Virgin Atlantic rescue deal, a drop in the ocean

How significant is Tuesday’s creditor vote?

There have been many breathless headlines about the upcoming vote of Virgin Atlantic creditors on Tuesday, such as this one from the FT: “Virgin Atlantic in last-ditch creditor talks ahead of crunch vote”. Does the significance of what is being voted on justify such headlines?

According to documents filed with the UK High Court, Virgin Atlantic has debts of about £2.2 billion and has essentially exhausted its cash. There is no doubt that if the deal isn’t agreed, the company will need to file for administration immediately.

Using some of the detail revealed in those documents, let’s look at what this deal is going to do to reduce Virgin Atlantic’s debts and rebuild its cash and liquidity.

Restructuring £2.2 billion of debts

£750m ($1bn) of the debt is in the form of finance leases on ten aircraft and “because of the potential complexities of including them in the scheme, it is no longer intended that their rights should be compromised under the Restructuring Plan.” So, no change.

Another £220m relates to bonds secured on Virgin’s slots. No changes appear to be proposed there either.

£210m ($280m) is in the form of a Revolving Credit Facility (RCF), secured on Virgin’s three remaining owned aircraft (I think these are 787-900s) plus some engines. The radical change here is to turn it into a term loan with extended duration at an increased interest rate (an extra 1% on top of the existing LIBOR + 1.75%). Oh, they have also graciously agreed to release one engine from the their security package so that Virgin can offer it as security to underpin a new £30m loan.

The remaining £1 billion ($1.25bn) relates to the outstanding payments on 24 operating leased aircraft. Lessors are to be offered a three way option: payment deferral, rate reduction plus a “bullet payment” (presumably paying back all the reductions with interest at the end of the lease) or lease termination. In the current environment where there is a massive surplus of aircraft, the last option is unlikely to be taken up by lessors. So all that is likely to happen is a re-profiling of payments. No actual debt reductions here either.

So, the only impact of the deal on the £2.2 billion of debt and lease liabilities is some extending of maturities and rolling up and deferment of short term payments. Not exactly a transformative restructuring and it is not surprising that this has already been agreed by lenders and lessors.

Trade creditors are asked to share the pain

Turning to unsecured trade creditors, there is £400m owed to jointly controlling shareholders, Delta and Virgin Group. They will exchange their claims for preference shares. As the owners of the business, this is literally the least that they could do.

Most other creditors will be unaffected by the restructuring, either because they are too insignificant to bother about (a thousand creditors each owed less than £50,000), too important to the ongoing business (air traffic control, insurance companies, sales agents, advisors and so on) or where an agreement has already been reached.

The only creditors who are being asked to make changes in this vote are 168 creditors who are collectively owed £54m. They are being asked to take a 20% haircut, get paid 10% straight away and to accept that the remaining 70% will be paid over two years with interest payable at 1%. So a £10.8m reduction in liabilities for Virgin and the remaining £37.8m paid over two years. This is all that is being voted on and the Court has the power to impose it anyway even if the vote is lost.

What new money is on offer?

The new money which is being “unlocked” by the changes being asked of the creditors adds up to £400m and it is all in the form of additional debt.

£30m is a term loan from a “new investor”, secured on the engine released by the RCF lenders.

£200m is from controlling shareholder Virgin Group and is in the form of an unsecured junior term loan facility. Not equity as you might have perhaps have expected.

The remaining £170m is from Davidson Kempner and is described as “secured financing”. I’m not really sure what it is secured on to be honest. All of Virgin’s aircraft and engines are either owned by lessors or pledged against the RCF. The slots are securing against the bonds. The brand is owned by Virgin Group. The frequent flyer programme isn’t worth much and would be worth less than nothing if the airline folds.

Proforma liquidity and debt

The day after the deal goes through, Virgin Atlantic will have liquidity of about £400m and debts of £2.6 billion, even if you count the preference shares as equity.

It will have no unencumbered assets left, so this is all the cash it will have to get through the rest of this crisis, fund employee and other restructuring costs and get the airline into profit.

Will it be enough?

In its Q2 results, IAG confirmed a liquidity level of €9.3 billion and net debt of €10.5 billion. IAG is about 8.5 times the size of Virgin Atlantic. Adjusted down to Virgin Atlantic size, that would be about £1 billion of liquidity and net debt. So Virgin will have less than half the liquidity and two and a half times the net debt that rival IAG has.

IAG also announced in its Q2 results that it felt it necessary to top up its liquidity and reduce its debt by launching a €2.75 billion rights issue. In Virgin Atlantic size terms that would represent another £300m of extra liquidity and reduced debt.

Everyone agrees that short-haul markets will come back before long-haul, so Virgin Atlantic, a purely long-haul focused airline should need more cash reserves than IAG in relation to its size. It has also not even made a start on dealing with its customer refund bill. With £350m of credit card liabilities, that could easily eat up most of its £400m post deal liquidity by itself.

In summary

I think that Virgin Atlantic will at some point over the next 6-12 months need around another £1 billion of new equity, even after this restructuring deal goes through. For an airline that hasn't made a profit in years, I’ve no idea where the business case for this will come from. Undoubtedly shareholder loans will be swapped into equity, but that doesn’t address the need for an equally sized amount of new cash.

Having said that, I fully expect the unsecured trade creditors to accept the 20% haircut in the vote on Tuesday. If they don’t and the Court fails to impose it, my guess is that Virgin Atlantic’s other creditors, shareholders and new lenders will go ahead with the rest of the package anyway. Remember, the concessions being voted on are only worth £10.8m and the spreading out of £37.8m of payments. That’s a tiny drop in the very large ocean of money that will be required to get Virgin Atlantic through the crisis and into a financially sustainable position.

Unless of course the 168 trade creditors resent being asked to accept a bigger haircut than other creditors and reject the deal, the Court refuses to impose the deal against their will and Davidson Kempner has been getting cold feet as the crisis drags on and is looking for an excuse to pull out and blame someone else.

If that is the case, the breathless headlines may in retrospect prove to have been fully justified.