Another set of Virgin Atlantic accounts

6 May

We had to wait until January 11th 2021 to get Virgin Atlantic’s 2019 results. I wrote about them here.

Less than four months later, they have now published their 2020 figures, which provides an opportunity to see how the financial restructuring has been reflected in the accounts.

But before we look at that, I want do a quick comparison of the results with arch-rival British Airways, who also filed their 2020 accounts a couple of weeks ago.

As I go through these comparisons, it is important to remember that the 2020 figures include an almost normal first quarter. The revenue and cost reductions due to COVID were all concentrated in the final nine months. However, I don’t have quarterly information, so that’s the best I can do.

With that caveat, let’s get into it.

The bottom line

Of course, the results were ghastly at both airlines.

At Virgin Atlantic, pre-tax losses were £669m before exceptional charges and £858m after them. The equivalent figures at BA were £2,631m and £4,184m. BA is a much bigger company, so we need to look at some figures which normalise for size. I’ve decided to show the figures as a percentage of revenue. As we will see later, revenue fell by almost exactly the same percentage at both companies, so I think it is a good basis for comparison.

The following chart shows the profitability for 2019 and 2020. The much better profitability at BA in 2019 was revenue driven and the evaporation of demand largely eliminated the performance differential in 2020.

Virgin’s pre-tax results were a little worse due to their higher financial leverage, but BA took relatively bigger exceptional charges from fuel hedging and restructuring. Overall, the 2020 figures were remarkably similar.

*Source: Company reports, GridPoint analysis*

A similar drop in revenue at both airlines

The following chart shows the revenue breakdown for each airline in 2019 and in 2020. I’ve used different scales for each airline due to the disparity in size. The 70% drop in revenue was virtually identical. Both are very long-haul dependent and both are based in the United Kingdom, so perhaps that is not a surprise. But the similarity was striking, nonetheless.

Cargo to the rescue

The figures would have been even worse if it hadn't been for cargo. At Virgin, cargo revenues were up 49% on the previous year, quite a bit better than at BA which saw an increase of 25%.

In volume terms, Virgin lost a very small amount of market share to BA. In 2019 they flew 47% as many tonnes of cargo as BA and that slipped to 46% in 2020. However, they outdid their rival in yield, which increased 118% versus 2019, more than doubling average prices. BA’s yields were up too, but “only” by 76%.

Why did Virgin do better on yield? I think it was largely catch up. BA’s absolute yields per tonne in 2020 were still 28% higher than Virgin’s. Maybe suddenly being totally reliant on cargo focused the minds of Virgin Atlantic’s management? Perhaps. But I think it was mostly schedule driven.

At both airlines, much of the flying schedule in 2020 was dictated by cargo opportunities. Virgin flew 3,897 cargo only flights and BA flew 9,987. According to CAA data, 51% of Virgin’s tonnage and 39% of BA’s was carried on such flights in the year.

BA’s route network in 2019 was more cargo friendly than Virgin’s, who had an incredibly North Atlantic oriented network pre-crisis. Yields on the North Atlantic were substantially lower than other markets due to excess capacity from the huge amount of belly-hold lift. The freedom to rejig the network to better serve the needs of cargo probably made more of a difference at Virgin.

Passenger revenue

Passenger revenue fell by 80% at Virgin, slightly more than at British Airways where revenues were down 76%. But given Virgin’s greater exposure to long-haul and the North Atlantic in particular, the hardest hit parts of the market, that actually looks quite a reasonable performance in the circumstances.

BA flew slightly more capacity compared to 2019, largely due to the brief demand recovery in short-haul during the summer. Load factors were almost identical at 61% for the year, but Virgin’s yields fell slightly less than at BA. Overall, very similar results to be honest.

Cost reductions

Before exceptional items, operating costs at Virgin fell by 52%, which was better than the 44% reduction at British Airways. It is hard to do a detailed comparison, as the companies categorise costs differently. I suspect the difference was probably driven by more of BA’s costs being fixed than at Virgin.

On the all-important employee cost line, the reductions were uncannily similar - a 33% reduction at BA and 34% at Virgin.

Balance sheet comparison

So the differences in the operating metrics and profit and loss account were quite small. The same was not true where the balance sheet is concerned.

At BA, equity reserves fell by £4.2 billion, which is £700m more than the post tax loss, mainly driven by extra pension liabilities due to the fall in interest rates. Net debt went up by £3.8 billion. Although BA’s parent company IAG raised €2.7 billion of additional equity during the year, none of this was passed down to BA. But BA’s equity reserves started off in a healthy position due to several years of strong profits, so reserves stayed positive at £1.3 billion.

At Virgin, equity reserves were already £190m negative at the end of 2019 and they deteriorated further to end the year at negative £576m. The £385m drop was less than their £864m after tax loss for the year because, according to the accounts, they raised £480m of additional equity during the year. That also limited the rise in their net debt to £522m. We will return to the question of where this additional capital came from in a moment.

Based on Virgin Atlantic’s reported balance sheet numbers and adjusting for size, BA’s balance sheet deteriorated proportionately more than Virgin’s. However, the starting position was so much stronger that the net debt levels at BA were still much lower at the end of 2020, whether measured relative to revenue or to fixed assets.

Virgin’s financial restructuring

The 2020 accounts contain further detail on the financial restructuring that took place during the year. It was billed as a £1.2 billion package but as we already knew, very little of this was fresh cash. The makeup of the package is described like this in the accounts:

Shareholder support of c.£600m over 2020-25, including a £200m investment from Virgin Group and c.£400m of deferred shareholder payments;
£170m of secured financing from Davidson Kempner Capital Management LP, a global institutional investment management firm; and
More than £450m of additional deferrals from our largest creditors alongside the support of our credit card acquirers (Merchant Service Providers).

There is some additional data in the notes to the accounts which allows us to dig into each of these elements, starting with the “circa £400m of deferred shareholder payments”.

Deferred shareholder payments

These relate to payments due to Virgin Group for brand licence fees and amounts due to Delta under the transatlantic joint venture agreement over the 2020 to 2025 period.

What has happened is that the two shareholders have agreed to be “paid” in newly issued preference shares rather than in cash until 2025. So there is no new cash, but it does reduce the cash outgoings of the company over the next few years.

The new preference shares have no contractual dividend or repayment date and so can be counted as equity for accounting purposes.

As at the accounting date of December 2020, only £77.8m of these new shares had been issued, £56.1m to Delta for joint venture payments from 2019 and £21.7m to Virgin Group for royalty payments in 2020 and settlement of “other liabilities”.

That leaves £298.1m of shares to be issued over the 2021 - 2025 period as these “payments” become due. For some reason, the company has chosen to include these unissued shares within the equity part of the balance sheet, matched by a corresponding intangible asset shown as a “joint arrangement and brand asset”.

I assume that one of the reasons they have done it this way to make their balance sheet look less bad. This accounting wheeze has somehow managed to turn £298m of future liabilities into £298m of additional equity and an extra £298m of assets. The other motivation is undoubtedly to “big up” the contribution that the two shareholders have made. I’m sure the creditors and credit-rating agencies are not fooled though.

How do these figures split down between Delta and Virgin? The company has tried really hard to obscure this in the accounts, but I think we can get pretty close by piecing together the different pieces of the puzzle that they do disclose.

Delta payments

By way of background, it is worth jumping to the Delta accounts, where they make the following disclosure:

“Effective January 2020, we combined our separate transatlantic joint venture agreements with Air France-KLM and Virgin Atlantic into a single three-party transatlantic joint venture. Under the new agreement, certain measurement thresholds were reset from the previous joint venture with Virgin Atlantic, reducing the value we would have received over the original term. In consideration for this reduced value, we entered into a transition agreement with Virgin Atlantic, which would have resulted in payments to us in future periods. However, as of December 31, 2020, based on our assessment of collectability, we do not have any assets or liabilities recorded on our balance sheet related to this transition agreement.”

As well as providing useful background, this disclosure makes it clear that Delta are under no illusions that these preference shares are worth much, if they are worth anything at all.

From the Virgin Atlantic accounts, we have the following:

“As a result of terminating the previous joint arrangement, the Group has a liability owed to Delta over the period 2020 - 2028, which is fair valued at £298m at 31 December 2020. The portion relating to 2020 – 2024 has been converted to preference shares, leaving an outstanding liability of £120m for the periods 2025-2028.”

“Fair valued” means that the amounts owed to Delta have been discounted back to today using an “appropriate” discount rate. The company doesn’t disclose what it has used or the profile of the payments, but based on the 12.9% rate they seem to have used for the Virgin Group loan (see later), and knowing that the payments in the 2025-2028 period average £30m a year, I think the payments in 2020-2024 probably average about £67m a year. That suggest a £244m ”fair value” for the 2020-2024 payments that have been turned into preference shares.

On top of this £244m for 2020-2024 payments, Delta has also received £56.1m of preference shares for payments for 2019, taking their estimated total to about £300m, about 80% of the preference shares to be issued.

Technically 51% of the company is owned by Virgin Group based on the split of ordinary shares. Richard Branson is recognised as the ultimate controlling party in the accounts. That is important for national ownership and control reasons. But in reality, the use of preference shares for all the recent “capital raises” means that if the company has any equity value at all, the vast majority of it is now owned in economic terms by Delta.

Virgin Group payments

The Delta estimate implies about £76m of preference shares for Virgin, of which £21.7m were issued in 2020, leaving £54m corresponding to the fair value of brand licence payments in the 2021-2025 period. Virgin Group usually charges 1% of revenue for a brand licence fee. Based on 2019 passenger revenues, that would be about £22m a year. In 2020, that would have fallen to about £4m. With near term revenues remaining depressed and outer years being heavily discounted, £54m passes the common sense check for the fair value of Virgin’s payments.

On top of this, Virgin Group also made a “£200m investment”. That sounds like an equity injection, but we already knew it was a loan based on earlier disclosures. The new information from the accounts is that Virgin Atlantic has only included an additional £96.3m of debt in their balance sheet corresponding to this loan. Once again, the difference is due to “fair value” accounting. The only terms that are disclosed is that the loan is repayable in January 2026. If you assume that it doesn’t bear any interest, then you can back-calculate the discount rate they have used to do the fair value calculation. I make it 12.9%, which looks a lot more like an equity return than a loan rate. That makes sense, given how little chance there is of the loan ever being repaid.

The effect of discounting the value of the loan is once again to flatter the equity position on the balance sheet. £200m was added to assets (cash), £96.3m was added to liabilities (borrowings) and the £103.7m difference was added to “other reserves”.

Back to that £480m of additional equity

So to summarise, the £480m of additional equity that we saw earlier actually consisted of:

£376m of amounts that were owed or would become payable to the shareholders over the next five years, which will now not need to be paid in cash but instead in “preferred shares”, which count as equity
£104m of “equity value” attributed to the £200m Virgin Group loan, which reflects the fact that if the loan had been made at commercial rates, it would have attracted a high interest rate due to the financially distressed position of Virgin Atlantic.

The accountants are apparently happy that these transactions add up to a £480m equity contribution during the year.

You and I might choose to differ.

Borrowings

During the year, Virgin Atlantic’s borrowings went up from £2,214.8m to £2,479.4m, an increase of £265m. That is a surprisingly small amount in the circumstances. Let’s see if we can reconcile the movement.

The cashflow statement shows new borrowings of £375m, which is pretty much accounted for by the £200m Virgin Group loan and the £170m loan from Davidson Kempner Capital. We know that they raised another £60m of debt through a bond issue, so that would take us over the total. Maybe they never drew the full amount of the Davidson Kempner loan? We know that they repaid $110m (c.£79m) after the year end because the interest rate was so penal.

The cashflow also shows the drawing down of a £216m credit facility and the raising of a new £2m finance lease, probably financing an engine. Repayments on long-term borrowings were £57m and they also recorded £56m of finance lease payments.

Taking account of all these movements should have increased borrowings by £480m. We know that £103m of the £200m loan was not included in borrowings. But we are still missing over £100m. Some of that might be due to the strengthening of the pound against the dollar, as Virgin have £1.9 billion of dollar denominated debts. Some may be due to lease payment deferrals where the interest rate charged by the lessor is less than the rate at which Virgin discounts the payments back to today.

Adjusted balance sheet metrics

Virgin Atlantic is obviously a bit nervous that their balance sheet looks quite “stressed” at the moment. They therefore included a set of “adjusted balance sheet metrics” in their accounts. These add the additional value of their UK slot portfolio, beyond what is already recognised in the balance sheet, to give an adjusted net assets position. This adjustment was shown as £423m at the end of 2020, up from £350m at the end of 2019.

I’m not sure on what planet the value of Heathrow slots went up during 2020, but apparently that’s the planet that the Virgin accountants inhabit.

Cash and liquidity

Virgin Atlantic finished the 2020 year with only £191m of cash. At two months of cash costs, that’s essentially zero for an airline the size of Virgin.

After the year end, they did a sale and lease-back of what I think were their last two unencumbered aircraft, raising £40m of net cash after paying off some of the Davidson Kempner loan. The accounts reveal that they got another £97m of funding from Virgin Group on the 15th of March and an additional £63m of “support from creditor groups”, presumably lessors continuing to defer payments.

With the UK government about to make an announcement about reopening travel from the 15th May, I’m sure Virgin are praying that this will include a reopening of UK-US travel. The jump in bookings that would undoubtedly result might enable them to start to rebuild their cash balances.

If not, let’s hope that Virgin Group still has some spare cash lying around.

Virgin AtlanticBritish AirwaysDeltaResults

Robert Boyle