Virgin America Continues Toward an IPO -- United Continental Beware!
Last week, Virgin America reported that its earnings improved yet again in Q1, although it still posted a loss in the seasonally slow quarter. Following the company's first-ever annual profit in 2013, this puts Virgin America in good position to pursue an IPO at some point in the next year.
An IPO would provide Virgin America with cash that could support additional growth. In the long run, United Continental has the most to lose if Virgin America ramps up its growth plans again, as Virgin's two main bases (San Francisco and Los Angeles) are also United Continental hubs.
Losses turning to profits
Virgin America first took off in 2007, but profits remained elusive until last year because of a combination of tough competition, high oil prices, and the 2008 Great Recession. In early 2013, Virgin America's creditors exchanged a significant amount of its debt for stock, cleaning up the company's balance sheet and reducing interest expense.
This was followed by strong improvement in the company's operating performance during the rest of 2013. As a result, Virgin America was profitable for each of the last three quarters of 2013, which allowed it to post a full-year profit of $10 million, compared with its $145 million loss from 2012.
Virgin America posted a much smaller earnings improvement in Q1 of 2014. The company reduced its net loss from $46 million to $22 million, but that was almost entirely driven by the 2013 debt restructuring. Virgin America narrowed its operating loss just slightly, from $15 million to $13 million.
This isn't a sign that Virgin America is returning to its money-losing ways, though. The first quarter is always the toughest for airline profitability. Additionally, Virgin America's earnings were hurt by a fourfold jump in flight cancellations caused by severe winter weather, as well as the calendar shift of Easter from March to April. Virgin America is still on pace for strong earnings growth this year.
Virgin America grew extremely rapidly in the first few years of its existence. In late 2012, the company made a decision to take a temporary pause in growth and canceled orders for 20 current-generation A320 aircraft. As a result, it has added just one plane to its fleet since mid-2012.
However, Virgin America will start to grow again next year, as it is scheduled to take delivery of five new A320s in the second half of 2015, followed by another five in the first half of 2016. After that, its next scheduled deliveries are 30 A320neos coming between 2020 and 2022.
In the past, United Continental has been the biggest victim of Virgin's growth. Virgin America set up its main bases at two United hubs (San Francisco and Los Angeles) and focused its service on key business markets. It has won the loyalty of many frequent business travelers who might otherwise fly United through superior customer service.
A look into the future
For the moment, Virgin America is focusing its capacity growth on Dallas Love Field, where it recently won the right to use two gates. Virgin will be moving its flights to San Francisco and Los Angeles to Love Field in October. It also plans to start service to New York, Washington, and Chicago -- along with increased frequencies to San Francisco and Los Angeles -- in the next year.
Dallas is not a United hub, but all five markets that Virgin America plans to serve from Dallas are United hub cities. As a result, Virgin's growth in Dallas will continue to put pressure on United, though it won't be as problematic as some of the carrier's other recent expansions.
Looking ahead, Virgin America is planning to use its 2015-2016 aircraft deliveries to support service from San Francisco and Los Angeles to Hawaii. It also wants to enter some more key business markets, including Denver, Phoenix, Houston, and Atlanta.
With just 10 planes on order between now and the end of the decade, there's only so much harm Virgin America can do to an airline the size of United, which has nearly 700 mainline aircraft. However, an IPO could give Virgin America the financial flexibility to ramp up its growth plans. Given the U.S. airline industry's tight supply situation, there should be plenty of opportunities.
Virgin America is never going to return to its 30% growth rate of just a few years ago. However, its rapidly improving earnings may allow it to move to a somewhat more aggressive growth posture compared with the status quo.
Virgin America is definitely looking to go public soon, possibly as early as this fall. Its newfound earnings power and growth potential -- not to mention its potential appeal as an M&A target -- should make it an appealing target for investors in an IPO.
The people who shouldn't be excited about Virgin America's trajectory are United Continental investors. Virgin America has set up shop in United's backyard, and its premium amenities and superior customer service are helping it gradually steal some of United's most profitable customers. Further expansion by Virgin America in San Francisco and Los Angeles will make it even harder for United to retain its grip on the corporate travel market there.
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The article Virgin America Continues Toward an IPO -- United Continental Beware! originally appeared on Fool.com.Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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