The Connect Airways’ takeover is curious, says Ian Taylor

The sale of Flybe reached its endgame on Monday with shareholders voting to accept the £2.2-million offer from the Connect Airways consortium comprising Virgin Atlantic, Southend Airport-owner Stobart Group and US hedge fund Cyrus Capital.

The offer of 1p per share was opposed by the two biggest shareholders, but that was rendered largely irrelevant since Flybe’s directors sold the group’s assets, including the airline, to Connect Airways for £2.8 million on February 22.

The board said it did so “to enable Flybe to continue to trade”. The choice for shareholders was 1p per share or nothing.

Flybe was put up for sale in mid-November following a profit warning in October.

The airline was trading with a market capitalisation of £43 million in early December, but its position deteriorated rapidly as credit-card companies withheld payments.

The consortium emerged with an offer the Flybe board accepted on January 11, with a bridging loan to keep Flybe operating.

The offer was revised on January 15 with an additional payment of £2.8 million for Flybe’s assets and a £10 million loan made immediately available as “Flybe had been unable to draw any funds”.

The sale of the assets forestalled a potential bloc on the deal which was opposed by investment group Hosking Partners, owner of almost 19% of the group, and by the estranged former boss of Stobart Group, Andrew Tinkler, who spent £1 million acquiring a 12% stake.

 

Survival required minimum delay

Clearly, Flybe would have folded without the takeover proceeding quickly. But the deal begs some questions – not least, what is in it for Virgin Atlantic, Stobart and Cyrus Capital?

Virgin Atlantic will own 30% of Connect Airways, Stobart Group 30% and Cyrus Capital 40%.

Flybe will be rebranded as Virgin Atlantic but continue to operate independently.

Stobart Group’s Stobart Air, which operated on behalf of Flybe from Southend under a franchise agreement, will form part of Connect Airways as will Stobart aircraft-leasing company Propius.

Cyrus, Stobart and Virgin Atlantic have committed “to provide up to £80 million of further funding”.

They promise “enhanced connectivity to the UK regions and Ireland under the Virgin Atlantic brand”, “improved connectivity at Manchester and London Heathrow” and “an enhanced presence at Manchester [and] Heathrow . . . with the potential to grow in London Southend Airport”.

The consortium’s intention is to “adjust Flybe’s network to improve connectivity with Virgin Atlantic’s long-haul network, particularly at Heathrow and Manchester”.

That is all very well, but the business newspaper the Financial Times noted the Connect Airways group is “paying a heavier price” than it appears: “The total cost will be at least £185 million.”

It also noted: “Flybe faces multiple challenges. It competes with trains and roads on 100-plus routes, [and] with Ryanair and easyJet on the most lucrative ones. It is weighed down by excess capacity and costs, resulting in £82 million-plus in debt.”

Overcapacity squeezing margins

The deal’s rationale is hard to see in the cold light of the current aviation market where overcapacity is squeezing margins on short-haul routes.

Hedge fund Cyrus Capital has partnered with Virgin Group in the past. It was a launch investor in 2005 in US airline Virgin America, which was acquired by Alaska Airlines a year ago.

But Flybe is not Virgin America, and the UK regional market which comprises 55% of Flybe’s flying is not the enormous and profitable US domestic market.

Stobart Group, which made a previous bid for Flybe in February last year, has issues of its own.

The group is a hybrid combining Southend Airport, acquired in 2008, with Stobart Air, aircraft lessor Propius and a biomass business. The Stobart road transport business was long since divested.

Stobart Group cut its dividend to shareholders in December, triggering a fall in its share price, and has said it needs funds to invest in Southend Airport where Ryanair is due to launch flights this summer.

It spent £18 million developing and promoting its franchise arrangement with Flybe at Southend, then announced in October that it was ending the deal.

Instead, Stobart Air will now operate as part of Connect Airways from Southend, where it will soon come up against Ryanair.

Southend is very much London’s sixth London airport. It has grown rapidly in the past year, serving 1.45 million passengers in the 12 months to November, but remains some way behind the size of Southampton and Belfast City and smaller than Jersey airport.

Stobart’s options with Southend are limited by its geography to flights to Continental Europe, to which it must compete with Gatwick, Stansted and London City.

Virgin Atlantic’s need is clear

Virgin Atlantic’s need for connecting traffic is clear. But its experience with its own Little Red operation between Heathrow and Edinburgh, Aberdeen and Manchester indicates the difficulty of making domestic routes viable.

Little Red launched in 2013 when Virgin Atlantic took over slots released by British Airways-owner IAG as a condition of its acquisition of BMI.

Virgin pulled the plug on Little Red in 2015 as losses mounted and the slots went to Flybe. The acquisition will now see them revert to Virgin Atlantic-Connect Airways.

It will see Virgin Atlantic get a lot more, of course – Flybe operates 76 aircraft on 190 routes – and Virgin has the backing of US giant Delta Air Lines, so it is secure.

The carrier will also be joined later this year by Air France-KLM both as a shareholder and in an expanded joint venture.

Air France-KLM’s UK strategy is based on multiple daily flights from UK regional airports connecting to long-haul services by KLM from Amsterdam Schiphol and Air France from Paris Charles de Gaulle. Where does Southend fit into that?

The notion of Connect Airways developing connections to Heathrow and Manchester to suit Virgin Atlantic on the one hand and building capacity at Southend on the other appears contradictory.

And Flybe operates to only two of Virgin’s three UK departure points – having sold almost all its slots at Gatwick to easyJet in 2014 and the remainder to Vueling in January this year.

The economics of operating a regional fleet, which Flybe struggled to make work, won’t change.

Flybe’s competitors on its busiest routes – easyJet and Ryanair – won’t go away, and neither will the competing modes of transport, road and rail, on domestic routes.

There are absolutely no operational synergies between Virgin Atlantic’s long-haul fleet and Flybe’s fleet of small regional turboprops.

All in all, it is a curious deal.

tw3