Qantas CEO Faces Biggest Test in Borghetti’s Revenge

Jan 23, 2014 10:39 pm ET

(Corrects reference to cash flow in fourth paragraph of story published on Jan. 22.)

Jan. 22 (Bloomberg) -- John Borghetti spent 36 years helping build Australia’s biggest airline, Qantas Airways Ltd. Since joining its main rival in 2010, he’s worked to exploit every weakness he can find at his former employer.

The chief executive officer of second-ranked Virgin Australia Holdings Ltd., who lost out to Alan Joyce in running for the top job at Qantas in 2008, has added business class seats, renovated airport lounges, and taken control of smaller airlines to challenge the so-called Flying Kangaroo’s dominance of the nation’s lucrative domestic aviation market.

“He’s out for revenge,” Tony Webber, managing director of Webber Quantitative Consulting who was a colleague of both men as Qantas’s former chief economist, said of Borghetti. “He’s out to prove a point to Qantas and say ‘This is how it’s done’. And he’s outdoing them.”

Joyce, 47, is on the defensive. Since forecasting a first- half loss of as much as A$300 million ($266 million) last month and 1,000 job cuts, 93-year-old Qantas has lost both its investment-grade credit ratings and hit a record low of 95.25 Australian cents per share. Over the full year to June, the carrier is forecasting negative free cash flow, highlighting the shortcomings of a business model built on its once near-monopoly status.

By adding seats and flights, Borghetti, 58, has forced Joyce to increase capacity to defend Qantas’s 65 percent share of the domestic market -- a “line in the sand” the carrier says it won’t surrender.

Mail Room

Borghetti arrived in Australia from Italy in 1963 at the age of seven, unable to speak English. After leaving school, he took his first job at Qantas in the mail room.

He’s been backed up in his fight against Qantas by shareholders Air New Zealand Ltd., Singapore Airlines Ltd. and Etihad Airways PJSC. The three carriers, which compete with Qantas internationally, have a combined stake of about 64 percent in Virgin, according to data compiled by Bloomberg, after committing to spend as much as A$316 million on a capital raising late last year.

“Fighting for market share for the sake of market share is expensive, and beyond a certain point it becomes a zero sum game,” Scott Gustetter, chief executive of aviation consultants Aspirion and a former Qantas network strategist, said by phone from Sydney. “To maintain that 65 percent line against an airline that has access to equity capital is a losing battle.”

National Battle

The fight has hit the stock of both airlines. Qantas’s shares have dropped more than 50 percent under Joyce and plunged 27 percent last year. Virgin has slumped more than 20 percent since Borghetti took over and slipped 8 percent in 2013.

Qantas shares fell 1.3 percent to close at A$1.105 in Sydney. Virgin Australia also declined 1.3 percent.

Joyce, the Irish son of a cleaner and cigarette factory worker, went to Dublin’s Trinity College and took his first job in the industry at Aer Lingus Group Plc as a graduate recruit when he was 22. He has framed the contest with Virgin as a national battle and lobbied the government to scrap a 49 percent cap on foreign ownership of Qantas to help it fight back.

“The agenda of these foreign airlines is to terminally weaken Qantas,” Joyce wrote in a Nov. 22 e-mail to staff. A federal law caps foreign ownership of Qantas and limits its access to capital, according to the airline.

Purely Business

Any competition between the two companies is purely about business rather than personal rivalry, Qantas spokesman Andrew McGinnes said by e-mail. Virgin doesn’t comment on its competitors, spokeswoman Emma King said by e-mail.

When Joyce took over as chief executive in 2008, Qantas had a near-monopoly of Australia’s domestic non-discount market. The collapse of Ansett Holdings Ltd. in 2001, at a time when Virgin Australia was a fledgling discount carrier, left Qantas without a nationwide competitor in full-service aviation.

Borghetti, who had also been considered for the chief executive role, had risen from the mail room to become Joyce’s executive general manager in charge of sales, marketing, customer service and network. He’d been responsible for unveiling new Airbus SAS A380 interiors, premium economy cabins, and Qantas’s first logo change in 23 years.

Contrasting Styles

Six months after Joyce took over, in May 2009, Borghetti left the airline. A year later, he took a new job as Virgin CEO, and in May 2011 announced a rebranding of the former budget carrier with a promise to capture a bigger share of the Qantas- dominated corporate market.

The two men had contrasting management styles at Qantas, said Webber. Joyce’s background as a mathematician gave him a superior understanding of the company’s financial and operational data, while Borghetti had better inter-personal skills, he said. Neither executive was available for interview.

Borghetti has increased Virgin’s share of domestic aviation capacity to 34 percent as of October, from 29 percent in May 2010, after consolidating flights by its majority-owned budget carrier Tigerair Australia, according to data provided by airlines and the government. The expansion has come at a cost: Virgin has racked up A$143 million in net losses during the three full years that Borghetti’s been in charge, data compiled by Bloomberg show.

In December, more than 85 percent of Qantas domestic flights arrived at their destinations on time, compared with 82.3 percent for Virgin, 78.4 percent for Jetstar and 77.3 percent for Tigerair Australia, according to new data from the Bureau of Infrastructure, Transport and Regional Economics.

“I’m not convinced that the shareholders of Virgin have bottomless pits of money,” Matt Crowe, an analyst at Commonwealth Bank of Australia in Sydney, said by phone. “They have a strategy to enter the corporate market and be competitive on lots of domestic routes -- I wouldn’t put it any stronger than that.”

Shareholder Backing

A loss for the six months to Dec. 31 at results due next month may also leave Qantas with aggregate net losses since Joyce took over in November 2008, data compiled by Bloomberg show. That compares with A$3.31 billion of profits posted in the previous five years.

Joyce, who’s started a review of the airline’s corporate structure and capital spending and promised to cut A$2 billion in costs, has declared just a single dividend as chief executive, at his first interim results in February 2009.

Key investors aren’t deserting. Only one of the company’s top ten shareholders has cut its stake since Joyce forecast a first-half loss Dec. 5, according to regulatory filings.

The 22 million shares which third-placed Capital Group Companies Inc. has sold have been surpassed by a 46 million- share stake build by the company’s largest shareholder, Franklin Resources Inc., the filings show. UBS AG has also added about 24 million shares to its holding, the fifth-largest, according to data compiled by Bloomberg.

‘Magic Bullet’

Tony Cannon, a Tokyo-based spokesman for Capital Group, and Erica Borgelt, a Sydney-based UBS spokeswoman, declined to comment. Andrew Sisson, investment manager of Franklin Resources’ Melbourne-based Balanced Equity Management, didn’t respond to three phone messages seeking comment.

Qantas has been the victim of circumstance rather than mismanagement, said Sean Fenton, who helps manage about A$4.7 billion in assets at Tribeca Investment Partners Pty. in Sydney.

“I don’t think a different board, a different strategy or anything else would have made the competition go away,” he said by phone. “Sometimes there is no right answer, no magic bullet that would make everything fantastic.”

The country’s domestic aviation market can generate more than A$1 billion in annual profits, according to Deutsche Bank AG estimates. Airlines globally will post a combined $19.7 billion in net income in 2014, the International Air Transport Association said last month.

Optimal Place

By holding onto a 65 percent share, Qantas is seeking to maximize profits through connections and departure times that make its network more attractive to corporate accounts, while making it costly for competitors to get a foot in the door, according to Gustetter.

“There’s an optimal place where you get the greatest benefit in terms of yield and distribution, without having so much dominance that you’re under scrutiny from the regulator,” he said.

With Qantas funding its battle through costly debt and Virgin accessing equity capital from its airline shareholders, that business model may now be outdated, he said: “There will come a point where the Qantas management team will do their sums and say, ‘Holding the line at 65 percent costs us more than we can afford’.”

--Editors: Edward Johnson, Anand Krishnamoorthy