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Qantas not impressed by Virgin capital raising

Qantas Airways (ASX: QAN) CEO Alan Joyce has launched an aggressive campaign in opposition to a proposed $350 million capital raising by competitor Virgin Australia Holdings (ASX: VAH).

Virgin, which operates airlines Virgin Australia and TigerAir, last week announced a 5-for-14 share offer to existing shareholders in order to improve the company’s debt position and allow it to more aggressively compete with Qantas on its profitable domestic routes.

Mr Joyce has taken exception to the raising, labelling it the the “final act” of “predatory” state-owned airlines looking to undercut Qantas. In a brutal letter to Prime Minister Tony Abbott, Transport Minister Warren Truss and all state governments, My Joyce requested the government view the raising as a takeover attempt with the relevant forensic review by the Foreign Investment Review Board.

Currently 63% of Virgin shares are owned by Air New Zealand (ASX: AIZ), Etihad Airlines, and Singapore Airlines. Mr Joyce’s theory is that the airlines are bankrolling the loss-making Virgin airlines in order to weaken Qantas’s domestic operations to the point where Qantas cannot continue to support its currently loss-making international routes, allowing its competitors to move in. It seems a fair assessment, seeing as Virgin made a huge push in 2012-13 to undercut Qantas on its domestic routes, pushing the company to a $98 million loss while Qantas was still marginally profitable.

The share placement is underwritten by the three airlines, who will pick up any entitlements not taken up by other investors in order to take their holding to 73%.  Under the deal, the three airlines will also be given seats on the board.

Mr Joyce’s letter comes as Qantas looks to cut its codeshare agreement with South African Airlines (SAA) short of the 2015 end date. It is understood that the regulatory hurdles have become unworkable and the Sydney-Johannesburg route would be replaced with a Perth-Johannesburg route, most likely through Dubai with codeshare partner Emirates.

Qantas and SAA last year requested a five-year extension to the codeshare but was only awarded a one-year deal due to concerns that the pair had a duopoly on the route which would make entry by a third party difficult. At the time, SAA noted that the route was loss-making, however the Perth-Johannesburg route was generating a small profit. Qantas have confirmed that it remains dedicated to servicing the route, regardless of the codeshare agreement.

Foolish takeaway

Alan Joyce is doing his best to turn around Qantas. The company is undertaking an aggressive fleet renewal program and cutting costs all over the business in order to start generating reasonable returns from the airline’s huge fleet and cash hoard.

His job is being made no easier by international rivals and any intervention by the government will be seen as a positive and likely result in significant share price upside. Buying now would be risky, with share price downside possible if demand remains poor and discounting by Virgin continues to lower yields on Qantas domestic flights.

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Airlines have unperformed the market over the short and long term, and don't pay any dividends. The potential for medium term gains is there, especially for Qantas if it can withstand the sustained pressure from Virgin, however if you're more interested in a stock paying a big, reliable dividend, you should discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."

Motley Fool contributor Andrew Mudie does not own shares in any of the companies mentioned.

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