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Virgin Is In For A Bumpy Ride

Branson's flashy airline is having a tough time Down Under

Virgin Is In For A Bumpy Ride

Branson's flashy airline is having a tough time Down Under

When Richard Branson announced plans for a low-cost Australian version of his high-flying Virgin Atlantic Airways last year, the news sent a chill through the local industry. It wasn't that Qantas Airways Ltd. and Ansett Australia, the titans of Australian air traffic, weren't expecting new competition; the same year, the federal government had formally relaxed industry ownership rules, for the first time allowing foreigners to own Australian carriers outright.

But this was Richard Branson. The flamboyant Briton's reputation for innovation and aggressive marketing tactics set Australian investors to fretting that his discount-fare Virgin Blue would provide stiff competition for Qantas and Ansett. Even though Branson's new carrier was months away from its launch date, investors hammered down Qantas' stock price by 20%--a level from which it has never fully recovered. The Branson buzz continued right up to a Virgin Blue launch party in July that featured celebrities, dancing, and a photogenic, champagne-spraying Sir Richard.

DOGFIGHT. Since then, Branson has had little reason to celebrate. Virgin Blue's early August launch had to be postponed for several weeks because the carrier failed to clear regulatory hurdles. The delay forced it to refund ticket money to some 1,500 passengers. Virgin Blue's moves to undercut rivals with cheap tickets have also achieved limited success. Qantas and Ansett, it turns out, were prepared for a bruising dogfight. And until at least next year, Virgin's fleet will comprise only five 162-passenger Boeing 737-400s, making it hard to attract business travelers, who demand frequent flights and flexibility.

Nothing, however, is hurting Virgin Blue more than high oil prices and a weak Australian dollar. Since last November, when Branson announced his plans, oil has jumped from $22 a barrel to more than $30. The Australian dollar has fallen 16%, to 54 cents to the greenback. Virgin Blue CEO Brett Godfrey admits this double whammy has played havoc with his forecasts. The currency and oil shocks, he says, "will obviously impact the bottom line. I've already alerted my board."

The fare war is also hurting Virgin Blue's balance sheet. Branson originally vowed to sell 50% of all domestic seats for $54 one-way, or half the regular fare. But in August, Impulse Airlines, another low-cost upstart, began offering an $18 one-way fare from Sydney to Brisbane. Branson came back with a short-term offer of $26 on the same route. But Godfrey admits he never expected fares to go so low.

Unlike Virgin Blue, the big carriers can easily afford to continue discounting seats. After all, Qantas made a record $235 million in profit last year on revenues of $4.92 billion. Nor is it hurt by expensive fuel, because management hedged at $10 below the current price, say analysts. Already Qantas is selling about one-third of its seats within Australia below or near Virgin Blue's benchmark of $54.

BIG BLITZ. Branson acknowledges that his new airline will need to fill a lot of seats just to break even. From the start, he has declared himself willing to lose money for the first three or four years. But Virgin Blue will likely burn through its $10 million in seed capital and $15 million loan from the parent company well before then. Godfrey insists that Branson will fund the venture "indefinitely."

Branson's gamble is that his flashy, low-fare airline will kick off a surge in Australian air travel, which will eventually deliver profits. As ticket prices fall, analysts do expect the number of passengers to rise at least 8% this year, up from 26.2 million in 1999. Ten years ago, when local airline Compass I made a run at this market, airfares fell 30% and passenger volume grew 60% in 12 months, according to Goldman, Sachs & Co. analyst Jean-Louis Morisot. But that didn't prevent Compass I from failing shortly afterwards. This time, new operators like Virgin are using smaller planes and relying on cheaper, mostly non-union staff, as well as promoting cost-effective electronic ticketing.

By the end of the year, Virgin Blue plans to have five routes Down Under--each producing annual revenues of some $27 million. Ten more Boeing 737s will arrive in the next two years. The Branson marketing blitz will be relentless.

But Virgin Blue must still expect turbulence. Impulse is just one of a handful of new carriers moving into Australian skies. Even Godfrey admits that two low-fare carriers don't typically attack the same route and prosper. Branson definitely has the dash. What he needs now is the grit to hang on.