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AirAsia X IPO prospectus shows strength. AirAsia synergies help, also require definition

9th November, 2012

The prospectus for the forthcoming IPO for AirAsia X, a separate business from AirAsia, shows that the low-cost long-haul model can be successful, operationally and profitably, but only when deployed sensibly. During 1H2012, a challenging time for the global industry, AirAsia X reported a respectable 7.9% pre-tax margin on services to Australia, which comprise about half of the carrier's capacity.

The low cost model is ideally suited to Asia's price sensitive, high growth environment and AirAsia X's symbiotic relationship with Asia's biggest LCC, AirAsia, makes it a formidable model.

Attempts to serve Europe, since ended, resulted in a -26% margin in 2011. Yet Europe's weakness for AirAsia X was acknowledged early on. The sharply business-minded CEO Azran Osman-Rani went in saying he would be happy to break even; AirAsia X fell to pressure to plant the red flag in Europe at the behest of part-owner AirAsia, which still harbours an entrepreneurial spirit – and, at times, the associated confidence.

This will be the market's crux for AirAsia X's future – where AirAsia stops and where AirAsia X begins. AirAsia X is substantially complemented by AirAsia to sustain its effectiveness. The relationship between the two is a give and a take. The market, in assessing the IPO, will determine the balance.

AirAsia X's IPO has been long mooted, but the prospectus on some levels is underwhelming, often not effectively reflecting the carrier's strengths and similarly also tending towards saccharine and at times superficial commentary. 

The IPO will offer up to approximately 790 million shares. The vast majority, 686 million, will be available to institutional shareholders while 104 million will be available to retail shareholders. Foreign ownership is limited to 45%. All of the major shareholders will see their ownership decrease but Tony Fernandes, via Aero Ventures and AirAsia, will remain the single largest shareholder.

The carrier is young and has rightfully evolved and experimented considerably, all of which has impacted figures – yet there is little explanation of why the carrier's current position on network is sensible and the way forward to profits. Explanations for past mistakes and hindrances – services to Europe, for example – are brief, blaming fuel and tax/fee increases, although the routes were barely profitable before those factors came into play.

Then again, a more complete explanation touching on the perceived strategic value and influence from AirAsia would perhaps limit its apparent independence. The result is a perception of an airline which is less than sure of itself when, in fact, it has had a strong grasp of its core business.

AirAsia X direct shareholding of substantial investors: prior to and after the IPO

    Prior to the IPO   After the IPO  
Name

Country of incorporation/

nationality

Direct no. of shares % Direct no. of shares %
Aero Ventures (investment arm of Tony Fernandes and associates) Malaysia 928,618,666 52.2 816,885,443 34.4
AirAsia Berhad Malaysia 326,130,573 18.3 286,889,902 12.1
Orix Airline Holdings Ireland 193,468,447 10.9 170,189,944 7.2
Manara Malaysia I Cayman Islands 193,468,447 10.9 170,189,944 7.2

Dato' Kamarudin Bin Meranun

Malaysian 66,356,360 3.7 66,456,360 2.8

Tan Sri Dr. Anthony Francis Fernandes

Malaysian 35,223,907 2.0 35,323,907 1.5

Profits have been rare – but it is a very diverse story

At a bottom line level, AirAsia X's profits have been rare. The carrier commenced services in Nov-2007 but financial information released as part of the prospectus only dates back to 2009. The years 2007 and 2008 were inevitably loss-making years, as fuel prices spiked and the world slipped into economic turmoil. AirAsia X's sole profit in the disclosed period was in 2010 when it squeaked out a mere MYR7.2 millon (USD2.3 million) operating profit at a margin of 0.5%. Its pre-tax profit was significantly higher owing to favourable gains from foreign exchange.

AirAsia X operating profit/loss and PBT/LBT (USD 000): 2009-2011

The first half of 2012 is performing better than in past years but so far is still in the red. AirAsia X's peak period is from November to January, and 2H2012 should be significantly boosted by the carrier's withdrawal in mid-1H2012 from loss-making routes.

AirAsia X operating profit/loss and PBT/LBT (USD 000): 1H2011-1H2012

Aside from a weak 1H2011, the carrier's margins have been respectable, and certainly ahead of some peers in what has been a relative downturn for the industry for most of AirAsia X's existence.

AirAsia X operating margin: 2009-2011, 1H2011-1H2012

Period 2009 2010 2011 1H2011 1H2012
Margin -4.4% 0.5% -3.2% -9.9% -0.4%

The bottom line view, however, obscures critical nuances. AirAsia X's negative performance has been dragged down by services to Europe, India and New Zealand – all of which were cut in early 2012. The Australian market has delivered handsome pre-tax profits while north Asia has had swings. These are the carrier's two core regions; the Middle East, served via charters, had profits in 2010 and 2011 (the latter almost insignificant). 

AirAsia X PBT by region (USD 000): 2009-2011

Results from the first half of 2012 continue the trend with Australia and the Middle East growing while north Asia was almost at break-even. Losses in Europe and New Zealand for 1H2012 almost matched 1H2011's figures despite being served for only a fraction of the first six months, indicating that without cancelling the services, losses would have been higher in 1H2012.

AirAsia X PBT by region (USD 000): 1H2011-1H2012

Profits and losses show how AirAsia X is diverging from Jetstar

The low-cost long-haul concept is nascent with only a handful of active practitioners: Jetstar and Scoot complementing AirAsia X. Despite the small handful of carriers engaging in this market, there are strategic divergences. Jetstar is less bullish on long-haul ambitions. Its growth profile currently comprises 15 787-8s, which will be used to replace 11 A330-200s, leaving four aircraft for growth whereas AirAsia X and Scoot are planning growth of approximately 20 aircraft by mid/late this decade.

Jetstar prefers to serve high-volume point-to-point routes – which works very well from its base in Australia where a large market with relatively little long-haul leisure competition gives its routes for the picking, from Bangkok to Honolulu to Tokyo. AirAsia X, however, is relying on the growing network of short-haul AirAsia units to feed its network. (Scoot will now do the same via a partnership with Tiger Airways). These connecting services, however, must confront greater competition. That may explain why Australia has been so consistent for AirAsia X whereas north Asia has been a mixed story.

There is little discussion from AirAsia X on north Asia's varying performance. Its 2010 profit before tax occurred despite the launch of new routes to Seoul and Tokyo Haneda, which typically incur significant start-up costs. In comparison, 2011 only saw the launch of one new north Asian route (Osaka Kansai). This offers some cause for concern since north Asia is the carrier's single largest region based on ASKs and will grow even further as capacity into the region will likely outpace Australia. North Asia revenue in 2011 was slightly higher than in Australia.

The region undoubtedly sees mixed performance, with Tokyo Haneda performing well but Tianjin struggling. AirAsia X has increased Kuala Lumpur-Haneda services and has spoken of adding a service to Tokyo Narita to connect with short-haul AirAsia Japan's base at Narita but leaving the Haneda link intact owing to success. Tianjin was used as an alternative airport to Beijing Capital, which Malaysian regulators initially did not permit AirAsia X to serve out of fears of competing with state-owned carrier Malaysia Airlines.

AirAsia X in 2012 switched its Tianjin service to Beijing Capital to have a more direct service to the city. AirAsia X maintains its link to Hangzhou, sometimes referred to as an alternative to Shanghai but has its own traffic owing to its status as a tourism hub, unlike Tianjin where the city is primarily an alternative to Beijing. AirAsia X may consider serving Shanghai but leaving Hangzhou intact.

See related article: As AirAsia X switches from Tianjin to Beijing, Asian alternative airports face uncertain future

AirAsia X international capacity (ASKs) by region: 05-Nov-2012 to 11-Nov-2012

AirAsia X revenue by region (USD 000): 2009-2011

While AirAsia X could claim that Australia is a high-demand market, both inbound and outbound, north Asia sees bloated legacy carriers where AirAsia X's cost advantage should be felt more. Plus the region, on paper, is home to a growing middle class.

Australian yields are the highest while European costs become unsustainable

While AirAsia X has not disclosed yields and unit operating expenses on a regional basis, it is possible to approximately calculate the figures when using historical data from OAG (a CASK calculation per region is not possible as AirAsia X's CASK includes adjustments not quantified). Costs per region have moved consistently with each other, impacted by fuel price. The exception is the Middle East, which saw costs plummet as AirAsia X dropped scheduled flights to Abu Dhabi and commenced lower overhead charter flights to Tehran.

AirAsia X approximate operating expense (USD) per ASK per region: 2009-2011

Australian yields showed high growth from 2010 to 2011 while Middle East yields declined as operating costs did so as well.

AirAsia X approximate yield (USD) per ASK per region: 2009-2011

Europe had a clear imbalance between costs and revenue, leading to it being cut. The A340's inefficiency is clearly felt on the balance sheet. Approximate fuel expense per ASK in 2011 was 39% higher to Europe than Australia and 32% higher to Europe than north Asia. Per ASK maintenance expenses to Europe were 18% higher than to Australia.

Of other cut routes, India's sagging performance was going to be negatively impacted by then-impending airport charge increases. New Zealand's cost-revenue imbalance was not going to be reversed owing to weakened demand to Christchurch (AirAsia X's only port in New Zealand) following the 2011 earthquake there. Approximate fuel expense per ASK was about the same as to Australia.

Cost breakdowns help begin to explain north Asia's profitability swings. North Asia's ground expenses per ASK were 48% higher in 2011 than in Australia. Ground expenses comprised 4.3% of total expenses in Australia but 6.0% in north Asia, reflecting generally higher input costs in the region. Fuel cost for north Asian sectors was 5.5% higher per available ASK.

See related articles on AirAsia X's withdrawal from Europe, India and New Zealand:

Europe, India and New Zealand were failures – but lessons have been learned

It is worthwhile to continue considering AirAsia X's withdrawn services to Europe, India and New Zealand. European services were brand extensions for part-owner AirAsia; profitability was not the target. Mr Osman-Rani spoke of the European services as being independent of his profit-oriented A330 strategy.

Mumbai and New Delhi were started as part of a wave of Indian expansion at the AirAsia group. But with a line drawn in the sand that AirAsia X would operate services over four hours in duration. The Mumbai and New Delhi sectors, being over four hours long, were given to AirAsia X when, perhaps, less capacity in the form of an A320 (which IndiGo uses between Mumbai and New Delhi to Singapore) would have been more suitable. The Malaysian government did not help the routes with its ending of visa on arrival procedures, but this could possibly have been sorted out through diplomatic channels.

AirAsia X also faced a distribution hurdle: ethnic Indian Malaysians traditionally hail from southern India, leaving AirAsia X's Mumbai and New Delhi services without VFR traffic that could be gained via word of mouth recommendations. For Mumbai and New Delhi, AirAsia X was dependent on local distribution but was hindered by AirAsia's agreement with online travel agency (OTA) Expedia that made the OTA AirAsia X's online partner, cutting AirAsia X off from more popular Indian OTAs. Meanwhile Christchurch in New Zealand was started with solid intentions but affected by weakened demand due to the earthquake, which occurred almost simultaneously with the route's inauguration and devasted the city.

Withdrawal reasons were complex, but launch of services to Europe and India – the more high-profile of the carrier's losses – were mainly at the behest of AirAsia. AirAsia X has sought to remove itself from AirAsia's influence and different culture by re-locating its head office away from AirAsia. Despite AirAsia X being a separate company from AirAsia, aside from shareholder overlap, sharing a brand and certain functions like booking engine, there are sometimes hints AirAsia is still exerting influence that may not lead to the strongest possible profits.

Asked in Aug-2012 about the location of future growth after AirAsia X announced a growth acceleration, Mr Osman-Rani remarked “my personal preference is Asia”. He has been less bullish than AirAsia founder and CEO Tony Fernandes about re-entering Europe with A350s, although Mr Fernandes may have been making such remarks to generate media profile. Mr Fernandes is known for his microblogs on Twitter, and in one statement, after meeting with officials from Japan's Nagoya, publicly wrote to Mr Osman-Rani asking for an AirAsia X route to Nagoya – perhaps only half-serious, indicating both that there is no clear demarcation between AirAsia and AirAsia X and that the synergies between the two can be highly valuable.

A leadership transition may be in the wind

In the absence of reassurances to the contrary, the prospectus may suggest that a leadership transition is under way at AirAsia X. The document notes Mr Osman-Rani's contract expires in Jul-2013 in what will likely be right after the IPO and perhaps a fortuitous time for him to find a new challenge. Mr Osman-Rani has held a number of business roles prior to coming to AirAsia X, his first airline job, and the aviation industry is not one to handsomely reward hard-workers. His style is one centred on achieving success and turnarounds. Doing not only what many doubted – bringing a long-haul LCC to sustainable existence – but bringing it to market could be a fine way to bow out for his next endeavour.

A key trait that any successor will need to possess is the ability to achieve the appropriate balance between reliance on AirAsia's connectivity and the inevitable quid pro quo that follows with that relationship. The European route experience suggested a subordinate role for AirAsia X, in order to achieve strategic and operational goals which probably benefited AirAsia more than AirAsia X.

On the other hand, examples of the cross-benefits of the AirAsia relationship include the ability to use the multiple bases its shorthaul cousin has established. While investors may not have as efficient a company as possible on each route basis, this will be a small price to pay to piggyback on AirAsia at the same time as exploiting the opportunity to invest in a carrier that exhibits profitable growth potential.

AirAsia X to have 33 aircraft by 2017, which will also be deployed at bases outside KLIA

As CAPA has previously reported, AirAsia X is accelerating growth in 2013 and 2014 to ensure it maintains an advantage over Scoot, which in Oct-2012 announced it would take ownership of Singapore Airlines' first of 20 787s from 2014.

See related articles:

AirAsia X fleet growth: 2012-2018

Year A330-300 A340-300 A350-900 Total
2012 - base 9 2 - 11
2013 7 - - 18
2014 7 - - 25
2015 5 (2) - 28
2016 4 - - 32
2017 1 - - 33
2018 onwards - - 10 43

Not all of this fleet growth will be based at Kuala Lumpur. AirAsia X is considering long-haul services from other short-haul AirAsia bases, like Bangkok, Denpasar and Tokyo Narita. This raises some intriguing issues.

The ownership structure of such growth is unclear; as a Malaysian carrier AirAsia X cannot base aircraft at foreign ports. It could place the A330s on the registry of short-haul AirAsia brands like Thai AirAsia and AirAsia Japan, or it could establish its own foreign joint ventures, such as AirAsia X Japan. In either case, AirAsia X would not see the full profits as they would be shared with local investors, who in other countries need to own at least 51% of a carrier.

With the fast moving Asian landscape this is all still a work in progress. AirAsia and AirAsia X are still working through the details and the prospectus offers little clarity.

The AirAsia brand is licensed for five years, extendable

AirAsia X has licensed the AirAsia brand for an initial term of five years from 21-Jul-2012, according to the prospectus. After that point the two parties may enter into negotiations to extend the term for up to four successive terms of five years each. While that brings the carriers into the 2030s, there is no indication what occurs afterwards if the two are still standing in their present form. The minimum fee is MYR680,000 (USD222,550) per annum, or if gross revenue exceeds MYR136 million (USD44.5 million), then 0.5% of gross revenue, capped at no more than the average of 0.5% of gross revenue for three of the five best proceeding years.

The brand license agreement prior to Jul-2012 is not clear, but AirAsia X discloses that in 2011 it paid MYR19,299,000 (USD6,319,245) for branding rights; that sum is more than double what AirAsia X would have paid at the new 0.5% rate. For 2012, AirAsia X estimates the brand fee to be only MYR9,454,000 (USD3,094,095), in line with the 0.5% rate. AirAsia also bills AirAsia X for various service charges, ranging from engineering to marketing.

In exchange AirAsia will not establish another low-cost long-haul carrier in Malaysia and will give AirAsia X first right of refusal to establish a low-cost long-haul carrier elsewhere in ASEAN. Outside of ASEAN, AirAsia may establish low-cost long-haul carriers provided AirAsia X is allowed to invest alongside.

But with AirAsia exerting influence on AirAsia X, if a dispute arose it is conceivable that AirAsia could pressure AirAsia X to forego cooperating in another low-cost long-haul venture. As part of the IPO, AirAsia Berhard and Tony Fernandes' investment vehicle, Aero Ventures, "must continue to retain legal and beneficial ownership in the largest equity stake", according to the prospectus. Any such dispute would likely arise from conflict between AirAsia and AirAsia X management, not from a disgruntled executive as occurred during the easyJet brand dispute.

AirAsia X to keep A340-300s but still working to dispose of A330-200s

The impact from AirAsia's influence on AirAsia X to serve Europe extends beyond balance sheet losses. AirAsia X acquired two A340-300s on lease to serve Europe and has since sub-leased the aircraft out for the duration of 2012 and hopes to continue sub-leasing them until their leases expire in 2015. Losses from the sub-lease could grow as demand weakens due to the global economy and as fuel prices remain high. AirAsia X in 2010 and 2011 spent approximately MYR61.6 million (USD20.2 million) to lease its two A340-300s. In 1H2012, with reduced flying following the European pull-down, leasing costs for the two frames dropped to MYR23.0 million (USD7.5 million).

To achieve better efficiency to Europe, AirAsia X in Dec-2010 agreed to take three A330-200s, its first of the type, which seats fewer but has a longer range than its A330-300s. They were to offer a step up in efficiency over its A340-300s, but following the cancellation of European services the aircraft are no longer needed. One aircraft order was converted to an A330-300, scheduled for delivery in 4Q2014; one A330-200 was built for AirAsia X but disposed of to a third party while AirAsia X intends to sell or lease its remaining A330-200 due for delivery in Nov-2012. AirAsia X says there is no direct penalty from Airbus for its disposals, perhaps one of the other spinoff benefits from its relationship with AirAsia.

AirAsia X also disclosed it estimates it will pay Malaysia Airlines by 31-Dec-2012 MYR57.1 million (USD18.7 million) to carry passengers to the European and Indian routes it discontinued. While the figure may be substantial, AirAsia X's losses would have certainly have exceeded that amount had it kept flying.

Adelaide, Chongqing, Fukuoka and Nagoya flagged as potential new destinations

As part of its fleet expansion, AirAsia X expects to increase most existing services to double daily while increasing services to cities like Chengdu and Osaka to a daily offering. Beyond that AirAsia X in the prospectus flags interest in serving Australia's Adelaide, China's Chongqing and Japan's Fukuoka and Nagoya. AirAsia X benefits from liberal bilateral agreements, including open skies to China, Japan, South Korea and Taiwan. Singapore, the home of Jetstar Asia and Scoot, faces restrictions to South Korea.

While AirAsia X expects most growth to be concentrated around Asia-Pacific, it does mention the possibility of serving markets in eastern Europe, south and central Asia, the Middle East and north Africa with A330-300s from its Kuala Lumpur hub. New bases would open different cities, both in terms of demand and accessibility with aircraft range, but AirAsia X has expressed interest in achieving scale in existing AirAsia group destinations, allowing it to piggyback off existing ground infrastructure and market awareness of the AirAsia brand. AirAsia will likely watch Scoot, which may be more bullish in opening new markets outside of Asia-Pacific.

Revenue is growing but so too is CASK as utilisation takes a hit and maintenance creeps up

Since 2010, revenue per RPK and CASK have been growing, with revenue in 1H2012 increasing 12.7% year-over-year compared to 6.7% CASK growth. It is not evident yet what the affect will be of the withdrawal of services from Europe, India and New Zealand.

The European services had a longer stage length, which typically reduces CASK, but the A340-300s operating the sectors seated 50 fewer passengers than AirAsia X's A330-300s. Any CASK efficiencies from the European services could have been offset by the higher CASK of India flights, which were about four to five hours in duration.

AirAsia X key operating metrics: 2009-2011, 1H2011-1H2012

AirAsia X is confident it can increase revenues, especially ancillary ones, but it faces a rising cost base. After fuel, maintenance is the carrier's largest cost (19%) and will be increasing as its fleet ages. The carrier's average fleet age, and associated maintenance needs, will increase with the addition of six leased A330s from Dragonair via ILFC. While these aircraft have been secured to accelerate growth and see that the carrier maintains a clear edge over Scoot, they will not be as efficient as its new A330s.

Their affect on utilisation rates could be mixed. While their older age may reduce dispatch reliability, requiring greater ground time and lower utilisation rates, the scale they provide the fleet could allow for an overall increase in utilisation, which has slightly fallen from its 2009 peak of 16.4 hours a day, although its utilisation rates of around 15 to 16 hours are, it believes, the highest for the aircraft type. AirAsia X says it believes its maximum utilisation rate is 17 hours a day, which other carriers nudge up to: Cathay Pacific, for example, averaged only 12.1 hours for its A330-300s (which also operate shorter sectors) but 15.7 hours for its 777-300ERs.

A relatively minor decrease in utilisation rates is not necessarily an entirely negative story. As the carrier briefly notes (but likely missed an opportunity to elaborate on to shore up investor confidence), fleet flexibility has been limited in recent years. AirAsia X came into markets trumpeting utilisation rates above all else, operating flights not only at odd hours of the morning but having flight times vary on almost a daily basis. It is now chasing higher yields, entering slot-restricted airports like Beijing, Haneda and Sydney.

While AirAsia X was of the view it could achieve a balance of slot-restricted and open airports, its utilisation rate perhaps suggests otherwise. AirAsia X is also finding it can gain yields by having flights connect better with others. As evidenced by the hybridisation of LCCs, it is perfectly acceptable for CASK to grow if the increase is outpaced by revenue growth as a result of the increased complexity.

Ancillary revenue comprises about one-fifth of total revenue, and cargo quietly appears

Ancillary revenue is growing at AirAsia X. The carrier believes ancillary revenue will be a major profit driver as it is at a relatively high margin, unlike ticket revenue.

AirAsia X ancillary revenue by region (USD): 2009-2011

Ancillary revenue is nudging its way towards accounting for one-fifth of total flight revenue (including cargo). One exception to its growth has been in the Middle East, where charters have replaced scheduled flights, reducing ancillary revenue options as ancillary items are bundled into charter contracts.

AirAsia X has pioneered ancillary revenue streams in the AirAsia Group, and indeed the industry. The prospectus noted this position, but was short on what growth opportunities are envisioned. While witholding specifics is understandable due to competitive pressure, even general statements or abstract areas of improvement were not forthcoming. 

AirAsia X ancillary revenue as percentage of total revenue by region: 2009-2011

Cargo is quietly growing in importance for Asian LCCs as they are positioned around high-volume Asia. While the majority of cargo is typically controlled by a few players, the lower cost from LCCs is finding some converts. Singapore Airlines markets the belly capacity of subsidiary Scoot's 777-200s while Jetstar Asia even lifts cargo in its A320s. North Asia was AirAsia X's largest cargo market by revenue in 2011, reflecting bidirectional nature of intra-Asia flights. While Australia was much smaller, the Asia-Australia segments are typically significantly higher than Australia-Asia. 

AirAsia X cargo revenue by region (USD): 2009-2011

With the exception of suspended Indian flights, cargo accounts for less than 10% of revenue. Once the cargo market rebounds and AirAsia X gains greater scale and network coveraage, cargo will likely play a greater role for AirAsia X.

AirAsia X cargo revenue as percentage of total revenue by region: 2009-2011

Outlook: A model that demonstrably works in a price sensitive, high growth market. The relationship with AirAsia is a positive, but needs to be managed

From the outset, AirAsia X has hd to deal with the doubters of  the "longhaul-low cost model", with every change of direction (typical of most new entrants, short or longhaul) being held up as evidenece that the model did not work. Its survival and profitability has largely put those concerns to rest.

And the carrier has come a long way since the days of government protectionism for MAS limited its route options. There is little likelihood that will be reinstated, especially as the ASEAN multilateral open skies programme progresses. A priority for AirAsia X will be in consistently replicating its success in Australia to north Asia, which has been up and down.

The great strength of AirAsia X is its ability to work closely with a shorthaul hub operation, AirAsia. At the same time, the carrier also needs to address – somehow – its separation from AirAsia. This wil be straightforward as the respective goals of AirAsia and AirAsia X do not always coincide. AirAsia X depends considerably on its relationship with AirAsia, but that should not mean the latter controls the former.

AirAsia and AirAsia X need to find a balance, and no doubt potential investors will be looking for one too. Nonetheless, AirAsia X offers much: a lean cost base in a growing market, operational agility and a highly visible and respected brand. These are the envy of many airlines around the world.

In Asia's highly price sensitive, but fast growing market, AirAsia X offers a near-perfect profile to match these needs.

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