Virgin America's Ownership Question

I've written several posts around the question of whether or not Virgin America should be considered "American" (here, here, and here, to start). Now, after having some more time to think about it, I thought I'd spend a little more time on this question.

As followers of this saga know by now, US foreign ownership rules state that that a foreign entity may only own less than 25 percent of the voting shares of an airline that carries passengers domestically within the US. Whether or not this program makes sense (I tend to argue against it), it is the law and there is no way around that fact.

When Virgin America was first conceived, we all knew it would get extra scrutiny since the catalyst for its existence was Sir Richard Branson, British national. It took them quite some time, but they eventually created a structure that the DOT approved. Branson's Virgin Group owned all that it could, and the rest was owned by two US-based funds that were only funded by US citizens.

There was a unique clause in the agreement allowing the funds to pull out their investment with a guaranteed 8 percent return if the funds so chose at certain points in time. This has been the subject of many arguments lately.

The rumors started awhile ago, but it was only recently that word had been leaked that the two funds had decided to take the money and run. And who could blame them? An 8 percent return on an investment is absolutely stellar considering the state of the economy in general these days. Meanwhile, Virgin America continued to lose money. I can't imagine anyone else would have acted differently. But what happened to their shares?

Virgin America denies that anything has changed, but the awkwardness of CEO David Cush's statement would say otherwise. He said, "Any story saying that 76% of voting shares have been sold back to the Virgin Group and are being held by the Virgin Group is an inaccurate story." That sort of specific statement seems like it would be factually correct but it might be shadowing what has actually happened.

If we assume that the reports are true that the US funds have cashed out, either Virgin Group had to buy the shares back or they would have had to find new US-based investors to buy the shares. Considering the current state of the airline and the entire industry, there realistically are probably only two options here. It would be very hard to find an investor to take that kind of risky investment in this economy, so they would likely have to offer the same guaranteed return to an American investor if they had to act immediately.

But that wouldn't be consistent with Cush's statement. So what else could they have done? They could have set it up so that while the funds cashed out, they still retained the voting shares while Virgin Group reviews its options. That would be consistent with David Cush's earlier statement. If true, I think it's safe to assume that this is a temporary arrangement until Virgin America can find someone to take them off their hands.

All these changes may technically satisfy the law, but that doesn't mean the DOT will end up accepting them. Certainly, the changes that have happened recently cast some doubt on the independence of the US-based ownership group. If there's a guaranteed return at the end of the day, should it really be considered equity or is it really just debt in disguise?

The current situation which has shares owned without any financial commitment may also stoke the fires at the DOT, but that raises an even better question. Is the DOT even paying close attention these days?

President Obama's choice for Secretary of Transportation, Ray LaHood, has had very little exposure to the airlines in his past experience, and his new organization hasn't really been filled out yet. There are probably bigger fish to fry right now than dealing with a relatively tiny upstart airline and its ownership. If it's in a gray area as it appears to be now, then the incentive to devote time to this is probably fairly low until his organization is built out further. That's probably why Alaska continues to push hard on a review of the ownership question. They're probably hoping the squeaky wheel gets the grease.

So where does that leave us? It's unclear right now. But my guess is that Virgin America will not be shutdown for ownership reasons anytime soon. It will, however, make for a very interesting DOT review.