainty around Air NZ’s announcement and the outcome of Virgin’s capital structure review. Moody’s also cites slower than expected momentum in the deleveraging of the business and the deterioration in the company’s liquidity profile in 1H16. The corporate credit rating is currently B2 while the bonds are rated B3. If the outcome of the capital structure review brings Virgin Australia's financial metrics into line with expectations for a B2 rating, Moody's would affirm the current rating. If not, the airline will be downgraded to B3 and the bonds downgraded to Caa1. In order for the rating agency to consider a rating upgrade, Moody's would need to see strong shareholder support, operational initiatives to enhance cashflow and profitability, and debt reduction to a level well inside the thresholds for a B1 rating. The rating agency views this scenario as unlikely.


    In terms of the ownership situation, we see the various scenarios and the potential impact for Virgin’s credit profile as follows: 

  • If one of the remaining major airline holders (eg: Singapore Airlines or Etihad) were to launch a takeover of Virgin following this news we would see this as credit positive. The bonds have a change in control provision at $101, however we’d expect the bonds to rally above this level in a takeover scenario given the relative credit strength of both Singapore Airlines and Etihad 
  • If the stake is sold to another airline or to the Virgin Group, we would see this as broadly credit neutral. The recent USD2bn sale of Virgin America to Alaska Air Group will free up capital for the Virgin Group to potentially acquire the Air NZ stake. Virgin Group currently owns around 10% of Virgin Australia
  • If the equity is sold to parties not affiliated with the airline sector (eg: the general retail market), we would see this as a weakening of Virgin’s credit profile given the loss of institutional airline support in the ownership profile
  • If the sale takes longer than anticipated and/or Air NZ cannot find a buyer for its equity stake, we would see this as credit negative 

As a result of the news, Virgin bond prices have fallen by around USD1 and the bonds are currently indicatively offered at a yield to maturity of 8.04%. We would expect further price falls if the bonds are downgraded, however at this stage we see a more likely scenario being that an alternative airline or the Virgin Group acquires some or all of Air NZ stake in Virgin which we would consider credit neutral.