SYDNEY (Reuters) - The bad-tempered battle between Virgin Australia Holdings Ltd (VAH.AX) and Qantas Airways Ltd (QAN.AX) over Australia's skies is a proxy for increasingly tough regional competition among carriers including ambitious Gulf airlines Etihad and Emirates.
The Australian rivals are already losing money in a bitter price war. Now they're trading barbs over Virgin Australia's move to tap its major shareholders - Etihad, Singapore Airlines (SIAL.SI), Air New Zealand (AIR.NZ) - for A$350 million ($330 million) in new capital to bolster its balance sheet.
Analysts expect Virgin Australia to funnel some funds into its business class offering, upgrading onboard and lounge facilities as part of its drive to lure customers from Emirates-backed Qantas.
The Australian business travel market, a high-yielding sector, is estimated by analysts to be worth as much as $3.8 billion. That domestic prize, combined with the potential for loyal customers flowing through to crowded regional routes in the Gulf, Japan and China, makes the country very attractive to the trio of Virgin Australia investors and Qantas's alliance partner Emirates.
"Australia is an important travel market in its own right," said CIMB analyst Mark Williams. "It's the second- or third-largest market for these carriers outside their home market."
Although Australia has a small population by global standards, its relative wealth, far-flung cities and lack of high-speed rail give it an outsized domestic aviation market. The Melbourne to Sydney route ranked fifth in the world by passenger numbers in 2012, according to Amadeus, a specialist provider of IT services to transport companies globally.
Etihad has labeled Australia a "key and long-term" market, even in the face of the price war that helped push both Qantas and Virgin Australia into a net loss in the latest financial year.
The Abu Dhabi-based carrier plans to build premium lounges at Sydney and Melbourne airports next year. Early this year Dubai-based Emirates began daily flights to and from Adelaide, making it the only international airline operating through the southern Australian city with first-class suites.
Qantas earlier this week called on the Australian government to stop its rival's capital raising and reconsider its status as an Australian carrier. Qantas argued Virgin Australia is largely funded by money from predatory airlines backed by foreign governments.
The Australian designation gives Virgin Australia government backing in negotiations for bilateral access rights and traffic slots around the world, while Qantas's status as the national flag carrier restricts its access to foreign capital.
Under plans for Virgin Australia's capital increase, the combined Etihad, Singapore Airlines and Air New Zealand stake will rise to more than 70 percent. Analysts expect each to creep higher still, potentially leading Virgin Australia to de-list from the Australian stock exchange and freeing it from financial reporting regulations that would still bind its rival.
Virgin Australia responded to Qantas with the threat of legal action after its rival's management sent out an email urging employees to sign an online petition against an "unfair playing field".
"When you bring competition to a monopoly, prices do go down," Virgin Australia Chief Executive John Borghetti told shareholders at the company's annual general meeting on Wednesday.
"If this is affecting our competitor's bottom line, I am not going to apologize," said Borghetti. A 40-year veteran of Qantas, Borghetti left the national flag carrier six months after current CEO Alan Joyce took the top job.
Launched in 2000 under the Virgin Blue brand by entrepreneur Richard Branson, Virgin Australia started a price war 18 months ago as it set out to break the Qantas stranglehold on the business market.
That lowered prices for passengers but raised costs for both itself and its rival against the backdrop of a sluggish domestic economy.
Qantas has maintained a stake of over 80 percent of the business market over the past year as Virgin Australia added capacity. But analysts expect that share to be under pressure as capacity plateaus and the pair fight over existing routes.
Qantas domestic passenger numbers fell 3.5 percent in August, the latest month for which figures are available, compared with a 6.5 percent rise for Virgin Australia. The latter still lags in the total number of passengers carried, though - 1.53 million passengers to 1.86 million for Qantas.
Borghetti has promised Singapore Airlines, Etihad and Air New Zealand a board seat each in return for supporting the capital raising. He has been credited with success so far in keeping three potentially competing interests happy within a structure unreplicated anywhere else in aviation world.
Still, Etihad and Singapore Airlines' participation in the capital raising is dependent on approval from the Foreign Investment Review Board. A desire by any of the three to build up a dominating stake - they are currently at broadly even levels - would also tip the fine balance.
Etihad and Singapore Airlines declined to comment. Air New Zealand did not reply to requests for comment.
($1 = 1.0617 Australian dollars)
(Refiles to correct dateline)
Reporting By Jane Wardell; Editing by Kenneth Maxwell