Virgin America hangs as its hedge fund owners get antsy

— -- Its planes are packed with travelers who love its affordable, hip service. Still, 19-month-old Virgin America might be the most endangered airline in the USA.

Virgin America lost $227 million in its first 12 months of operation, far more than expected, thanks largely to last year's historic run-up in fuel prices. And now, the U.S. hedge funds that own 75% of the airline could be reaching for the rip cord on British billionaire Richard Branson's foray into the U.S. domestic market.

Should either of the funds, Black Canyon Capital or Cyrus Capital Partners, exercise unusual "put" rights in their investment agreement with Branson's Virgin Group to start the airline, the Britain-based group would be forced to buy back the shares.

Virgin America's rivals claim that would violate U.S. law that says airlines operating domestic routes in the USA must be 51% owned by Americans who have 76% voting control.

Neither Black Canyon nor Cyrus Capital will state publicly their intentions. But there are tell-tale signs that one or both are about to cash out: The biggest being Virgin America's hiring of investment banker Lazard Group to search for new U.S. investors.

Virgin America CEO David Cush says the search is "just the prudent thing for us to do, recognizing the options available to our current U.S. investors." He promises that management will remain in the hands of U.S. citizens and maintains the privately held airline could soon make a profit.

Starting up in a downturn

It's easy to see why Black Canyon and Cyrus Capital would want out now. The U.S. airline industry is caught in a strong downdraft in consumer demand caused by the faltering economy. The downturn couldn't come at a worse time for a start-up carrier.

Virgin America's best performance so far was a minus-52% operating margin in the third quarter of 2008. Cush says slight second- and third-quarter operating profits are possible this year "unless things deteriorate more than they already have." But he doesn't project an annual profit until 2010, providing the economy recovers.