Aviation: Virgin leads offer for Flybe

A consortium comprising Virgin Atlantic, Stobart Group and US equity firm Cyrus Capital Partners have tabled a formal offer to buy troubled UK-based regional airline Flybe. The deal, unanimously recommended by the Flybe board but subject to shareholder approval, values the carrier at £2.2m or £0.01 per share. The three partners have also pledged to provide £20m in working capital and future investment of up to £80m to secure the future of the struggling short-haul operator.

Flybe's Embraer 175 jets are likely to be retained if a takeover by a consortium including Virgin Atlantic is agreed by shareholders. (Flybe)

Connect Airways has been formed as a platform for the bid, with holdings in the new firm split between Virgin Travel Group (30%), Stobart Aviation (30%) and DLP Holdings (owned by Cyrus’ funds - 40%). If the deal is finalised following a court hearing and a shareholder meeting, the Flybe name will be maintained in the short term. However, longer term plans involve Connect Airways flying under the Virgin Atlantic brand “to the extent possible.” Flybe is expected to retain its UK air operators certificate (AOCs), while Irish carrier Stobart Air will be brought into the group but will maintain its current franchise and leasing activities.

Route optimisation is anticipated, which is likely to result in cuts to the fleet of 76 Bombarder Q400s tubroprops and Embraer 175 jets currently operated by Flybe, as well as some job losses. But Connect Airways says it recognises the “importance of regional connectivity” in the UK and will focus on Flybe’s core network, which will be simplified with the aim of improving its performance. Flybe’s timetable will also be optimised to improve links with the Virgin and Delta Air Lines networks.

Broader network

In a statement to the market, the prospective buyers said: “Cyrus, Stobart Group and Virgin Atlantic believe that combining Flybe and Stobart Air in a more commercial operation with Virgin Atlantic’s long-haul operations will create a fully-fledged UK network carrier under the Virgin Atlantic brand… Such a combination would be a compelling proposition with a comprehensive regional network in the UK and Ireland coupled with an enhanced European footprint, providing... connectivity for customers to travel to destinations all over the world.”

Christine Ourmières-Widener, CEO of Flybe, added: “The industry is suffering from higher fuel costs, currency fluctuations and significant uncertainties presented by Brexit. We have been affected by all of these factors which have put pressure on short-term financial performance… By combining to form a larger, stronger group we will be better placed to withstand these pressures.”

Shai Weiss, CEO of Virgin Atlantic said that Connect Airways will provide excellent connectivity to Virgin’s long-haul network and that of its joint venture partner Delta Air Lines (holder of a 49% interest in Virgin Atlantic) at London Heathrow and Manchester airports. He added that the proposition will be further strengthened through the proposed 31% investment Air France / KLM aims to take in Virgin Atlantic.

Declining value

Flybe has been profitable in only two of the last six years. It was floated on the UK stock market in 2010 and its value briefly peaked at £300m but shares dropped below £0.09 in November 2018 following a profits warning. After an early-November announcement it was open to acquisition, Flybe stock rose to £0.22 but then fell back to around £0.16 this year. Trading conditions have since deteriorated with credit card acquirers withholding more cash. On January 11 when the Virgin / Stobart / Cyrus offer was announced, Flybe's share price slumped to less than £0.03.

There may be light at the end of the tunnel for struggling Flybe as increased connectivity will add value to its network. (The Aviation Oracle)

The bid made by Connect airways values Flybe at less than 1% of its peak. Less than two months ago the ailing airline unlocked £5m in capital by selling and leasing back a hangar at Exeter Airport. The proposed takeover deal now puts FlyBe's value at less than half of that sum. While there is no doubt that Virgin, Stobart and Cyrus see an opportunity to strengthen their existing businesses, the struggling airline's parlous financial situation has enabled a low-ball offer.

The directors have recommended the buy-out that will pay shareholders £0.01 per share, around 6% yesterday's value, describing the offer as "fair and reasonable." This suggests the board believes there is little chance of Flybe being turned around as a standalone alone entity or without substantial additional investment. Shareholders are therefore likely to accept the deal no matter how unpalatable it seems at first sight; the stock is now worth around £0.03 and the alternative could be liquidation and a complete loss.

Stronger with partners

The Aviation Oracle has previously discussed the prospects for Flybe in some depth. The proposed takeover by Virgin Atlantic / Stobart Air / Cyrus makes a lot of sense. The carriers already code-share on some routes and a revitalised regional operation under the Virgin brand creates an opportunity improve connectivity at two of the UK’s major international gateways. Flybe provides more than 20% of the flights from Manchester, from where Virgin Atlantic and its shareholder Delta Air Lines operate to destinations in the USA and the Caribbean. At Heathrow, Flybe holds a limited number of domestic slots which are currently ring-fenced for domestic services, but with some juggling further opportunities to channel passengers onto Virgin's services to North America, Asia and Africa will be possible. And if Air France / KLM's proposed 31% investment in Virgin is approved by competition authorities, Connect Airways will be further boosted through Flybe’s significant slot holdings at Amsterdam and Paris Charles de Gaulle airports.

Winners and losers

Connect Airways says that following a successful acquisition, it to focus on three principal objectives:

• Simplifying and focusing on improving the performance of Flybe's core network whilst recognising the importance of regional connectivity.

• Adjusting Flybe's network to improve connectivity with Virgin Atlantic’s long-haul network, particularly at London Heathrow Airport and Manchester Airport.

• Operating the combined group as an independent company, and optimising the combined commercial, operational and functional expertise and scale of Virgin Atlantic and the Stobart Group.

Flybe currently controls more than 30% of the UK domestic aviation market, slightly behind easyJet but well ahead of British Airways. Flybe has focused on regional services between secondary airports that are uneconomic for larger jets. Its Bombardier Q400s are ideal for many of these operations but some of the airline’s routes and bases are loss-making. AviationAnalytics recently ranked only nine of Flybe's focus airports as 'excellent' or 'good' in terms of profitability per seat. A further eight were ranked as 'marginal', while four were judged 'poor' and one 'heavy losses'. With a renewed focus on long-haul connectivity and a need to improve financial performance there will inevitably have to be some cuts.

The Flybe fleet, including Boombardier Q400s, is likely to be rebranded with Virgin's corporate colours. (Flybe)

There will be an increased focus on connections at Manchester Airport. Three of Flybe’s top ten routes (to Belfast, Aberdeen and Southampton) originate from the northwest hub and others will be boosted or retimed to improve interlining. Heathrow will see greater schedule coordination between Flybe and Virgin, but with very few slots available there will be constraints on how much the enlarged group can do. Flybe routes with little or no long-haul connectivity at either end – such as those radiating from Doncaster / Sheffield, Cardiff, East Midlands, Humberside and Norwich – are likely to be vulnerable to capacity reductions and cancellations. Bases as Southampton and Exeter, which are believed profitable in their own rights, are likely to remain relatively intact.

Although the Birmingham Airport (BHX) operation was cut back last year, it is a major base for Flybe and it is where Connect Airways true ambitions will likely be revealed. Maintaining BHX services, few of which plug into Virgin's network, at or near current levels will point to an ongoing commitment to the UK regional and near-European short-haul network. Substantial cuts will indicate a substantial refocus on long-haul connectivity.

Still needed

Flybe is vital to the UK's regional air connectivity. Although it has been loss making in most recent years, it offers services between areas of the country that are not quick or easy to reach by surface transport. It is therefore vital that at least part of the carrier's network is preserved and the performance of what remains is honed into a profitable operation. The proposed Virgin / Stobart / Cyrus deal offers an opportunity to do that. The loss of the well-known brand, cutbacks to the network and some redundancies will be disappointing to many, but the closure of the airline would be worse. It is however possible that shareholders could reject the deal. Alternatively a better offer could yet be made by another party. How much would IAG (owner of British Airways) or easyJet now have to pay to gain control Flybe, if either have ambitions to grow their UK domestic market or stifle Virgin's ambitions?

Text © The Aviation Oracle